A CD can help your money grow over time without risking it in the market

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  • A certificate of deposit (better known as a CD) is a financial product that allows you to earn interest on your money at a fixed rate without the risks inherent in investing.
  • To use a CD, simply deposit a certain amount into the CD account. Your money will then grow at a set interest rate for a set term.
  • You run the risk of paying early withdrawal fees if you need to take cash out of your CD before it matures, so make sure any money you deposit is cash you won't need in the short term.
  • See Business Insider's picks for the best CDs »

Although investing in the stock market can be a great way to earn money in the long run, some people want a less risky place to put their money.

One option is the certificate of deposit, better known as a CD, with its promises of risk-free growth and flexible term lengths. But without an understanding of exactly what a CD is and how it works, it's possible to get burned by early withdrawal fees.

So how do you know if a CD is right for you? Or how to pick the right one? Whether you need a refresher course or a full-on deep dive, let's untangle all your most pressing CD-related questions.

What is a CD?

First, the basics — CD is shorthand for certificate of deposit, a financial product that's sold to consumers by institutions like banks or credit unions.

Typically insured by the Federal Deposit Insurance Corporation (FDIC) for banks and by the National Credit Union Administration (NCUA) for credit unions, the CD is a risk-free savings product that allows you to grow your deposit at a fixed rate for a fixed term.

In its simplest terms, a CD is basically a savings account but with two major differences. While checking and savings accounts can be withdrawn from at any time, a CD is an account with a specific maturity date. And while a savings account's rate can change at any time, your CD rate is locked in until the term ends.

How do CDs work?

When you open a CD, you're essentially promising your financial institution access to your money for a set term. (These terms can be as short as 21 days or as long as 10 years, but the most common ones you'll see range from one to five years.) Your bank likes this because during that time, it can earn interest on your funds by extending them as loans to other account holders. 

To incentivize this act of trust on your part, the financial institution insures your funds and guarantees a certain amount of growth, as dictated by your interest rate. These rates tend to be slightly higher than typical savings account rates, and often rise even further when you increase factors like term length and the size of your deposit.

No matter what the market does in the meantime — and whether interest rates fall or rise, or your provider itself goes out of business — your money is guaranteed to grow at the same rate you were offered the day you opened your CD.

At the end of your term, you'll be able to withdraw the full amount, or to reinvest the capital and begin a new term.

In what circumstances should I get a CD?

Financial experts recommend CDs for savings goals pinned to set dates in the near future. They can be a great place to stash a down payment for a home, for example, or to set up a college savings account for a grandchild. Because of their guaranteed growth, CDs can also be useful once you get closer to retirement age for those who wish to keep accumulating capital without the risk inherent in the stock market.

It's a less compelling choice for something like your emergency fund, however, where liquidity is the most important factor. For any chunk of change where you need guaranteed, easy access, you'll likely find a high-yield savings account is better suited to your purposes.

What are the potential downsides of a CD?

The biggest potential downside of a CD is the limited access to your funds in the event of an emergency or unexpected change of circumstances. 

It is possible to get your hands on your deposit before its maturity date, but it must be done as a lump-sum withdrawal, and you'll have to pay a hefty penalty. Depending on the financial institution and your chosen CD, you could miss out on months of interest, potentially nullifying your earnings. So if you're looking for an account you can occasionally dip into to tide you over, the CD is not for you.

Additionally, the fixed interest rate can itself be a double-edged sword. In an ideal world, you'll open your CD at the perfect time, and watch interest rates drop like a stone while your money continues to grow at your locked-in rate. But in the alternate scenario, you could get trapped for years at a low interest rate while the rest of the country sees rates soar.

How do I know if a CD is right for me?

In deciding whether or not to invest in a CD, the main question you should ask yourself is, "When do I need this money?" If the answer is a date in the near future, it's probably an excellent place to stash your money.

If the answer is at all murky, meaning you're not positive you can stand to part with the funds long term or there's some uncertainty in your future, let that give you pause. Letting the promised growth blind you to your financial reality is a serious gamble. If you overextend yourself and have to take an early withdrawal penalty, you could end up wishing you'd opted for a high-yield savings account instead.

In those cases, look for a CD with a shorter term or a no-penalty CD, with the understanding that either option will likely reduce your interest rate significantly.

What should I look for when choosing a CD?

There's no one CD that works for every investor's needs. But in making your selection, there are five factors you need to consider: interest rates, the financial climate, term length, the size of your principal deposit, and the rules and regulation of your chosen financial institution.

The first two factors actually go hand in hand, as the best way to find a promising interest rate is to look at the current financial climate. The best time to get a CD is just before interest rates drop, which helps you lock in a solid rate that's unlikely to be bested by the market. (Like right around July 2019, for example, when the Fed hinted that rates were about to take a tumble.)

So don't just jump at the highest rate you see the first time you look; take in the context of the overall market as well.

Then, look for a term length that fits the timeline of the goal you're saving for. A lot of folks open multiple CDs and stagger them so that a different account matures every six months or year. This process is often referred to as CD laddering, and gives investors more opportunities for fee-free withdrawals. 

Next, boosting your initial deposit can net you better interest rates. So once you've narrowed in on a few options, see if it might be worth saving a bit more money before opening your CD, to cash in on a higher rate.

And finally, it's important to read the fine print so you're aware of the rules and regulations of any given financial institution. That's where you'll get all the information you need about early withdrawal penalties and what will happen to your funds if your bank doesn't get instructions from you by the maturity date.

How much money should I put in my CD?

That's really up to you, but there are a couple things worth noting when deciding how much to deposit. Some institutions reward you with higher interest rates for depositing higher balances, so shop around to find one that's best for the amount you're looking to sock away.

Additionally, there are limits to the amount of money that can be insured. When the FDIC was first established back in 1933, that limit was $2,500. It's steadily increased since then, and currently sits at $250,000 per depositor, a figure that includes principal plus interest. 

If you find yourself approaching that limit, you should look to distribute your funds through several different FDIC-insured banks and ownership categories so that you don't put any portion of your deposit at risk. 

Who has the best CDs right now?

This information is constantly changing in light of national interest rates and particular specials on offer. But luckily we constantly update our list of the best CD rates for multiple terms and categories, so you can always stay up to date on the top options.

How do I invest in a CD?

The list of financial institutions offering CDs is nearly endless. The same bank where you hold a checking or savings account likely has a variety of options available, if the convenience of having all your accounts in one place appeals to you. 

But of course, you can and should shop around. Once you've found one you like, most locations will give you the option to sign up easily online, so your funds will be growing in no time.

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