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CDs can be a great investment only in some circumstances. Read on to learn when to avoid CDs. [[{“value”:”
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If you open a CD right now, you could easily earn above 5.00% APY. But while that’s a pretty impressive rate for a risk-free investment, and it’s a guaranteed rate for the duration of the CD term, CDs aren’t a good idea for everyone.
Here’s why a certificate of deposit might not be a great investment for many, or even most, people — despite the competitive yields currently on offer.
CDs only make sense in very specific situations
Opening a CD makes sense if, and only if:
You can tie up your money without issue for the duration of the CD termYou don’t want to commit to keeping your money invested for around five years or more
CDs typically have term lengths that range from three months to five years. If you take money out early, you face a hefty penalty. It doesn’t make sense to open one if you won’t be able to leave your money in until the CD matures.
It also doesn’t make sense if you can leave your money invested for five years or more. That’s because if your time horizon spans at least five years, you’re better off putting your money into an S&P 500 index fund.
The S&P has historically earned 10% average annual returns (around double even the best CD rates available now) and a five-year time horizon is long enough that you’re likely to make money, even if you happen to invest at a bad time.
A five-year time horizon is long enough to wait out a potential market crash. Ideally, you’d stay invested through a recovery and make a profit, even if you have poor timing when you buy shares of an S&P 500 fund. There’s a risk of loss, but it’s pretty small, and the higher returns justify taking it.
CDs aren’t a fit for most people — but there are other options
Because CDs only make sense in the limited situations mentioned above, they’re not a good fit for most people. That’s because most of us don’t really have a lot of savings that we can lock up for exactly three months to five years exactly.
If you have emergency savings, you have to keep it accessible, so a CD won’t work. The same is true if you’re saving for expenses like car repairs or home repairs. And if you have major long-term goals like retirement or college savings for your kids, CDs don’t make sense for this either.
Now, if you’re saving for a house or a car you’ll be buying in a few years, a CD might be a good option — if you won’t need to make an offer sooner or access funds sooner if your current car calls it quits earlier than expected. In these situations, you’re also usually saving little bits of money over time. Unless you’re opening a CD every couple of months, it may not make sense even in this situation.
If you don’t happen to have any medium-term goals that make a CD a good investment, here’s what to do instead:
Put money you may need soon into a high-yield savings account. The Ascent has a list of close to a dozen savings accounts that pay 4.00%-5.00% APY right now. Most require low or no minimum opening balances, so open one today.Put money you won’t need for a while into a brokerage account and buy an S&P 500 ETF. Check out the best brokerage firms for ETFs to pick one. You can open your account online and use the ETF screener it offers to find a fund to invest in.
These options make better sense than a CD, even with today’s high rates. Now, if you do have money you won’t touch for three months to five years, The Ascent has a guide to the best CD rates that will help you find one that’s a fit. So, you can check that out, too — if a CD will actually work for you.
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