Fixed-Rate Certificate of Deposit (CD): What It Is, How It Works (2024)

What Is a Fixed-Rate Certificate of Deposit (CD)?

A fixed-rate certificate of deposit (CD) is a type of savings account with a set interest rate over its entire term. CDs generally offer terms in increments of three months up to one year and then switch to two-, three-, and five-year terms, during which your money remains untouched in the account. There are also CDs with 10-year terms.

In general, the longer the term of the fixed-rate CD, the higher the fixed interest rate, although exceptions exist. You can buy CDs online or in person from a bank or credit union.

Understanding a Fixed-Rate CD

Savers who are conservative with their investments may be attracted to fixed-rate CDs, which provide steady income streams until maturity. Furthermore, because CDs are guaranteed by the Federal Deposit Insurance Corp. (FDIC) up to $250,000 (per account holder, per issuer), investors placing money in CDs feel comfortable about their asset’s safety. Fixed-rate CDs may not pay as much interest as other fixed-income securities, but conservative savers accept the tradeoff of lower interest for lower risk.

However, as with any interest-earning investment, investors do encounter inflation risk. This occurs when the inflation rate exceeds the investment’s interest rate and erodes your future purchasing power.

You can choose various terms for your CD that typically range from one month to several years. During this time, you leave your money in the CD account until the maturity date, or the date when the term ends. At the maturity date, you can remove your original deposit plus interest earnings or roll over the amount and interest into a new CD.

Banks typically charge a penalty for early withdrawal of funds from a CD, so it’s usually best to leave the money in the instrument until it matures. Upon maturity, depending on your financial needs, you may roll over the matured CD into another one. However, the new fixed rate for the CD is likely to be different from the CD that just matured.

Fixed-Rate CD vs. Variable-Rate CD

A variable-rate CD has a fixed term like a fixed-rate CD, but the CD’s interest rates can fluctuate. Some CDs may include one or two options to raise your rate during the term, which tends to be longer with fewer options than a fixed-rate CD.

For example, you may only be able to choose between a two- or four-year term and the ability to raise your rate only once. These CDs may be called rate bump CDs, bump-up CDs, or another term exclusive to the bank or credit union. Other variable CDs are tied to a certain index, such as the prime rate index.

An investor in a variable-rate CD is less risk-averse than a fixed-rate CD buyer and may believe that interest rates will rise over the time that the CD locks up cash. If correct, the CD will generate more interest than a fixed-rate CD.

Fixed-Rate CDs vs. Money Market Funds

Fixed-rate CDs and money market accounts are both popular savings options with different features, benefits, and flexibility. However, each have quite different functionality. Fixed-rate CDs offer a predetermined interest rate that remains constant throughout the term, while money market accounts offer variable interest rates that can fluctuate based on market conditions.

Fixed-rate CDs also have fixed terms ranging from a few months to several years, while money market accounts offer more flexibility in accessing funds. Investors can often deposit and withdraw funds multiple times in a given month, though there may be limits to how many times a saver can interact with money market funds in a short period of time.

Money market accounts are designed for those seeking a balance of liquidity and higher interest rates compared to regular savings accounts, suitable for emergency funds or short-term savings goals. In some cases, fixed-rate CDs can’t be broken, meaning savers may have money put aside that they can’t access until the term has finished.

Minimum deposits for fixed-rate CDs typically vary based on the financial institution and the CD’s term. Money market accounts may also have a minimum deposit requirement, but it tends to be lower than fixed-rate CDs.

Account activity for fixed-rate CDs is minimal until the account matures, with interest earned on the principal and not much else. Meanwhile, there are some potential additional functionalities with money market accounts. For instance, some accounts may have check-writing privileges and automated teller machine (ATM) access.

Advantages and Disadvantages of Fixed-Rate CDs

Pros of Fixed-Rate CDs

Fixed-rate CDs offer peace of mind with guaranteed returns, as the bank or credit union promises to pay the headline—or gross—interest rate over the CD’s term. The rate remains constant regardless of fluctuations in the economy or financial markets. This is particularly beneficial for risk-averse individuals or those who prioritize stability in their financial planning (e.g., retirees who are relying on specific amounts of cash flow becoming liquid at specific times).

Fixed-rate CDs are low-risk investments with, as mentioned earlier, FDIC insurance protecting deposits up to a certain limit. This insurance protects principal investment and interest earnings against the risk of bank failure, allowing recovery even if the bank faces financial difficulties.

Fixed-rate CDs offer stability and predictability, allowing for accurate calculation of future value, thus making it easier to plan financial goals and align savings strategies accordingly. They do not depend on market movements or economic conditions, making them appealing during periods of economic uncertainty or market downturns. In certain cases, investors may consider hedging riskier equity investments with fixed-income securities like fixed-rate CDs in an effort of overall portfolio risk diversification.

Finally, fixed-rate CDs discourage spending, as they are time-bound investments, committing to keeping money deposited for a specific term. This discourages impulsive spending and promotes disciplined saving. For savers who might need a little help committing to longer-term saving, this helps individuals work toward long-term financial goals.

Cons of Fixed-Rate CDs

Fixed-rate CDs offer stability and security, but this comes at a cost. Fixed-rate CDs generally provide lower returns compared to volatile investments like stocks or mutual funds. Keep in mind that equities may incur losses in addition to potentially incurring higher returns.

These CDs are designed to be low-risk and provide a guaranteed return, but investors may not keep up with inflation, potentially resulting in a loss of purchasing power over time. This is especially true in periods where inflation quickly rises over a short time.

Fixed-rate CDs are also not liquid assets. This means that they are not easily accessible before the CD reaches its maturity date. If you need to withdraw money before the CD matures, you will face penalties and forfeit a portion of the interest earned, which can be a significant drawback if you have unexpected expenses or financial emergencies.

Example of a Fixed-Rate CD

A bank offers a fixed-rate CD that guarantees interest rate returns of 5%. The CD’s term period is six months. Tatiana invests $1,000 in the CD. After six months, she has earned about $25 (the exact amount depends on how often the interest is compounded). She can withdraw the $1,025 or roll it over into another CD. She chooses the latter option and, at the end of a year, withdraws about $1,050 upon its maturity. She will owe taxes on her $50 earnings.

In contrast, Tatiana’s friend Marc also invested $1,000, but in a variable or bump-up 24-month CD. If rates rise to 6% or more in the next 12 months, Marc will make a little more than Tatiana by the first year’s end.

The Bottom Line

A fixed-rate CD allows your money to grow in a low-risk vehicle as long as you keep your money in the CD for the entire term. Fixed-rate CDs can pay a consistent and higher interest rate than other types of CDs, with the rate being based on the term length.

Compare fixed-rate CD options that different financial institutions offer and the term lengths to find the best rate. Remember that if you withdraw your money before the maturity date, you’ll likely pay a penalty of several months’ interest. If you’re new to CDs, you might start with a shorter term (such as a three-month CD), a CD ladder, or a liquid or penalty-free CD.