What is the certificate of deposit?
A certificate of deposit is a savings certificate issued by the commercial bank with the fixed maturity date and fixed interest rate. In the certificate of deposit access to the funds are restricted until the date of maturity. The certificate of deposit is defined as the investor depositing some amount of for the specified period of the time at a fixed rate of interest. The CD’s rates, amount and terms are different from institute to institute. CD is especially beneficial for the risk-averse investors.
Advantages of a CD:
Term of investment: With the longer term of the investment in the certificate of deposit the higher rate of interest is received monthly, yearly or after the maturity.
Grace period: The bank gives the grace period of seven days for planning the further investment of the matured amount.
Fixed rate of interest: The rate of interest is almost the fixed for the entire period of tenure of the certificate of deposit.
Lower risk: The certificate of deposit offers the investors the option of investing at the lower risks.
More rate of interest than savings account: The rate of interest is higher for the certificate of deposit than the traditional savings account.
Promotes safe investment by banks: The bank guarantee the fixed rate of return, so investing in the certificate of deposit will promote and generate growth.
One size fits all: Certificate of deposit fits both the individuals of higher income group and individual of lower income group.
Disadvantages of a CD:
Penalty: The main disadvantage of the certificate of deposit is the invested amount cannot be withdrawn before the maturity. If the customer wants to withdraw, some amount of penalty has to be paid to the bank.
Automatic rollover: If the customer doesn’t decide about what to do with the matured funds. Then the bank will automatically renew the amount with the same interest rate. Which may be the loss for the customers as the interest paid will be less.
Limited Liquidity: The certificate of deposit cannot be easily liquidated in the time of emergency. The bank charges the penalty for premature withdrawal that may reflect in loss of interest.
Inflation risk: The interest rate does not increase with inflation in the certificate of deposit. But the time value of money will decrease with increasing inflation.
Types of Certificate of deposit:
Traditional CD: The customer receives a fixed interest rate for a specified period of term. The cash can be withdrawn only after maturity without penalty. There is an option to roll over for more period of time.
Bump-up CD: The customer is allowed to bump up the existing rate of interest on the certificate of deposit to match the current market rates. It offers the best returns if the customer holds them while interest rates increase.
Liquid CD: The customer can withdraw the amount without penalty with liquid CD. But the customer has to maintain a minimum balance. The rate of interest is lower in the liquid CD when compared to other CD’s.
Zero-coupon CD: In zero-coupon CD no interest payments are received. The maturity fund can be reinvested in order to gain higher interest.
Callable CD: The bank can recall the CD from the investors after the time period expires or before the CD is about to mature. This may result in the return of the deposit and the interest earned.
The components included in the certificate of deposit calculator:
- Initial deposit: The amount deposited in the certificate of deposit.
- Interest rate: The interest rate payable to the investor.
- Compound: The compounding period of the certificate of deposit.
- Deposit length: The time period of the amount is deposited.
- Marginal tax rate: The tax rate paid on the marginal.
- Inflation rate: The inflation rate of the present currency.
This calculator helps the investor to estimate the interest earned on the certificate of deposit over a period of time. The tax and inflation should be added to the interest to get the accurate results.