3 Reasons to Pass on 5% CD Rates

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Many CDs have impressive rates right now. Read on to find out why they still may not be the right fit for your finances. [[{“value”:”

Certificates of deposit (CDs) have become a popular place to put your money as CD rates climbed over the past few years. Some CDs pay an annual percentage yield (APY) of 5%, and the accounts are FDIC-insured, making them a safe place to let your money grow.

But there are a few downsides to locking up your money into a CD, even if you score a high interest rate. Here are three reasons why I’m personally passing up the high rates — and why you might want to as well.

1. The money could go toward your retirement portfolio

Even if your CD pays a 5% APY, it’s not a good substitute for investing in the stock market. The historic annual rate of return for the S&P 500 is 10.2%.

I’ve got at least a couple of decades left of working, so I have time to let my investments ride out volatile times and continue growing. If you have a similar investment horizon, you should strongly consider buying stocks rather than putting your money into a CD.

Here’s an example of investing $5,000 into the stock market vs. a 5-year CD earning 5%:

Of course, there’s no guarantee you’ll earn 10.2% from your stock market investments, but taking on the extra risk is worth it if you’re not near retirement age because your money has lots of potential to grow.

2. You need to pay off high-interest debt

If you have high-interest debt — like a credit card balance — then it could be far better to pay off that debt than to put your money into a CD.

I recently paid off more than $7,000 in credit card debt, which greatly improved my finances because my credit card’s annual percentage rate (APR) is 19.5%. With that high interest rate, I saved $4,000 in interest payments by paying off the debt rather than investing in a CD.

Let’s assume you have a $5,000 credit card balance and you’re paying the national APR average of 21.5%. If you put $137 toward your balance each month, you’ll pay it off in five years, and you’ll have spent $3,201 in interest.

In contrast, a 5-year CD with a 5% interest rate will earn you $1,381 over that period. This means you’ll save $1,820 if you immediately pay off your credit card with the $5,000 instead of investing it in the CD.

3. You don’t have an emergency fund

I once used all my savings to buy a car, believing that having no debt from the vehicle would be the best thing for my finances. What I failed to plan for was that the car would have ongoing mechanical issues and that my house would need regular maintenance.

Sometimes, what seems like a wise financial decision can put you in a worse position. There’s nothing wrong with putting cash into a CD, but it can be the wrong decision if you’re left without any money in your savings account.

Most financial experts recommend having enough cash to cover three to six months of expenses in your emergency fund. If that’s too much to manage, start with $1,000. The goal is to have some money to fall back on when expected expenses pop up — because they will!

CDs can be a good investment, but they’re not the best place to put your money if you have high-interest debt, don’t have any money in your emergency fund, or if you’re trying to maximize your retirement savings. Before you invest in one, evaluate your financial goals to see if a CD makes sense for you.

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