What is a Certificate of Deposit (CD): Meaning, Features & How It Works

Introduction to Certificates of Deposit (CDs)

The history of the certificate of deposit (CD) goes back to the mid- 20^th century. In the year 1961, the National City Bank in New York, now known as Citibank, introduced the CD with the help of a stockbroker who dealt in government-issued securities, helping the bank raise money for lending. This was followed by Barclays bank in Britain, in cooperation with the National Bank of South Africa in 1964. India introduced the CD in 1989, after its popularity had grown in the preceding decades amongst investors. Today the CD is an important financial instrument, used widely in both India and globally.

What is a Certificate of Deposit (CD) and How Does It Work?

A certificate of deposit is a financial instrument of fixed duration and amount, which accrues interest based on the amount and time of deposit. CDs are issued by the Federal Deposit Insurance Corporation and regulated by the Reserve Bank of India. CDs restrict holders from making withdrawals from the principal before maturation, usually in the form of heavy penalties. These are also usually rerolled if left untouched after maturation. CDs are a low-risk investment.

Key Features of Certificates of Deposit

The features of CDs include:

•  Not all financial institutions or banks are allowed to issue a CD. Only scheduled commercial banks and All India Financial Institutions are allowed to issue these financial instruments.

• CDs have a term duration of 1-3 years when issued by financial institutions, and 3 months to 1 year when issued by commercial banks.

• CDs are in a de-materialised form and are transferable.

• CDs require a minimum of Rs 1 lakh as deposit.

• CDs have no lock-in period, hence banks do not issue loans against them.

• CDs are offered at discount rates or floating rates.

• CDs differ from fixed deposits (FDs) in that they are customisable while FDs are not.

Advantages of Investing in Certificates of Deposit

We now discuss the advantages of CD. These include:

• CDs are government-backed financial securities, and are insured against loss to a certain extent. This means that investing in CDs is a low risk.

• CDs offer higher rates of interests and better returns than conventional savings accounts.

• CDs require very little in terms of maintenance charges, if any at all.

• While withdrawals from the principal are heavily penalised, holders of CDs can customise the certificates and specify whether they want to withdraw the interest on a monthly, quarterly, or yearly basis, or with the principal at the time of maturation. Investors can also customise the amount of the principal and duration of the certificate within certain parameters. This makes CDs flexible instruments for investment.

Additional Read: 7 Reasons to Invest in Mutual Funds

Conclusion

Investors often look to diversify their portfolio in order to mitigate the risk of loss from investments owing to factors like market fluctuations. Such diversification usually involves a mixture of low-risk and medium-high-risk investments across multiple economic sectors. In such a situation, government-backed securities like CDs form an excellent option for a low-risk investment. Investors looking to invest in CDs must carefully conduct their research, and choose the right bank and CDs in order to reap maximum benefit from investment in this financial instrument.