CD Rates

Certificates of deposit (CDs) are one of the many tools available to banks and individual investors looking to manage their money and maximize the return on their investment. When investing in a CD, it is important for investors to understand why they are created by the bank, and how they are intended to be used.

A bank does business by collecting money from depositors and loaning it out to borrowers. The bank’s ultimate goal is to take in more money from loan repayments made at higher interest rates than it pays out to depositors who hold savings accounts. To do this, it carefully monitors and adjusts the interest rates of its various products, including CD rates. Generally, a bank is able to offer a better return for investors through CD rates that are higher than the interest rates offered to investors through their standard savings accounts.

How does a CD work?

An investor enters into a certificate of deposit agreement with a bank by agreeing to “lock up” their money for a set period of time. Because banks need to meet daily reserve balance requirements, and funds held in checking and savings accounts can be withdrawn at any time, the certainty of money held in CDs is more attractive to them. It allows banks to more accurately calculate how much they have available to loan out to borrowers, and in exchange for this assurance they are willing to offer higher interest rates. Usually, the assurance that the money will remain at the bank is guaranteed by the threat of a penalty for early withdrawal of funds.

What affects CD rates?

A number of internal factors can influence the CD rates offered by a bank, but their calculations always start with the federal funds rate. In the United States, the federal funds rate is set by the board of governors of the Federal Reserve, and they in turn base their rate on a number of factors currently influencing the economy. Other factors that will influence the CD rate offered by the bank include the duration of the CD and the size of the bank involved. The general idea is to compensate investors more willing to make risky investors, which is why banks not insured by the FDIC will offer higher CD rates than non-FDIC-insured institutions.

What should investors consider?

Potential investors should consider how much money they expect to need in the near future, and how quickly they will need to access it. The interest rate environment should also be carefully considered. For example, it may be better to invest in shorter-duration CDs when rates are low so that the money can be reinvested more easily when rates go up. In a period of high interest rates period, longer-term CDs can be more valuable because the highest possible yield will be locked in when rates have nowhere to go but down.