What Is a CD Account, and How Does It Work?

Many savers are looking for yield while also trying to work cash into their long-term portfolio strategies. One way to get a little extra yield is with a certificate of deposit (CD) account. There are different types of CDs, including brokered CDs, that allow a little extra freedom and flexibility. Here’s what you need to know.

What is a CD account?

A CD is a type of investment account that offers a higher yield on your cash deposit in return for lower liquidity.

So how does a CD account work? Basically, you choose an amount you’re willing to deposit and decide how long you’re willing to let the money stay invested. The longer you’re willing to keep the money locked up, the higher your yield. For example, you might be able to get an annual percentage yield (APY) of around 4.8% on a three-year CD, which could be a better deal than getting a yield of 1% or less on a traditional savings account.

However, a CD bank account does come with restrictions. Taking the money out early can lead to a penalty, reducing your earnings from interest. It’s possible to find CD accounts with maturity terms as short as one month and all the way up to 10 years. The shorter your term length, typically, the lower your yield.

As with any financial product, there are pros and cons, and CD accounts can be used in different ways depending on the individual goals of every unique saver and investor. And it’s important to note that CD accounts are typically opened at a bank, not at a brokerage firm, such as TD Ameritrade. However, TD Ameritrade does offer brokerage accounts that are dedicated to CDs. See below for more on the difference between bank CDs and brokered CDs. 

CD accounts vs. savings accounts

With a CD bank account, you don’t have the same level of access to your cash as you would with a traditional savings account. With the savings account, there may be restrictions on the number of transactions you can make, but you won’t pay a penalty for withdrawing money soon after depositing it.

With CD accounts, though, you’ll likely pay a penalty if you withdraw funds before the end of the term. So, if you know you won’t need the money for at least five years, choosing a five-year CD may be in your best interest. It’s also possible to get 10-year CDs that are designed to be held in IRAs, which can help you protect your principal for a long period of time while reaping the potential tax benefits that come with keeping your money in an IRA.

As mentioned, CD accounts often offer higher yields than traditional bank savings accounts. Plus, with a savings account, the rate fluctuates with the federal funds rate and other short-term benchmarks. In contrast, when you get a fixed-rate CD bank account, the current rate is locked in when you open it. (Some banks do offer floating-rate and so-called “step-up” CDs with an interest rate that rises periodically over the CD’s life.) With a fixed-rate CD, even if the Fed cuts rates, you’ll still earn the same yield.

For some savers, it might make sense to use CDs to lock in higher yields when the Fed looks to be signaling future rate cuts. When rates are on the rise, though, some savers might decide to hold off a little longer to see if they can get just a bit more yield.

Risks of CD accounts

Before you use any financial product, it’s important to understand the risks. Here are some risks of CD accounts:

• Potential to miss out on better yields if rates rise during the term of the CD
• Large accounts might not be fully protected by FDIC insurance, which has a limit (currently $250,000 per account based on ownership type)
• Inflation might outstrip the yield earned on a CD, leaving a saver vulnerable to rising prices
• If a CD is “callable,” the issuer might choose to redeem the CD before maturity

Weigh the risks against the benefits to determine where a CD bank account might fit into your long-term financial plan or if there are other products that might work just as well or better.

What about brokered CDs?

Another way to include CD accounts in your investment portfolio is to consider brokered CDs, which allow you to buy CDs through a broker like TD Ameritrade instead of through a bank.

Brokered CDs are sold on the secondary market, with prices that fluctuate with interest rates. So, when you’re buying a brokered CD, or if you need to sell one before maturity, it’s possible for price fluctuations and transaction costs to eat into your principal. Also, if you’re expecting FDIC protection in your brokered CD, it’s important to read the fine print. Some brokered CDs don’t have FDIC protection, so be aware of that before making investment decisions.

In some cases, brokered CDs also offer the potential for higher yield, greater flexibility, and sometimes the ability to avoid early withdrawal penalties.

Potential uses for CD accounts

After learning how CD accounts work, you can consider adding them to your portfolio. Some savers like to use CDs as alternatives to savings accounts when working toward medium-term goals, such as vacations or saving for a down payment on a house.

Others prefer to keep longer-term CDs in an IRA to capture the potential for high yields combined with principal protection for the cash portion of a long-term portfolio.

Still others like the idea of using brokered CDs to boost yields, increase choices, and enjoy a little more flexibility.

Before deciding on a strategy, carefully consider your own goals and portfolio to create a plan best designed to help you reach your objectives—with or without CDs.

Investors wishing to sell CDs prior to maturity will be subject to market risk (investment may be worth more or less than original cost) and limited liquidity in the secondary market. FDIC insurance does not cover loss of principal you may incur when a CD is sold prior to maturity.