If there’s one type of investment I truly know nothing about, it’s the certificate of deposit. Unlike stocks or mutual funds, or even the trusty old savings bond, it never comes up in casual conversation. But now that I'm older, I’ve become more, well, invested in learning as much as I can about what each type of investment brings to my portfolio. So I decided to research certificates of deposit and here’s what I found out!

Certificates of deposits: defined

Known as a "CD" for short, certificates of deposit are really not that complicated!

Here are some key features:

  • CDs are generally considered to be "low risk" investments.
  • You can buy CDs in different denominations.
  • Their maturity date (the date when you get your principle back plus the interest you've earned) is a fixed date.
  • The interest rate you earn on the CD is fixed at the time when you buy it.
  • CDs are issued by banks (technically they’re "promissory notes"—a written guarantee to you from the lender that you’ll get paid a specific amount at a specific time).
  • If you want to cash in ("withdraw") your funds early, you’ll pay a penalty to do so.

A word about “low risk”

There are two main issuers of CDs: banks and credit unions. Each is typically (but not 100% guaranteed to be) insured by their respective governing entity.

  • Banks: Insured by the FDIC (Federal Deposit Insurance Corporation).
  • Credit Unions: Insured by the NCUA (National Credit Union Administration).

What you need to watch out for is the amount the CD is insured for. Both the FDIC and the NCUA currently have a limit of $250,000 per CD. So if you decide to buy a CD that’s worth more than the insurance limit, any additional losses won't be insured. These limits can change at any time, so it’s wise to ask before you purchase.

How to buy a CD

You can buy a CD at your bank or credit union. Here’s what you need to know before you make your purchase decision.

  • Terms: CDs are offered in terms of 3 months, 6 months, 1 – 5 years, and longer.
  • Rates: Interest rates are typically fixed (although not always), and they typically increase the longer your term is.
  • Types: There are different types of CDs to choose from.

Types of CDs

  • Variable rate CD: These CDs are linked to the market index rate (or some similar measure)—you could earn less or more than fixed-rate CDs depending on how the market performs during your term.
  • No/low-penalty CDs: These CDs come with a lower (or no) penalty if you decide to withdraw your funds early.
  • Callable CD: Here, the bank or credit union gets the benefit of being able to cut short your CD term (which they may or may not do).
  • Jumbo CD: These CDs are so named because their minimum face value is quite high (think $100,000). However, their interest rate is typically much higher than a normal CD as well.
  • IRA CD: This is a CD you purchase as a part of your retirement portfolio under the auspices of money held in an IRA (Individual Retirement Account).

What to research before you buy

Because CDs are not risk-free, and most come with penalties for early withdrawal, it’s important to choose your CD carefully.

Here’s what to look at before you buy:

  • Penalty fee: Find out what your penalty will be if you withdraw early (the most common penalty is a percentage of the interest earned).
  • Interest rates: Since CDs are often sold based on the APY (annual percentage yield) interest rate, and this can be influenced by how often the bank or credit union decides to compound your interest (options include daily/weekly/monthly/quarterly), even CDs that offer the same APY may not pay out equally. So be sure to read the fine print before making your final selection!

Calculate what you’ll earn

Bankrate's Interest.com offers an easy online calculator to help you figure out in advance what you will earn from purchasing a specific CD. The calculator works from the term, the initial deposit, the compounding frequency, and the interest rate—and gives you your yield by year.

Top CDs for 2015

As of January 2015, these are the top five institutions offering the highest rates for CDs. Each of these institutions is FDIC-insured up to $250,000. You can buy each of these CDs either online or via snail mail.

1. CIT Bank

2. Barclays Bank

3. Nationwide Bank.

4. GE Capital Bank.

Ways to Gain Interest: What You Need to Know About Certificates of Deposit