If you're looking for a safe place to stash your cash and earn some interest, certificates of deposit may be for you. CDs are commonly purchased through banks or credit unions, but you can also invest in them through some brokerage firms. CDs aren't without their downsides, however, including early withdrawal penalties, because banks typically use the money to fund loans.
According to Bankrate.com and the U.S. Securities and Exchange Commission, CDs pay higher yields than other deposit accounts, such as savings accounts. So, if you won't need the money for a while, you can earn more interest using a CD. But, if you can afford some risk, you may prefer to invest in mutual funds, stocks or bonds because those will often provide an even higher rate of return.
CDs allow you to lock in your interest rate for the term of the CD so that if interest rates fall, you still get your higher rate for the remainder of the term. However, if interest rates rise, you're stuck with your predetermined rate of return unless your CD has a special provision that allows you to adjust your rate. For example, some banks offer bump-up CDs that allow you to change your CD rate to the current interest rate once during the term.
The Federal Insurance Deposit Corporation protects certificates of deposit at banks up to the coverage limits, so even if the bank goes under, your money is safe. As of 2013, up to $250,000 of your money is protected per bank. So, if you have certificates of deposit at two different banks, the FDIC protects up to $500,000 in total. If you invested in something riskier, like a mutual fund or stocks, you could lose your entire investment.
One significant downside to CDs is that you must leave your money in the account for a specified term or pay a hefty penalty. Typically, if you withdraw your money early, banks charge three months' worth of interest on CDs that mature in less than one year. If you have a longer term, penalties average six months' worth of interest. So, if there's a chance that you will need the money earlier than when the CD matures, you might choose a different account that you can access without penalty.