The pros and cons of CD investing
Key takeaways
- CD investing offers a return without any loss, since CDs are a type of savings deposit account.
- These accounts are insured at banks that are members of the Federal Deposit Insurance Corp. (FDIC), so even if a bank goes under, you’re guaranteed your money, up to a certain amount.
- If you want access to your money right away or you only have a little bit of cash to get started, CD investing might not be right for you.
Investing isn’t just stocks, bonds and other financial securities traded in public markets. You can earn money without the risk of losing any through certificate of deposit (CD) investing.
CDs may not be the most exciting investments, but it’s their safety and predictability that make them attractive. Consider adding CD investing to your portfolio, whether you’re a risky investor or a conservative one.
Pros of CD investing
1. Safety
CDs from federally insured banks and credit unions are backed by the full faith and credit of the U.S. government up to $250,000 per depositor, per insured bank, per ownership category.
“The return of your money is more important than the return on your money,” says certified financial planner Buz Livingston of Livingston Financial Planning in Santa Rosa Beach, Florida.
According to the Federal Deposit Insurance Corporation (FDIC), the independent government agency that protects funds deposited in banks, no one has ever lost a single cent invested in CDs it backs. Even if a financial institution is forced to close its doors, your money is safe up to the insured limit.
2. Better APYs than savings deposits
Because CD account holders can’t take their money back at a moment’s notice like savings account holders can, CDs are more valuable to banks than savings deposits. Banks often pay CD investors a higher yield in exchange for locking up their money for a set term.
Now that the Federal Reserve has maintained its key borrowing benchmark in July at the range of 5.25-5.50 percent, investing in CDs continues to be appealing. The best one-year CD pays slightly less than the best high-yield savings account, so locking in a competitive rate with a CD could be beneficial.
3. Fixed, predictable returns
Unlike other types of deposit accounts or investments, savers can count on fixed-rate CDs to deliver a specific yield for a specific time.
Even if interest rates fall precipitously in the broader economy, a fixed-rate CD, opened at a time when rates were high, will provide the same APY for the full term of the CD. That guaranteed rate of return makes it easy to do the math and calculate how much interest you could earn through the end of your term, which could be helpful when assessing your financial plan.
4. Wide selection of terms
CDs are available in an assortment of maturities and yields from thousands of banks and credit unions. You can find CDs with terms typically ranging from three months to five years, some as short as one month and others as long as 10 years. This diverse set of options helps investors find a CD that fits their needs.
Top CD APYs peaked near the end of 2023, but you can still find CDs that earn competitive APYs. Savers who invest in CDs now, especially by building a CD ladder, can take advantage of such high yields, before the Fed is expected to cut back its benchmark federal funds rate in September, which could cause CD rates to fall in turn.
5. Wide selection of account options
Investors interested in CDs also have unique CD options. Some banks offer no-penalty (or liquid) CDs, which are ideal for savers who want to snag a decent interest rate with the option to close the account — if needed — without incurring an early withdrawal penalty.
Other CDs you might come across include step-up and bump-up CDs and jumbo CDs as well as add-on CDs that allow more than one deposit. If a traditional CD isn’t a good fit, there may be another option that meets your short-term financial needs.
6. Laddering opportunities
A CD ladder is when you open many CDs at once with different maturity rates. For instance, if you have $5,000, you can put $1,000 into each of the following:
Then, when the CDs mature, you can reinvest those funds into a new CD. You don’t have to put equal amounts into each account, especially if you earn a higher APY on shorter-term CDs as opposed to longer ones. You can also divide up CDs at different financial institutions based on the ones that give you the highest APY and have the fewest eligibility requirements and fees.
Cons of CD investing
1. Early withdrawal penalty
One major drawback of a CD is that account holders can’t easily access their money if an unanticipated need arises. They typically have to pay a penalty for early withdrawals, which can eat up interest and can even result in the loss of principal.
“During times of uncertainty, liquidity is often paramount. This liquidity could be used for buying opportunities in a distressed market, or could even be essential for covering spending needs so that other long-term investments don’t need to be sold,” says Alex Reffett, principal and co-founder of East Paces Group in Atlanta.
Though buying a CD is a good way to earn interest on cash that might otherwise be stagnant, consumers must weigh CD yields and terms against a potential need for liquidity.
One way CD investors can increase their flexibility is to create a CD ladder made up of CDs of differing maturities, so portions of your CD savings will be available at regular intervals.
For example, you could build a CD ladder with three rungs: six months, one year and two years. The shorter-term CDs give you access to some of your cash sooner so you can take advantage of higher rates in the future. The longer-term CD lets you earn the higher yields that are being offered now.
2. Inflation risk
Locking your money in fixed-rate CDs carries the danger that your money could lose its purchasing power over time if your interest gains are overtaken by inflation.
“You are going to be exposed to inflation any time you lock your money up in a fixed-rate investment,” says Michael Foguth, founder of Foguth Financial Group in Brighton, Michigan.
3. Comparatively low returns
Though the yields tied to CDs are often more favorable than they are for other more liquid bank accounts, returns are typically lower than they are for higher-risk asset classes such as stocks and ETFs. This presents a problem of opportunity risk.
“If something comes along that offers a real opportunity to grow your money and your money is tied up in a CD, then you lose,” says Lamar Brabham, chief executive officer and founder of the Noel Taylor Agency in North Myrtle Beach, South Carolina. “Safety alone is not the only thing to take into consideration.”
A look at historical CD interest rates over the past 30 years shows they have had their ups and downs. In the mid-1980s, five-year CDs boasted yields exceeding 11 percent. More recently, rates were trending mostly downward, falling to very low levels during the COVID-19 pandemic. But, the Federal Reserve raised rates aggressively between 2022 and 2023, causing rates on competitive CDs to increase considerably.
CD rates can vary a great deal among banks, so it pays for investors to shop around. The average five-year CD currently earns 1.44 percent APY, while the best five-year CD rates are more than three times that rate.
4. Reinvestment risk
When an investor locks in a CD rate, there is a possibility that when the CD matures, yields will have dropped, and if they choose to reinvest, it would be at a lower APY — a result known as reinvestment risk.
Creating a CD ladder of varying maturities with terms on the shorter end of the spectrum is one way to combat reinvestment risk; it allows investors to take advantage of higher rates as their CDs mature.
5. Tax burden
Another downside for CD investors is the taxes they’ll owe on the accrued interest, which can eat into yield and cause cash flow mismatch problems.
As long as you’re aware of the impact taxes could have on your savings, it’s possible to plan ahead and make adjustments, as needed.
Should you get a CD in 2024?
It’s certainly worth considering adding a CD to your savings portfolio, especially if you feel uncertain about investing in the stock market or any future market turbulence. With CD rates higher now than they were a few years ago, now might be the best time to capitalize and lock in rates before they potentially drop. But the time window to do so might be narrower than you think, as the Fed is expected to lower interest rates this fall, whereby CD APYs could drop, in turn.
Bottom line
Factor in the pros and cons of CDs if you’re looking for a safe place to keep your money, and look at which institutions are offering the best CD rates.
Regardless of what’s happening in the U.S. economy, don’t be swayed by fear and anxiety when it comes to investing in CDs. Instead, consider your time horizon (how soon you’ll need the CD money) and your financial plans and goals before you determine whether a CD is right for you.
—Freelance writer Dori Zinn contributed to updating this article.
