A, or CD, is a savings account that can be used to grow your savings — and get a higher interest rate than what’s available from some other types of accounts. With a CD, you deposit your money for a fixed period of time at a fixed interest rate, which is often higher than what you’ll earn from a standard . But your deposit will be inaccessible for a predetermined period of time. And if you need to withdraw before the end of that term, you will be subject to a penalty.
We break down all of the pros and cons of investing in CDs.
How CDs work
When you’re ready to invest in a CD, you’ll need to make a one-time deposit and choose a CD term. Your bank will typically offer a range of terms, from 28 or 30 days up to 10 years. The term is the length of time you agree to keep your money in the CD, and the annual percentage yield, or APY, is typically fixed, meaning you earn the same rate for the entire CD term.
You cannot withdraw the money you saved until the CD matures. Many banks automatically roll your savings into a new CD at the end of the term if you do not specify that you want to make a withdrawal. If you decide to withdraw money before the maturity date, you’ll likely face a penalty.
Pros of investing in a CD
Safe and secure
CDs provide one of the safest places to store your money because that money is insured. When banking with a federally insured bank and credit union, your money is insured by the Federal Deposit Insurance Corporation up to $250,000 per depositor, per account ownership type, per financial institution. Even in the case that your bank shuts down entirely, your CD savings will be protected by FDIC coverage.
Higher interest rate than saving accounts
CDs typically offer higher returns than savings accounts because CD account holders can’t withdraw money at any given moment without facing a penalty. Additionally, CD accounts typically yield a higher interest rate and APY compared to savings accounts.
It’s easy to withdraw money from a savings account because there aren’t any consequences aside from watching the balance drop.
Fixed rate of return
Since rates are typically fixed, your return is relatively predictable. With a CD account, you’ll be able to determine how much interest your CD will earn over time, and you never have to worry about market fluctuations.
More term options
There are more maturity and yield options available with CDs than with other savings options. CDs come with terms that range from one month to 10 years.
More account options
When it comes to selecting the right CD for your investment, there’s more to select from than just the traditional certificate of deposit. There are specialty CDs that offer more flexibility and better rates — even liquid (or no-penalty) CDs.
Other CD options may include a bump-up CD, step-up CD, zero-coupon CD, callable CD and many more. This offers a give-and-take scenario. When it comes to a liquid CD, be sure to consider whether or not it’s worth the convenience. It’s important to consider the right investment strategy that will ultimately meet your short- and long-term goals, while also maximizing the return.
With, you can simultaneously open multiple CDs with different dates of maturity. When one CD reaches maturity, you can cash out or continue to build your investment by opening another CD with a longer term and higher interest rate. By creating a CD ladder with varying maturities, you can leverage interest rates and build liquidity.
Cons of investing in a CD
Early withdrawal penalties
If you need the money in your CD before it matures, you may have to pay a penalty in the form of a flat fee or a percentage of the interest earned. Early withdrawals can eat up any interest earned and may even result in the loss of principal funds. If you’re looking for a lucrative way to grow your emergency fund, a CD account is probably not the best option.
May not keep up with inflation
The return on your CD may not keep up with inflation, which could make your money worth less over time. When inflation rises, the rate of return you’re earning on your CD may be outpaced. When, it’s important to consider the risk of locking up cash in a fixed-rate investment.
The rate of return tends to be lower the safer the investment. Even though CDs offer flexibility and security, your money may grow faster with higher-risk assets such as stocks, ETFs and mutual funds.
One of the biggest downsides when it comes to investing in a CD is the taxes you’ll owe on the accrued interest. While this is also the case with savings accounts, paying taxes on the accrued interest can make any profit earned appear nonexistent.
The bottom line
CDs can offer a safe investment option with guaranteed returns, but may have lower rates than other investment accounts. At the end of the day, it’s important to keep your savings goals in mind so you can determine what type of CD term will work best for you and your finances.