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Investing Basics: How Certificates Of Deposit Work

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If you’re currently browsing for investment options, it is highly likely that you already came across the term “certificate of deposit.” Certificates of deposit, often referred to as simply CD/s, are among the most recommended types of investments that feature low risk and decent gains. If you’re keen to get started on a CD investment today, check out CIT Bank CD rates for some of the best CD offers on the market to date. CIT Bank has some of the best CD agreements with high-interest rates and no early withdrawal charges. 

In this article, we talk about the basics of CD investments to give you a rough idea of how this investment works as a whole.

Why is it called a “certificate of deposit”?

Certificates of deposit are called such because it involves the process of leaving a certain amount of fund in the bank for a fixed period of time. In such an arrangement, the bank will have full control over the funds from the time the deposit is made up until the agreed-upon date of maturity. 

What happens to the fund?

Let’s say you have set up a CD investment with a particular bank for an amount of $1,000. Throughout the course of the investment period, the bank will usually allocate this money to certain areas of operations. For instance, some banks include your money in their revolving fund, which is part of their daily transactions and activities. In some other cases, banks will use these funds to purchase other types of investments with the goal of earning interest. This is a completely legal arrangement between the bank and the investor, and this is duly stipulated in the certificate provided to the investor at the date of deposit.

How does my money grow?

As a form of compensation for letting the bank strategically use your money for operating or investing purposes, you are entitled to receive an interest income. Interest income is usually set in percentages that range from decimals all the way up to 4 or 5 percent. The interest rate is applied to the principal, which refers to the sum of money that you have initially invested. Note that interest is compounded in this type of arrangement. 

For example, let’s say you have deposited an amount of $1,000 with 5% annual interest. At the end of the first year, you are already entitled to $1,000 plus the 5% interest of $50, totaling $1,050. By the second year of your investment, the 5% will now be based on the $1,050 total and not solely on the $1,000 initial investment. The same is true for the succeeding years. This means that your earnings are compounded, hence the term “compounding interest.”

What should I be aware of?

The primary concern that you should have to take into account when investing in CDs is if you are required to pay penalties on early withdrawals. An early withdrawal refers to the process of pulling out the investment in an untimely manner, which is earlier than the agreed-upon date of maturity. Most CDs come with early withdrawal fees to prevent the immature collection of funds. However, there may be cases when you really need the funds. Before pulling out the investment, make sure that you are aware of all the necessary fees that will be deducted from your investment. Usually, early withdrawal fees are higher than the interest rate to better incentivize investors to leave their investment until the date of maturity.

How can I maximize my CD investment?

One of the most recommended strategies when investing in CDs is to “ladder” your investment. Laddering is an investment technique that involves the purchase of different CDs, each with different maturity dates. For example, you could have three separate CDs with maturity periods of 1, 2, and 3 years each. This approach to CD investment allows you to have access to funds for your short-term financial needs, such as emergency scenarios. At the same time, it also allows you to maximize your interest earnings because you still have your long-term CD that is still earning interest until the maturity date further down the line.

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