A certificate of deposit (CD) is a time deposit offered by banks and credit unions. You agree to leave a specific capital allocation untouched for a fixed term (ranging from 1 month to 5 years) in exchange for a locked-in, guaranteed interest rate. Like MMAs, CDs are FDIC-insured up to $250,000.
The primary friction of a CD is illiquidity: withdrawing principal prior to maturity triggers an early withdrawal penalty (EWP). The EWP is typically calculated as a set number of days of interest (e.g., 90 days of interest for a 1-year CD, or 180 days for a 3-year CD). If you withdraw early in a rising rate environment, the penalty can exceed the interest earned, eating into your original principal. Interest on CDs is taxed as ordinary income in the year it accrues, even if it is reinvested in the CD and not paid out in cash.