The Pros and Cons of Using CDs as Part of Your Investment Strategy

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CDs can be a great place to put your money, but there are drawbacks. Read on to find out how to wisely use CDs as part of your investment strategy. [[{“value”:”

Certificates of deposits (CDs) can be a great way to let your money grow over time without much risk. With many CDs offering annual percentage yields (APY) over 5%, many people are opting to put some of their money into a CD right now.

If you’re still deciding whether to open a CD, here are some pros and cons of these accounts and how to evaluate a CD if you choose to open one.

Pros of opening a CD

CDs offer you a low-risk opportunity to earn interest on your money. And while they won’t make you rich, there are some great reasons to put money into a CD right now.

1. It’s a guaranteed return

You know upfront what the APY is for the term of the CD, giving you the chance to calculate exactly how much you’ll earn over that period. For example, if you invest $5,000 in a 3-year CD that pays 5% interest, you’ll earn about $788 in interest over that period.

When you put your money into the CD and leave it there for the entire maturity period, you’ll earn the guaranteed interest and get your initial deposit back. You can only earn less if you withdraw your money early (more on that below).

2. You pick the terms

Another great thing about CDs is that you can decide how long you want your money to be in them, what interest rate you want, and how much you’ll invest.

For example, you may only want to part with your money for a year or less, making a 6-month or 1-year CD a good option. Or perhaps you have $2,000 to invest, and you need a CD with a minimum deposit amount that fits your budget. Whatever your preference, there’s likely a CD that fits your needs.

3. They’re FDIC insured

There aren’t many places you can put your money, earn a return, and have your initial deposit be FDIC insured. But because CDs are a type of savings account, the government insures deposits up to $250,000 per FDIC-insured bank, per ownership category.

This makes having your money in a CD safer than putting it in a mutual fund, bonds, or stocks, which aren’t FDIC insured. While bank failures aren’t common, five occurred in 2023, so FDIC-insured CDs can give you peace of mind that your money is protected.

Cons of opening a CD

The cons of CDs are minor, but it’s still important to know them when evaluating whether to open an account. Here are three things you should be aware of.

1. Your money is tied up

One drawback of CDs is that once you put your money into one, you’re committed to keeping it there. Unlike a savings account, where you can access your money easily and without penalty, a CD has more restrictions.

If you take some of your money out early, you’ll probably be charged a penalty. For most CDs with terms of more than 24 months, you’ll be charged a penalty fee of 90 days of simple interest for the money you take out early. For CDs with longer terms, the penalty is typically 180 days of simple interest.

2. You might make more money in the stock market

CDs are a great place to grow your money and keep it safe, but having that safety means you may forfeit some earning potential.

For example, the average historical annual rate of return of the S&P 500 is about 10%, far higher than any current CD rate. If you choose a 5-year CD over investing in the stock market, you could lose out on potentially significant gains.

Of course, there’s no return guarantee when investing in stocks, and you can certainly lose money.

3. CD returns don’t always outpace inflation

CD rates are relatively high right now, but it’s possible that putting your money in a CD with a low APY won’t keep pace with inflation.

For example, the average 3-month CD rate in mid-2022 was less than 1%, far below the U.S. inflation rate of 8.3% at the time. If you put your money into a CD account and let it sit there when inflation is high, it could potentially lose a lot of value.

How to decide if you should open a CD

The Federal Reserve has said it may lower interest rates later this year, and if it does, that will eventually cause CD rates to drop. Many CDs offer 5% rates or higher right now, so opening one and locking in a high rate may be a good idea.

Here are a few things to consider before opening a CD:

Find an annual percentage yield (APY) that works for you and outpaces inflation.Choose a CD maturity length that fits your financial situation.Most CDs have a minimum deposit amount, so pick one that fits your budget.Read the fine print on early withdrawal fees so you know what to expect if you need to withdraw money.

CDs are great for investing your money relatively cheaply and with low risk. Just be sure you’ve considered all the details above before opening one so you can make the best decision.

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