3 Questions to Ask Yourself Before Investing in a CD

Certificates of deposit (CDs) can be a great investment for some people. Since you can buy FDIC-insured CDs, you won't have to worry about losing the money that you've put in. You'll also know what rate of return to expect upfront and won't face any unpleasant surprises -- as long as you understand the details of how this investment works.

If you aren't sure if a CD is right for you or not, ask yourself these three questions before making the choice to invest in one.

1. Are you OK with tying up your money?

When you buy a CD, you commit to leaving your money invested for the duration of the CD term. In exchange, you get a guaranteed rate of return during the time your funds are invested.

If you withdraw your invest funds early before the end of the term, you get hit with a penalty. The exact penalty can vary based on the terms of your investment, as there are no maximum penalties imposed by law.

Some banks offer CDS with terms as short as one month, although not all banks offer such short-term CDs. It's more common to find offerings that require you to commit to being invested for between three months and five years.

Committing not to take out your money can be a major financial decision. You don't want to invest any funds you might need before the CD term ends. So, for example, your emergency fund doesn't belong in a CD since you never know when you'll need that. But you might want to use CDs to save for a wedding in three years' time if you're confident you won't decide to run off and elope earlier.

2. Can you meet the minimum deposit requirements?

In many cases, you'll need to deposit at least $500, and sometimes as much as $2,500, in order to be eligible to buy a CD, although requirements vary depending on the financial institution and the investment product you're choosing.

If you don't have the money available to meet the minimum requirements for most CDs, you can look into buying fractional CDs that may be more accessible to you. These allow you to buy a partial ownership interest in a CD. However, even these investments usually require you to make some type of a minimum commitment -- although it can be lower than the amount needed to buy a CD of your own.

If you can't or don't want to invest enough in a CD to meet the minimum requirements, you'll need to look elsewhere for other investment options.

3. Are you getting a great rate?

Finally, you'll want to make sure you're getting the best rate possible. CDs tend to have a higher rate than savings accounts, but rates do vary depending which CD you choose.

Usually, the longer you're willing to lock up your money, the higher the returns you'll get. However, in today's current environment, that's not necessarily the case. That's because interest rates are very high right now and banks aren't willing to bet they'll stay that way.

For example, the table below shows how much you could make on a $5,000 investment depending on the CD term if you bought a CD from Capital One at today's rates. Note that the highest rates are for 12- and 18-month CDs.

It's important to research the rates on offer and make sure they're competitive. Remember, while a CD with a longer term currently is offering a lower APY than one with a shorter term, the bank is committing to pay that rate for the life of the CD. So if rates do fall over the coming years, you may still be really happy to be getting a guaranteed APY of 4.10% for five years.

By asking these important questions, you can make a smart choice about whether investing in a CD makes sense for you.