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CDs may not earn as much as the S&P 500 over long periods. But they do have advantages. Read on to learn what happens when you choose CDs.
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It seemed like just yesterday that large national banks were paying just fractions of a penny on the dollar for money held within a certificate of deposit (CD). In fact, it was only last March, just before the Fed began its most aggressive rate hiking campaign in four decades, that the best CD rates were barely gophering above 2%, with most banks advertising — proudly, mind you — APYs far below that.
Fast forward 16 months later and CDs are having a bonanza year. Many great short-term CDs are on par with or above 5%, and the Fed’s “we’re not done here yet” attitude toward inflation could cajole CD rates a little higher before the year ends.
In comparison, the S&P 500 is slowly waking up but isn’t having the best performance of its life, especially now that the Fed will likely hike rates again this year. We’re technically in a bull market, albeit not the bulls of former days — like those with Michael Jordan — but a weaker market that can’t seem to decide if it will keep moving in this direction.
The certainty of CDs against the backdrop of market instability may make the former seem like a smarter investment than stocks. But are CDs better for your money in 2023? Let’s take a look at what happens when you open a CD instead of investing in the S&P 500.
What a CD offers that the S&P 500 can’t
When you deposit your money in a CD over the S&P 500, you get the certainty of guaranteed returns, assuming you don’t break your contract and pull money out too early. You know, for instance, that a 5% APY on a 1-year CD will return 5% of your deposit at the end of that one-year term, regardless of the economy or how the stock market swings.
This makes CDs suitable for those who have savings they’re not going to use in the near term, as well as those who have a weak appetite for risk. It’s also ideal for those who are nearing the completion of a big financial goal — like saving for retirement or the down payment on a first home — and want stability over volatility, even if it means getting smaller returns.
Additionally, today’s CD rates offer you what stocks have promised for years: the potential to earn above the rate of inflation. Even though you have to factor in taxes on your CD earnings (unless you’re holding it in a tax-advantaged account, like an IRA), many top-paying CDs can prevent your money from losing purchasing power to inflation, something stocks can target but can’t guarantee.
What the S&P 500 offers that CDs can’t match
Hands down, the S&P 500 offers investors greater upside potential. In this year alone, in fact, the S&P 500 has already appreciated by roughly 16% — far more than what short-term CDs could pay during the same period.
The stock market does have risks, but for investors with long time horizons, the S&P 500’s worst years are often more than made up for with the good days. You may not trust the stock market right now (and no one is telling you that you should), but if history can teach us anything, it’s that the S&P 500 always bounces back, eventually.
In the end, opening CDs will leave you with more stability, even if you’re sacrificing greater returns. You won’t have to worry about how your money is performing today, or if you will have a certain balance by tomorrow. This could help you plan your personal finances, as you’ll know exactly how much will be returned to you and on what day.
As with most things, a middle ground could be reached — if you have enough cash to invest in both — but if you’re after near-term stability, perhaps there’s no better time to open a top-paying CD.
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