This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.
Stocks tend to deliver higher returns than CDs. But sometimes, it makes sense to play it safe. Read on to learn more. [[{“value”:”
Image source: Getty Images
When you’re saving for a far-off goal, it’s usually a good idea to put your money into stocks, as opposed to keeping it in cash in the bank. That’s because the stock market has a long history of delivering solid returns — much higher returns than savings accounts and certificates of deposit (CDs).
In fact, over the past 50 years, the stock market has averaged an annual return of 10%. But even recently elevated savings account and CD rates have only been about half that high.
Featured offer: save money while you pay off debt with one of these top-rated balance transfer credit cards
As such, when I started saving for college around the time my kids were born, I decided to invest that money rather than keep it in the bank. I put some of that money into a 529 plan and some into a regular brokerage account with no restrictions attached. (With a 529 plan, your investments get to grow tax-free, but there can be steep penalties for taking withdrawals for non-educational expenses.)
But last year, I managed to save a chunk of money for my kids’ college. And I decided to put that money into a CD instead of stocks for one big reason.
It’s all about protection and diversification
When I put money into the stock market for my kids’ college accounts years ago, that made sense. At that point, college was a long way off.
But frighteningly enough, I have a middle-schooler now, which means college isn’t so far away. As such, it’s time for me to start keeping some of my college savings in more conservative assets. And CDs fit that bill.
With CDs, I don’t expect to earn the same return as I might from a stock portfolio. But the thing is, at this point, I need some of my college savings in cash in case a stock market downturn hits.
Because college isn’t so far away, I may not have time to ride out a down market. So by keeping some of my college funds in CDs, I’m basically guaranteeing that I’ll have some money available to pay my initial tuition bills should I be in a position where it’s not a good time to tap my stock portfolio.
Of course, I made sure to open a CD at an FDIC-insured institution. This way, I’m protected for up to $500,000 in deposits because it’s a joint account with my spouse. For an individual account holder, that limit is $250,000.
I also opened a 5-year CD because I expect the Federal Reserve to start cutting interest rates later this year. And once that happens, I anticipate that CDs will start paying less. So I wanted to lock in a CD rate of upward of 4% — which I did — while rates that high were still available, and for a longer period of time.
I won’t earn as much on my money, but that’s okay
I’m not going to share the amount of money I put into a CD. But to illustrate how much less I’m making with a CD versus stocks, let’s assume I made a $20,000 deposit. At 4.5% over five years, my balance should end up at about $25,000.
Meanwhile, a $20,000 investment in stocks at 10% over the next five years would give me a balance of a little more than $32,000. So in this scenario, you could say that I’m “losing out” on $7,000.
But I’m not really losing out, because I’m basically getting $5,000 risk-free. With stocks, I’m taking on risk. That risk can be more than worth it in the long run, but I’m not looking at the long run. I’m looking at having to pay for college about five years from now.
I still have the bulk of my kids’ college savings in investments. But in the next couple of years, I plan to shift some of that money out of stocks and into cash. I also hope to add to my cash savings for college purposes with my 2024 earnings.
When you’re saving for a milestone that’s far off, like retirement, taking on the risk of stocks absolutely makes sense. But as a general rule, I like to tell people not to invest in stocks if they’re saving for a goal that’s less than five years away.
I’m more or less within that window on the college front — which is shocking, because wasn’t I just bringing my oldest child home from the hospital and trying to figure out how to put on a diaper? But the reality is that I’m at a point in my savings window where I need to play things safe to some degree. So opening a CD is a move I stand behind.
These savings accounts are FDIC insured and could earn you 11x your bank
Many people are missing out on guaranteed returns as their money languishes in a big bank savings account earning next to no interest. Our picks of the best online savings accounts could earn you 11x the national average savings account rate. Click here to uncover the best-in-class accounts that landed a spot on our short list of the best savings accounts for 2024.
We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.
“}]] Read More
