The Truth About High-Paying CDs That No One Is Talking About

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CD rates have surpassed a two-decade high. But will CDs help you reach your savings goals? Find out the hard truth of CDs here. 

If you’ve been in the hunt for a house or borrowed money on a loan or credit card in 2023, then high interest rates have likely frustrated you. On the contrary, if you entered 2023 with savings and no debt, this has likely been a fun, fun year to save money.

The Federal Reserve’s federal funds rate, which sets the pace for the savings rate offered by banks, has reached a range of 5.25% and 5.50%. Likewise, today’s top-paying CDs have hit a range of 5% to 5.7%. Many of these CDs have short terms, like six months, which reflects the expectation that the Fed will start lowering rates in the near future. But, if you have extra savings, these short-term CDs could offer you a high rate that you might not find next year.

However, before you start locking money up into CDs, it’s best to take a step back and ask if it’s the smartest place for your money. If you’re saving for something that’s still a year or so away, like a vacation, a short-term CD could give you a little extra. But for bigger goals, like saving for retirement, I hate to break it to you, but — CDs just aren’t going to cut it.

Why high-paying CDs might not be worth it

Truth is, for most Americans, earning 5% isn’t going to change their personal finances significantly. In fact, it could work against them. Locking your money up for a guaranteed rate of return could mean missing out on opportunities to generate more wealth, like potential gains in the stock market.

Hands down, stocks and funds offer investors greater upside potential. You don’t even need to be risky: an ETF that tracks the S&P 500 could be sufficient to out-earn a CD. The S&P 500 has already appreciated by roughly 19% this year — far more than what any 12-month CD could have earned.

The stock market does have risks, but for investors with long time horizons, the S&P 500’s worst days are often more than made up for with the good ones. All in all, the total return of the S&P 500 since 1928 is 9.7% (this includes reinvested dividends). Factoring in inflation, that percentage comes down to 6.5%, which is still higher than today’s top-paying CDs, and even higher if we factor in inflation for CD rates.

What a CD offers that the S&P 500 can’t

Of course, it’s difficult to depend on figures derived from annualized rates of return, as the S&P 500’s yearly performances can vary significantly. For example, the S&P 500 dropped about 18% in 2022, while it had gained almost 29% the previous year in 2021. If you had started investing in 2021, you might still be feeling the pain from the bear market last year.

This is where a CD derives its greatest perk. You’re getting a guaranteed rate of return. When you lock into a 5% APY on a 12-month CD, you know you’re earning 5% for 12 months, assuming you don’t break your contract and wind up paying an early withdrawal penalty. It’s not as lucrative as stocks and funds, but it’s also not as gut-wrenching either.

Additionally, many of today’s CD rates are above the rate of inflation. Even though you have to factor in taxes on your CD earnings, many CDs can prevent your money from losing value, something stocks can target but can’t guarantee.

All of this is to say — there’s greater opportunity outside of CDs. But, inside them, there’s more certainty. Reflect on what you want your savings to accomplish, but don’t be afraid to say “no” to security if what you really need is a long-term investment. Today’s CD rates compared to last year’s may seem like a great deal. But when compared with a long-term investment, like stocks or ETFs, they could be a loss in opportunity costs.

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