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CDs are designed for saving money, but they differ from regular savings accounts and involve specific variables and terminology. For someone new to CD investment, the specific terminology can be confusing.
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This page will talk about how does a CD investment work by primarily focusing on explaining related vocabularies:
- CD Terms Explained
- What does APY mean on a CD?
- CD term length
- CD Principal Balance
- CD Renewal
- Early Withdrawal Penalty CD
- Fixed vs Variable CD Rates
- How to buy CDs
CD Investment Terms Explained
Below are some crucial terminologies important for investors wanting to know know how does a CD investment work.
What does APY mean on a CD?
The annual percentage yield (APY) is crucial when dealing with CD investment as it indicates your potential earnings.
APY represents the compounded interest rate for one year.
A higher APY means more earnings.
Although APYs and simple interest rates for CDs are usually the same, it’s essential to prioritize APY, as some accounts may compound interest more frequently.
Interest rates for CDs may compound daily, monthly, or quarterly, with more frequent compounding leading to higher earnings.
CD Term Length
The term is the duration your money remains in the CD account.
For instance, if you open a one-year CD, your money stays in the account for a year and grows at the designated APY until the maturity date.
The maturity date is when the account holder can withdraw the total balance, including earnings.
Financial institutions offer various term options, allowing you to choose the term that aligns with your needs and goals.
CD Principal Balance
The principal balance of a CD is the initial deposit into the account, representing the total balance minus earnings.
Most CDs have a minimum deposit requirement, ensuring your principal meets that required amount.
CD Renewal
Certain CDs may offer automatic renewal or rollover into a new CD.
Upon maturity, if the money isn’t withdrawn within a specified time (typically a few days), the CD starts a new term with a new total balance.
Early Withdrawal Penalty CD
Most CDs are locked for the designated term, restricting access to the principal or earnings until the term ends.
An early withdrawal penalty is incurred if funds are withdrawn before the term concludes.
The penalty may equal the interest earned over several months or a fixed dollar amount, potentially impacting the principal.
Some CDs allow withdrawals before maturity, known as no-penalty CDs.
The bank or credit union where you open your CD determines various aspects, including early withdrawal penalties and whether your CD will be automatically reinvested if you don’t provide other instructions at maturity.
Fixed vs Variable CD Rates
Most CDs have a fixed rate, ensuring a constant APY throughout the term. This stability is beneficial during declining rates.
While less common, variable rate CDs exist, providing an opportunity to benefit from rising rates but carrying more risk.
Falling rates can result in a lower rate until the CD matures.
How to buy CDs
- Think about your long-term financial objectives, short-term liquidity requirements, and time frame for investing to figure out where a certificate of deposit fits in.
- Find the best terms, such as maturity, interest, and type of CD, by researching and comparing CDs from different financial firms.
- Online applications are typically available, though this does vary.
- Put money into the CD by making an initial deposit, which is usually an upfront sum.
- Remember when your CD is due to mature so you may decide whether to take the money out or reinvest it.
- Explore various CD strategies.
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