:max_bytes(150000):strip_icc()/20171019_172018-5a12f5cdbeba3300373b7964-3d8c34a5e28d41cdb3c4e2df355329f4.jpg)
:max_bytes(150000):strip_icc()/IMG_0136-KatieMiller-984cc095e6ff4bf69e90b71a18e626fd.JPG)
:max_bytes(150000):strip_icc()/me-eb8cbda9691b4e53820b28cc0c7a990a.jpg)
Certificate of deposit (CD) accounts can be used to grow savings for short-term and long-term goals. The best CD rates can offer advantages over savings or money market accounts. However, there are some potential downsides to consider, like early withdrawal penalties, high minimum deposit requirements, and more. Before opening a CD account, looking at the pros and cons is helpful.
Key Takeaways
- A certificate of deposit (CD) is a savings account that pays a fixed interest rate to savers.
- CD advantages include the potential to earn higher interest rates and the option to use a laddering strategy.
- You may be penalized for taking money out of a CD account before it matures.
- It's important to compare CD rates, terms, and penalties before opening one to fund your savings goals.
What Is a Certificate of Deposit (CD)?
Certificate of deposit (CD) accounts are time deposit accounts offered by traditional banks, credit unions, and online banks. This type of account pays a fixed interest rate, so you know exactly what you'll earn when the term is up. You also can roll your money plus the interest into another CD as soon as the first one matures, a strategy known as CD laddering.
CD terms can vary depending on where the account is opened. For example, you might choose a CD with a maturity term as short as 28 days or as long as 10 years.
The minimum deposit to open a CD may range from $100 to $25,000. Jumbo CDs require $50,000 or $100,000 minimum deposits. CD rates can also vary by the financial institution, with online banks typically offering higher rates than brick-and-mortar banks.
Bank-issued CDs are often insured by the Federal Deposit Insurance Corporation (FDIC), while those issued by credit unions are often insured by the National Credit Union Association (NCUA).
This means CDs, on the whole, are safe places to keep the money you want to save. There is an exception for brokered CDs, which brokerages sell. These CDs, which can be traded on the secondary market, may not be FDIC-insured.
Pros and Cons of CDs
Safety and security
Widely available, varying types
Higher rates
Guaranteed returns
CD laddering options
Early withdrawal penalties
Inflation risk
Lower returns than other investments
Limited liquidity
Requires research
:max_bytes(150000):strip_icc()/pros-and-cons-of-cds-5223947-final-ce4e60ecbcfa4aa196a1691d1fcf32be.png)
Investopedia / Julie Bang
Pros of CDs Explained
Are CDs worth it? They can be if you can get a great rate of return on your money. Here are the main pros of using CDs to grow your money.
- Safety and security: You can save money in a CD without worrying about a stock market plunge or other risks. CDs come with fixed interest rates and FDIC or NCUA insurance, which could protect your money even if your bank fails.
- Widely available, varying types: You can find CDs at banks and credit unions. Beyond traditional CDs, specialty CDs include no-penalty CDs, step-up CDs, and more.
- Higher rates: Saving in a CD could yield a higher interest rate and annual percentage yield (APY) than a high-yield savings account or traditional savings account. The rates earned with a CD depend on where you open it and the type of account.
- Guaranteed returns: CD accounts can offer fixed rates. This means there's virtually no guesswork about how much you'll earn on your money, even if other interest rates go down.
- CD laddering options: Laddering CDs means buying multiple CDs with varying maturity terms and interest rates. This approach creates flexibility since CDs can mature on a rolling schedule, and you're less at risk of missing out on higher rates over time.
Important
FDIC and NCUA protection is limited to $250,000 per depositor, per institution for all accounts open there.
Cons of CDs Explained
What's not great about CDs? There are a few key points to keep in mind before opening one.
- Early withdrawal penalties: One of the main drawbacks of CDs is that, in most cases, you're locked into the maturity term. If you take money from the CD before it matures, you will get hit with a penalty fee. This typically amounts to a few months of your interest earnings.
- Inflation risk: Inflation is an extended period of rising consumer prices. It can be challenging for CD rates to keep up when inflation increases steadily. Your earned savings have less purchasing power.
- Lower returns than other investments: CDs offer limited returns if you want to build wealth. You can often get better returns for your money by putting it into the market and buying stocks, mutual funds, or other investments instead—as long as the market is on an upswing.
- Limited liquidity: Without a CD laddering strategy, you can't take money out whenever you wish and avoid a penalty. Your access will be more limited than what you'd get with a savings or money market account.
- Requires research: Before you open a CD, shop around. Compare any minimum deposit requirements, early-withdrawal penalties, other conditions, and the best rates you can find. For example, rates for a 6-month CD can differ from an 18-month CD.
Note
Some banks and credit unions offer no-penalty CDs, which can allow you to withdraw money early without triggering a penalty.
Frequently Asked Questions (FAQs)
Is It Good to Invest in CDs?
CDs can be a good place to save money that you don't plan to spend right away if you're interested in a safe way to earn interest. Keeping all of your money in CDs, however, could mean missing out on the chance to earn higher returns elsewhere.
Are CDs Safe if the Market Crashes?
Compared to stocks or other securities, CDs are a relatively safe investment since your money is held at a bank. The biggest risk to bank CDs is usually an interest-rate risk, as federal rate cuts could lead banks to pay out less to savers.
Is a CD or IRA Better?
CDs are designed for shorter-term savings goals, and you pay taxes on interest earned. An individual retirement account (IRA) is a type of savings account specifically used for retirement planning. A CD is better for saving, and an IRA is better if you want to invest for retirement while enjoying some tax breaks. However, it's possible to combine the best of both worlds and open a CD in an IRA, too.
The Bottom Line
Keeping some money in a CD account is something to consider as part of your overall savings plan. Start by looking at CDs with your bank, then branch out your search to include credit unions and online banks. Also, consider whether a laddering strategy is something you might want to try if you're concerned about rates rising or falling over time.