A Certificate of Deposit or CD is normally a fixed-rate, fixed-term investment that is insured for up to $100, 000 by the FDIC, a department in the Federal government.

Because the investment in a CD is for a longer period of time than a savings account of checking account, it pays a rate that is higher than a checking or savings account where the money can be withdrawn with little to no advance notice to the financial institution. On the other hand, it does not pay a higher rate that reflects risk taken by the investor. Since these accounts are federally guaranteed up to limit there is little risk of uncertainty over the return of interest and principal. So, it is a safe, middle of the road investment.

In the larger sense, rates on CDs are affected by other rates, and tend to go up and down with the general cost of money in the investment world. When the Federal Reserve Board cuts the Federal Funds rate, for example, all rates tend to be effected in a downward direction. Similarly, when there is a lot of volatility in the marketplace rates tend to go down because banks are much more reluctant to lend money, and therefore they do not need to attract deposits by offering high rates.

On the local level CD rates are affected by competition. If there are two banks across the street from one another they advertise rates that compete with one another. So, if the Federal Funds rate goes down and one bank reduces the interest rate you will receive on an investment in a CD, the other bank temporarily will be offering a higher rate. If they decide that they are eager to compete for your deposit in a CD they may keep their higher rate.

This also means that a smaller bank is more likely to pay a higher rate on a CD than a larger bank. If a bank wishes to grow they must attract more deposits. The more deposits they have, the more money they are able to lend to consumers in the form of business loans, car loans, mortgages, and other loans. If a bank wants to grow they will typically offer better terms on a CD.

Rates of return on CDs are most noticeably affected by two factors. One is the length of time you are willing to invest the money. The other is the amount of money you invest. A CD that matures in two years will pay a higher rate than a CD that matures in a month. A larger investment will pay a higher rate of interest than a smaller one.

Here are four examples from a financial institution’s offerings in the second half of 2007 of how the term of the CD and the amount of the CD affect interest.

1 Month    $15,000    2.47%

24 Months    $15,000    3.94%

1 Months    $2,000    2.23%

24 Months    $2,000    3.70%

As you see the rate is significantly higher for a 24 month investment of $15, 000 than for a one month investment of $2000. Longer-term instruments in investments generally always pay a higher rate of return. Larger investments are not impacted as much but the larger the investment, as a rule, the rate of return will be slightly greater. A financial institution would prefer less paperwork and customer service required with a smaller quantity of significantly large accounts as opposed to lots of small accounts.

All of these guidelines apply only to the traditional Certificate of Deposit. Different rates will be offered for the growing variety of CDs that have non-standard features. For example, a bank may offer a higher rate of interest for what is called a “Callable CD,” meaning that if they do not like how the investment is turning out for them they can terminate it before it matures and pay you the principal and whatever interest has accrued to date.

In the current investment environment banks and other institutions are offering many more complex versions of the CD. Make sure that you know the exact terms and conditions of your investment before you invest. Go over all of the details on the CD offer regarding term, rate any fees or penalties before deciding how you would like to invest your funds.

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