Legal Definitions - certificate of deposit (CD)

A Certificate of Deposit (CD) is a type of savings product offered by banks and credit unions where you deposit a specific sum of money for a predetermined period, known as the "term." In return, the financial institution pays a fixed interest rate, which is typically higher than what traditional savings accounts offer. The defining characteristic of a CD is that your money is committed for the entire term. If you need to withdraw the funds before the term ends, you will usually incur penalties. At the end of the agreed-upon term, you receive your original deposit back, along with all the interest it has accrued.

Here are a few examples to illustrate how a Certificate of Deposit works:

• Saving for a Future Large Purchase: Sarah is saving for a new car and has accumulated $10,000. She plans to buy the car in 18 months and wants to ensure her savings grow steadily without any risk. She decides to open an 18-month CD with her bank, which offers a 2.5% annual interest rate. By placing her money in the CD, Sarah locks in that interest rate for the entire period, guaranteeing a specific return on her savings by the time she's ready to purchase the car. She understands that if she withdraws the money early, she might lose some of the interest she's earned.

• Managing Retirement Funds: David, who is 55, has a portion of his retirement savings that he wants to keep in a very low-risk investment for the next five years before he plans to start drawing from it. He decides to put $50,000 into a 5-year CD. This strategy allows his money to grow at a guaranteed rate, protecting it from market fluctuations, while also ensuring he won't be tempted to spend it prematurely due to the withdrawal penalties associated with CDs.

• Holding Business Cash Reserves: A small consulting firm, "Innovate Solutions," has $25,000 in excess cash reserves that it doesn't anticipate needing for operational expenses for at least 12 months. Instead of letting this money sit in a low-interest checking account, the firm's owner decides to invest it in a 1-year CD. This allows the company to earn a better return on its idle cash, maximizing its financial resources without exposing them to the volatility of other investments, and the funds will be readily available when the CD matures for future business expansion or unexpected needs.