A certificate of deposit, also known as a CD, is a short to medium term investment made with a bank or savings and loans institution. The basic idea is that you agree to deposit a certain sum of money for a period of time, typically anywhere from three months to six years, in exchange for a locked interest rate. This interest rate will generally be higher than that of a traditional savings account. After the length of the CD has expired, the initial balance will have increased substantially due to the accrued interest.

The reason banks are able to offer higher interest rates for CDs is because they are considered long-term investments. The investor agrees to keep a specific amount of money in the bank for X amount of time. It is essentially a loan made by the investor to the bank, which then generates a promissory note that obligates the bank to repay the loan at the agreed upon time. In return the investor agrees not to withdraw, deposit, or otherwise alter the principle sum for the length of time the CD is valid. There are heavy penalties for withdrawing money from a CD fund prior to maturity; most commonly a slashed interest rate.

A CD is considered a safe investment method as it is typically held at FDIC insured banks or, in the case of credit unions, the NCUA. The FDIC insures CDs for up to $250,000, which means that your money will not disappear should the institution that holds the certificate of deposit fail.

The amount of interest generated by a CD is variable based on the amount of time it is in place. Longer term CDs will have higher interest rates, which makes them a good choice for individuals who wish to make an investment but will not need to access their money for some time. The interest payments can be paid into a separate savings or checking account as soon as it’s earned, kept in the CD account to increase the balance and compound the interest, or rolled into a longer-term CD fund to take advantage of higher interest rates.