What is a CD?
A CD, or a Certificate of Deposit, is a deposit account offered by banks and other financial institutions such as credit unions and savings and loans.
CDs differ in one important way from regular savings accounts. When you have a savings account, you can withdraw money from that account at any time.
In contrast, a CD is considered a time deposit. A CD may mature anywhere from 1 month to 5 years in the future (and sometimes more). But if you withdraw your funds at any time prior to the maturity date, you will be penalized for doing so.
The typical penalty involves forfeiting a set amount of interest you would have otherwise received.
As compensation for having your deposit tied up for a longer period of time, CDs pay a higher interest rate than a regular savings account or a money market account.
The primary factors that affect a CDs interest rates are:
In general, the greater the deposit and the longer the holding period, the higher the CD's interest rate will be.
That still allows someone who truly needs access to their money to be able to get it (e.g. emergencies, unexpected expenses) while at the same time discouraging frivolous withdrawals.
Interest payments and options on a CD will vary depending on the CD. In the old days payouts would be in the form of a check or a transfer to a savings account somewhere and would be either quarterly or semiannually.
There are a lot more options with CDs these days, many of which include the ability to compound your interest instead of paying it out to you.
One popular strategy to maximize interest rate returns on CDs while not tying up your funds for long periods of time is what's known as laddering your CDs.
For instance, you could purchase 3 separate CDs in equal dollar amounts with different maturity dates - one year, two years, and three years out.
When the first CD matures after one year, you would take the proceeds and buy another 3 year CD. You keep doing that every year - each year a CD matures and each year to purchase another 3 year CD.
The advantage here is that a third of your savings will be accessible on a yearly basis, but since all of your savings will be in 3 year CDs, you will earn more in interest.
Is a certificate of deposit a good idea for a longer term kids saving account?
It can be if the money isn't going to be needed any time soon, and you want to teach your child about the long term benefits of saving money.
It can also be an acceptable alternative to investing in the stock market if you're uncomfortable doing so, or if you consider the stock market to be too risky. Like savings accounts (in the USA), CDs are also FDIC insured up to $250,000 so you can be confident of not losing any money.
If you are considering CDs, allow yourself time to do plenty of comparisions and to consider which one are best one for your child's situation. There are a wide range of CD offers available through banks, savings and loans, credit unions, and even credit card companies, both online and off.