How does a Certificate of Deposit Work?

Nowadays, new certificate of deposit investors usually ask 'how does a certificate of deposit work' before investing in them. In the past, certificates of deposit used to be one of the only ways to invest safely. Nowadays, there are other alternative investments. So, knowing how a certificate of deposit work exactly will determine if investing in a certificate of deposit is the right choice. With so many rules and banks claiming to offer the best certificate of deposit rates out there, make sure you know how a certificate of deposit works before you invest in one.

The answer to: how does a certificate of deposit work?

When you ask a bank or a financial institution about investing in a certificate of deposit, they will undoubtedly give you a certificate of deposit quote or the certificate of deposit rate. Sometimes, they will give you both the certificate of deposit's APY which is the Annual percentage yield as well as the certificate of deposit rate.

Each certificate of deposit has a term that your money is locked in. So, when investing in a certificate of deposit, pay attention to:

• the APY of the certificate of deposit (overall return from the CD),
• the certificate of deposit rate (monthly interest from the CD),
• the term or time to maturity of the certificate of deposit

How does a certificate of deposit work? - an example

An example of how certificates of deposit work is as follows: you invest $1,000 in a 1 year certificate of deposit. The certificate of deposit rate is 4.5% and its APY is 5%. Notice that the APY is higher than the certificate of deposit rate. The certificate of deposit rate will not change for the life of the certificate of deposit. That means if everyone else is now getting 7% on their CDs, you will still get 4.5%. If your certificate of deposit interest is compounded, then the certificate of deposit interest is calculated monthly and added to your total investment. Before you invest in a certificate of deposit, you should make sure with the bank or financial institution of all the certificate of deposit interest rates involved.