What Is the Return on a CD?

Anyone who is looking through the sea of investment opportunities is bound to come across the mention of a certificate of deposit — or CD — at one point or another. But, what exactly is a CD? How does it work, and how much return on investment can you expect from one, especially depending on the amount you put in?

Let’s learn more.

What Is a CD?

A certificate of deposit is a type of savings account where money is kept for a fixed amount of time, and during that time it earns a set amount of interest. The key here is the fixed amount of time since you can’t withdraw from it whenever you feel like it, in the same way you could with regular savings accounts.

The set amount of interest also means that you’ll know exactly how much you’ll earn by the end of the period. If you want to take out money from your CD before your agreed-upon term is up, then you’ll likely have to pay an early withdrawal penalty.

Certificate of Deposit’s Minimum Balance

The minimum balance required for a certificate of deposit depends on which bank or credit union you’re using. Generally, this minimum balance ranges between $500 to $1,000. That being said, there are some banks that don’t have any minimum balance requirements at all, and there’s such a thing as a jumbo CD, which requires a much higher minimum deposit (typically $100,000). 

Deciding on how much you want to put in your CD is important because most of the time you can’t add any more money inside after that initial point until the account reaches maturity. If you have more money you want to set aside in a CD, you can always open additional CDs.

Typical Interest Rates with Certificate of Deposits

When compared to a traditional savings account, certificate of deposits generally come with higher interest rates. Typically, the longer the term you agree to or the higher your deposit amount, the higher the interest rate you can get. In other words, if you go with a short-term CD, you’ll get access to your money sooner, but with a long-term CD, you’ll get a much better interest rate.

There are other factors that affect what kind of interest rate you get for your CD, including the federal funds rate. When the federal funds rate is high or increasing, then it means that probably the CD interest rates are high or are increasing too.

Are CDs FDIC Insured?

CDs are considered one of the safer investment options, and part of that is because they are FDIC insured. This is assuming that your CD is at a bank or credit union that’s a member of a federal deposit insurance agency, and most financial institutions are. 

Being FDIC insured means that if that financial institution where you have your CD fails, then up to $250,000 of your funds with them are insured/protected by the government and guaranteed back to you. That kind of guarantee can offer you a lot of peace of mind as you’re building out your investment portfolio.

Your Return on CD Investment

Remember discussing how CDs are considered a safer investment opportunity? Well, unfortunately, low risk does mean comparatively low returns. Stocks, mutual funds, peer-to-peer lending, and certain bonds can all potentially offer you a higher return if you’re willing to take that higher risk with them.

When evaluating investment returns with your CD, it’s worth it to look into several financial institutions so you can compare what kind of interest rates they’re offering for different deposit amounts and terms. That way you can figure out which arrangement will offer you the highest return on your CD investment.

Let’s cover what we mean in more detail:

The Lock-in Period

One of the most important things to understand about a CD is the lock-in period, otherwise known at the duration of the deposit. This is a critical factor in determining what the return on a CD investment will be. As mentioned earlier, longer lock-in periods usually result in higher absolute returns. However, the downside to longer lock-in periods is that it exposes investors to inflation risks. As inflation erodes the purchasing power of money, the interest earned on a CD may not be sufficient to keep up with inflation. This means that the longer the lock-in period, the more significant the inflation risk.

Investors should therefore carefully evaluate their financial goals and risk tolerance when selecting the duration of their CD investment. If they need quick access to their funds or are concerned about inflation, they may prefer to invest in shorter-term CDs. (And, also keep in mind that the early withdrawal penalty, which is usually a period’s worth of interest ranging from 90 days to 18 months, depending on the financial institution.) On the other hand, if they can tolerate a higher degree of risk and want to maximize their returns, they may choose to invest in longer-term CDs.

It’s also worth noting that some financial institutions offer special CDs with higher interest rates or more flexible terms, which may be worth considering. However, it’s necessary to read the fine print and understand all the terms and conditions before investing in any CD, and/or working with a financial advisor who can help.

Using a CD Calculator

One of the easiest ways to figure out your return on a CD is to use a CD calculator. With a calculator like this, you can put in the dollar amount of your initial deposit, time duration (or term of the certificate of deposit), interest rate, and compound frequency. Then, the calculator will tell you helpful insights like the amount of interest accrued (or your return), capital growth (both nominal and adjusted for inflation), and the value with inflation adjustment.

Some CD calculators also feature fields for periodic contributions, tax on the interest accrued, and more, so you can get an even clearer picture of what your current investment is doing or how a prospective investment might perform. Let’s take a look at some examples using a CD calculator!

If I put $500 in a CD…

Let’s imagine you’re considering opening up a short-term CD with a six-month term and 1% interest rate that compounds monthly. If you were to put $500 in that CD, you would accrue $2.51 in interest, bringing your deposit value after six months to $502.51.

Now let’s see how much things change if you decide to go with a long-term CD instead. In this scenario, imagine that your long-term CD has a five-year term and 4% interest rate. Putting $500 into that CD means that at the end of your term, you’ll have earned $110.50 in interest, bringing your deposit value to $610.50.

If I put $1,000 in a CD…

Using the same interest rates and terms as examples, how much money could you make if you decide to double your deposit to $1,000? If you put $1,000 in the same kind of short-term CD we mentioned previously, you would accrue $5.01 and raise your deposit value to $1,005.01 after the six months were up.

Putting $1,000 into a long-term CD like the one discussed above brings your interest accrued up to $221 and your deposit value to $1,221 after five years partially due to compounding interest.  

If I put $10,000 in a CD…

Thinking of investing in the five-figure range? As one last example, let’s consider what happens if you raise the initial deposit into your CD to $10,000. With the short-term CD, your interest comes out to $50.10 and your deposit value after the term is complete to $10,050.10. 

With the long-term CD, your interest accrued would be $2,209.97 and your deposit value after five years would be $12,209.97. As you can see from the examples, it can really pay off to deposit more money when creating your CD account and to let your money sit in there for longer.

Summing It All Up

CDs are just one of many different options if you’re looking to invest your money. To compare CDs with different interest rates and terms from different financial institutions, you can use a CD calculator to quickly and easily figure out exactly how much money you’ll accrue when your account matures.