Pros and cons of certificates of deposit (CDs) #CashNews.co

Opening a new certificate of deposit (CD) is a big commitment. You’re essentially putting away a good chunk of your cash for a set period of time to earn interest on your savings, usually at a higher rate than a traditional savings account. You can withdraw it early, but a CD usually has high penalty fees if you do this.

It’s a good idea to consider your full range of investment options before you choose a savings vehicle. A CD could be the perfect tool to help you reach your goals faster, or it could set you back on your journey.

So are certificates of deposit worth it? We’ll explain the pros and cons of CDs and other financial alternatives to help you make an informed decision about where to park your money.

Pros and cons of CDs

A CD is a good choice if you’re saving for a specific purchase that’s a long way off because you can pick a term length that ends near when you’ll need the money. Many retirees also use CDs to save money they won’t immediately need and avoid riskier investments in case of a financial downturn.

CD pros

• Higher interest rates: CDs are usually the highest-earning account type at most banks. And your CD rate will remain a fixed rate, even if market rates fluctuate in response to rate changes by the Federal Reserve.

• Deposits are insured: The Federal Deposit Insurance Corporation (FDIC) insures accounts held at banks and the National Credit Union Administration (NCUA) insures accounts held at credit unions up to $250,000 per depositor, per ownership category.

• Helps you resist the temptation to spend: Having a lock on the CD can help you ensure you don’t withdraw your money before the CD matures to avoid an early withdrawal penalty.

CD cons

• High minimum deposit requirements: Most financial institutions require a sizable minimum deposit for CDs. Although, there are several types of CDs with various term lengths. You should ask your financial institution what their minimum deposit requirements are.

• Early withdrawal fees: Some banks only require you to forfeit your interest, but others charge high early withdrawal fees that can eat into your deposit. When considering a CD for your savings needs, you should think about your time horizon so that you can avoid dipping into your funds before your CD’s maturity date.

• May earn less if rates increase: Although a fixed CD rate feels like a low-risk way to grow your savings, you could hurt your long-term saving potential. If rates go up after you open the account, you’ll be stuck earning a lower rate until the end of your CD term, which could make your timeline for hitting your savings goals a lot longer.

CDs vs. savings accounts

Savings accounts are one of the most basic accounts you can find at any bank or credit union. Since fewer withdrawal restrictions exist, they’re a good way to store your liquid cash reserves. They make great choices for emergency funds and general-purpose savings.

High-yield savings accounts are another safe way to grow your savings and they offer you the ability to withdraw money penalty free. They also have lower minimum balance requirements, if any.

However, in many cases, they offer lower annual percentage yields than CDs.

Go deeper: What is a high-yield savings account?

CDs vs. money market accounts

If you’re looking for a higher rate of return on your savings, one account option that may be more comparable to a CD than a savings account is a money market account. These can also be great choices to park your liquid cash reserves, especially if you want quicker access to the money.

Money market accounts are insured by the FDIC, tend to offer higher APYs than savings accounts and you can write checks or use ATMs. They often have considerably higher minimum deposit requirements.

Go deeper: CD vs money market account, what’s the difference?

CDs vs. investing

For most people, investing in stocks, bonds, or other higher-risk assets is recommended to save for your far-away financial goals, such as retiring or paying for your child’s college. That ensures you earn the highest return possible but still have time to recover when significant market downturns inevitably happen.

Investing pros

• Highest potential for long-term gain: The stock market typically generates higher returns than a CD — about 7% per year.

• Easier access to your money: You’ll need to sell your investments to use the cash, but this usually doesn’t come with early penalties like CDs do.

• Security investments insured by Securities Investor Protection Corp: This protects you if your brokerage firm goes under. It does not protect you if your investment value declines or if you invest in something that’s not covered by SIPC insurance.

Investing cons

• Taxes can be confusing: The IRS treats some investment returns differently than the interest you earn from a CD or other deposit account. For example, you may pay short-term or long-term capital gains tax depending on when you buy and sell stocks.

• Highest potential to lose money: One of the downsides of investing is that with greater potential rewards come greater risks. For example, the stock market declined by 56% from 2007 to 2009.

• Steep learning curve: It takes time to educate yourself so you can pick good investments.

If you’re interested in opening a CD, consider the offers from the federally insured issuers below: