CD Calculator

A certificate of deposit (CD) is an agreement to deposit money for a fixed period that will pay interest. Common term lengths range from three months to five years. The lengthier the term, the higher the exposure to interest rate risk. Generally, the larger the initial deposit, or the longer the investment period, the higher the interest rate.

As a type of investment, CDs fall on the low-risk, low-return end of the spectrum. Historically, interest rates of CDs tend to be higher than rates of savings accounts and money markets, but much lower than the historical average return rate of the equity market. There are also different types of CDs with varying rates of interest or rates linked to indexes of various kinds.

The gains from CDs are taxable as income in the U.S. unless they are in accounts that are tax-deferred or tax-free, such as an IRA or Roth IRA.

One of the defining characteristics of CDs in the U.S. is that they are protected by the Federal Deposit Insurance Corporation (FDIC). CDs that originate from FDIC-insured banks are insured for up to $250,000, meaning that if banks fail, up to $250,000 of each depositor's funds is guaranteed to be safe.

Anyone who wishes to deposit more than the $250,000 limit and wants all of it to be FDIC-insured can simply buy CDs from other FDIC-insured banks. Similarly, credit unions are covered by insurance from the National Credit Union Administration (NCUA), which provides essentially the same insurance coverage.

CDs are typically offered by many financial institutions, including the largest banks, as fixed-income investments. Different banks offer different interest rates on CDs, so it is important to first shop around and compare maturity periods, especially their annual percentage yields (APY). This ultimately determines how much interest is received.

The process of buying CDs is straightforward; an initial deposit will be required, along with the desired term. CDs tend to have various minimum deposit requirements. Brokers can also charge fees for CDs purchased through them.

"Buying" a CD is effectively lending money to the seller of the CD. Financial institutions use the funds from sold CDs to re-lend and profit from the difference, hold in their reserves, or spend for their operations. Along with the federal funds rate, all of these factors play a part in determining the interest rates each institution will pay.

CDs are effective financial instruments when it comes to protecting savings, building short-term wealth, and ensuring returns without risk. With these key benefits in mind, CDs can be used to:

• Supplement diversified portfolios to reduce total risk exposure — particularly useful for retirees approaching their retirement date who need guaranteed returns.
• Short-term savings vehicle— a safe place to put extra money that isn't needed until a set future date, such as saving for a down payment on a home or car.
• Estimate future returns accurately because most CDs have fixed rates, making them ideal for people who prefer predictability.

While longer-term CDs offer higher returns, an obvious drawback is that funds are locked up for longer. A CD ladder is a common strategy that attempts to circumvent this drawback by using multiple CDs.

Instead of investing all funds into a single 3-year CD, the funds are split into 3 different CDs with terms of 1, 2, and 3 years. As each one matures, making principal and earnings available, proceeds can be optionally reinvested into a new CD or withdrawn.

It is important to make the distinction between annual percentage yield (APY) and annual percentage rate (APR). Banks tend to use APR for debt-related accounts such as mortgages, credit cards, and car loans, whereas APY is often related to interest-accruing accounts such as CDs and money market investments.

APY is typically the more accurate representation of effective net gains or losses. CDs are often advertised in APY rates because it accounts for the effect of compounding.

As a rule of thumb, the more frequently compounding occurs, the greater the return. The calculator above includes options for different compounding frequencies — daily, monthly, quarterly, semi-annually, and annually — so you can see the impact each has on your final balance.

For example, a CD that compounds daily will earn slightly more interest than one that compounds monthly or annually, even with the same APY. This is because interest is calculated on a growing balance more frequently.

Funds invested in CDs are meant to be tied up for the life of the certificate, and any early withdrawals are normally subject to a penalty (except liquid CDs). The severity depends on the length of the CD and the issuing institution.

In certain rising interest rate environments, it can be financially beneficial to pay the early withdrawal penalty in order to reinvest the proceeds into new, higher-yielding CDs or other investments.