What You Need to Know About CDs

Kristin Fang

Danqin (Kristin) Fang, CFA, CFP® Financial Advisor

What is a CD and what do CDs provide?

As explained by Investopedia, “A certificate of deposit (CD) is a savings certificate with a fixed maturity date and a specified fixed interest rate, and can be issued in any denomination aside from minimum investment requirements.” CD maturity terms vary from one month to five years or even ten years with different interest rates determined by both the market interest rate and the maturity terms. The longer the term is, the higher the rate is. Additionally, there is usually a $1,000 minimum required for most CDs available on the market, and a CD with a greater than $100,000 minimum is known as a jumbo CD, accompanied by a higher interest rate for the same specified term. All CDs are FDIC insured up to $250,000 per account registration.

What is the difference between a Brokered CD and a Bank CD?


CDs issued directly by depositary banks are called bank CDs, while CDs offered by brokerage institutions are called brokered CDs. The brokered CDs are bulks of CDs bought by the brokerage firms, such as Charles Schwab or Fidelity Investments, and then re-sold to investors after slicing and repacking. The advantage of owning brokered CDs is diversification because you can buy different bank CDs from one brokerage firm and see the values and due dates all listed on one aggregated brokerage statement. This also helps you to track all your CDs easily. However, the disadvantage is the additional risk associated with owning CDs from banks that go under. Also, when buying brokered CDs, it is prudent to net the brokerage fees, although de minims in most cases, off their higher nominal interest rates when comparing them to the interest rates offered by bank CDs.

What is an Early Withdrawal Penalty?

With CD investments, you are restricted from withdrawing your funds before the maturity date unless you pay a penalty. The penalty usually takes up a few months’ worth of interest, depending on the issuing institution. This allows you to redeem your CDs before their maturity and opens the door to a more sophisticated CD investing strategy to be introduced next. Sometimes paying the penalty has a better outcome.

Advanced CD Investing Strategy

Regardless of the investment time horizon for your cash, you buy a five-year CD. Should the interest rate increase the following year, you’d then weigh your early withdrawal penalty against your interest income earned in the first year. If paying the penalty is the better option, then withdraw your entire CD portfolio and buy into a new five-year CD that offers a higher interest rate either from the same bank or from a different provider. In order to make this strategy work, a careful investigation of the early withdrawal penalty rules is key. Based on my research experience, some banks charge a lower early withdrawal penalty than others, for example, 180 days’ worth of simple interest versus 540 days’ worth of simple interest for a five-year CD. Let’s look at an example here:

You have $100,000 to invest for one year and are comparing a one-year CD offering 1% APR and a five-year CD offering 3% APR from the same bank. The early withdrawal penalty is 180 days’ worth of simple interest on the five-year CD.

Scenario 1: If you choose to invest in the one-year CD, your interest income after one year will be approximately $1,000 (1% multiplied by $100,000, to simplify the math from daily compounding to a simple interest calculation).

Scenario 2: Instead, if you choose to invest in the five-year CD, after one year, your gross interest income before paying the penalty will be approximately $3,000 (3% multiplied by $100,000), but you will need to pay approximately $1,480 ($3,000 gross interest divided by 365 days and then multiplied by 180 days) in early withdrawal penalty, which is equivalent to 180 days’ worth of simple interest, in order to redeem your five-year CD before its maturity date. This will net you approximately $1,520 in interest income ($3,000 gross interest income minus the $1,480 early withdrawal penalty), which is $520 more in interest income compared to Scenario 1. Clearly, with the additional $520 net interest income pocketed in Scenario 2, you are better off to invest in the five-year CD and pay the penalty at withdrawal in one year.

Below is a chart summarizing both scenarios:

CD Blog Picture

Caveat of using this strategy:

Please keep in mind that the outcome of this strategy depends heavily on the interest rates offered and the early withdrawal penalty levied by each bank. A prudent approach is to run the math thoroughly before taking any action, because banks adjust their CD rates periodically. For questions, please feel free to contact us at Evensky & Katz / Foldes Financial Wealth Management.

Feel free to contact Danqin (Kristin) Fang with any questions by phone 305.448.8882 ext. 222 or email: KFang@EK-FF.com.