Are CDs Worth It? Weighing the Pros and Cons

You may remember putting $50 in a certificate of deposit (CD) as a child and leaving it for five years. As a modern investor planning for savings goals, do CDs have a place? They certainly can offer value that a high-yield savings account, money market account or bond doesn’t. But the answer to the question, “Are CDs worth it?” depends on your investment and savings goals and situation. 

While CDs are not as attractive an investment option as they once were, they still have a place in a diversified financial strategy. Below, you’ll find the pros and cons of CDs to determine when they make sense for you. 

What Is a Certificate of Deposit (CD)?

A certificate of deposit is a type of savings account that holds a fixed amount of money for a set period of time, called a term to maturity. Usually, CDs are issued for three months to five years. Short-term CDs are less than a year, mid-term CDs are two to three years, and long-term CDs are issued for over three years.

You’ll receive the original capital invested plus interest when the CD reaches maturity. The interest rates of CDs vary. While you might think that the longer the term, the higher the CD rate, that’s not always the case. If you withdraw funds early on most CDs you’ll face penalties or fees, which are noted in the CD terms. 

The average interest rate for CDs is less than 1% annual percentage yield (APY), although some have higher interest rates for larger deposits. Five-year CDs have modestly higher interest rates, with an APY of up to 2.85%. That’s higher than a standard savings or checking account but lower than high-yield savings accounts or money market accounts. Some one-year CDs have an APY of up to 5.55%. However, you often need a larger deposit to earn higher interest rates.

CDs purchased through a federally insured bank are covered by Federal Deposit Insurance Corp. (FDIC) insurance up to $250,000, making them one of the safest savings options available. You can choose from various types of CDs, including:

• Traditional CD
• Jumbo CD
• High-yield CD
• Liquid CD
• Callable CD
• Zero-coupon CD
• Photo CD
• Bump-up CD
• Step-up CD
• Brokered CD
• IRA CD
• Foreign currency CD

While each has the same basic structure, they vary in terms. For example, a jumbo CD requires a higher minimum deposit but may also offer higher interest rates. A high-yield CD offers a higher interest rate. A liquid CD doesn’t have any penalties for early withdrawals, while a callable CD has a redemption option prior to maturity at a preset price by the CD issuer. 

Advantages of Certificates of Deposits

CDs have significant advantages that make them a key choice to protect long-term savings. 

Protected Principal

With a CD issued from an FDIC-insured bank or National Credit Union Administration (NCUA)-insured credit union, the principal is protected. While interest rates aren’t fantastic, you also don’t risk losing money. 

Fixed and Better Rates 

Fixed rates mean you know exactly how much you’ll earn and can build financial planning around those rates. Unlike speculative investment products, rates and terms of CDs are fixed.  Likewise, interest rates on CDs are often better than on traditional savings or checking accounts. 

Predictable Returns

Predictable returns mean you can build a secure financial plan, knowing exactly how much you’ll earn from the CD. The predictability and security are what make CDs an attractive option for storing cash reserves.  

Safe Investments

With FDIC or NCUA insurance of up to $250,000 for each account holder, account type and institution, a CD is a risk-free savings vehicle to protect your wealth and balance more aggressive or high-risk long-term wealth-building opportunities. 

Variety of Terms 

As it’s clear from the list of CD types, you can find CDs with various terms and interest rates. This gives you options to choose CDs with terms as little as three months or as long as five years, creating a flexible savings plan. 

Limitations and Risks of Certificates of Deposits

While certificates of deposits are often a preferred savings method, they’re not without limitations and risks, including:

Minimum Deposits

Many CDs require a specified minimum deposit. This can mean you may have to put in more than you’d like or tie up more money than you’d prefer. 

Early Withdrawal Penalties

With all CDs except for liquid CDs, you’ll have to pay penalties if you withdraw funds before the maturity term. CD penalties are usually expressed as a period of interest, such as 90 days’ interest or 18 months’ interest. The exact penalties depend on the CD terms. 

Less Liquidity

Funds are locked into a CD until the term finishes. Compared to a money market or high-yield savings account, which can offer higher interest rates with more liquidity, other savings vehicles make more sense if you need greater liquidity. While you can withdraw funds early, the penalties can mean that you lose the interest value. 

Missed Opportunities

With average CD interest rates, it’s difficult to beat inflation, especially in high-inflation years. The lost opportunity cost is significant. At a minimum, you want your money to earn more than average interest rates to preserve spending power, which isn’t the case with most CDs these days. 

When Do CDs Work Best?

Certificates of deposit work best for those with low risk tolerance or for holding cash short-term. Here’s what to consider:

Low Tolerance for Risk

If you have a low tolerance for risk or are saving funds for a short-term goal, a CD can make sense. If you don’t want to invest your funds, spreading savings across account types or institutions can make sense. But there are better low-risk savings vehicles where your money can earn more than inflation.

Financial Goal or Need in the Near Future

CDs work best when you have a financial goal in the near future, such as buying a car or paying tuition fees. Likewise, house down payments, a vacation fund for a special trip or other short-term savings can earn some interest while secured in a CD. 

For example, if you’re saving for a mortgage down payment in a year, putting funds in a CD until that time is an option. Likewise, if you’ve reached retirement and want to withdraw six months’ worth of expenses from investment accounts, putting half of it in a three-month CD is an option you can consider. 

But with current CD interest rates, a high-yield savings account or a money market account would be a better choice to optimize earnings and liquidity for short-term savings goals. 

Approaching Retirement 

Generally, when you’re younger with a stable income and a longer retirement timeline horizon, you can take a more aggressive, high-risk investment approach. As you get close to retirement many financial advisers suggest shifting your approach to lower-risk, conservative investment options. A CD can make sense for someone who wants to preserve their savings while generating income.

Simple and Straightforward Investment

For those craving simplicity with modest returns, CDs give you a viable option. Likewise, CDs make sense for someone just stepping into investment opportunities or if you want to teach children a buy-and-hold investment strategy. They are a simple and straightforward investment savings option. 

How to Maintain Flexibility of CDs

Some CDs offer better flexibility than others. If you need flexibility with your CD investment, consider these options: 

Look for a No-Penalty CD

A no-penalty CD gives you the benefits of reasonable interest rates with no penalty for early withdrawals. You get the flexibility of a savings or money market account with (potentially) higher interest rates. 

Use a CD Ladder

A CD ladder allows you to mix terms to maturity and interest rates to get the best of both worlds. For example, if you have $2,000 to invest in CDs, you might create a CD ladder strategy like this:

• $400 in a one-year CD with 5% APY
• $400 in a two-year CD with 4.5% APY
• $400 in a three-year CD with 4% APY
• $400 in a four-year CD with 4% APY
• $400 in a five-year CD with 4.3% APY

As each CD reaches maturity, you can use those funds for anything you want, including putting them in another CD, a savings account or other investments. 

Alternatives to CDs

If you’re considering alternatives to CDs to reach your savings and investing goals here are some of the best options:

High-Yield Savings Accounts

A high-yield savings account offers 3% to 5% APY with greater liquidity than a CD. You can withdraw funds at any time. While some savings accounts limit withdrawals to six per month, compared to a CD, that offers significant liquidity. These accounts are also FDIC-insured up to $250,000 per account holder, per institution, meaning your funds are protected. 

Choose a high-yield savings account instead of a CD when you need to access funds regularly or at higher interest rates with a lower minimum balance. 

Money Market Accounts

Like high-yield savings accounts, money market accounts offer 3% to 5% interest rates. Money market accounts also come with a debit card and, in many cases, checks, making it easy to use your savings. These accounts are also FDIC-insured up to $250,000 per account holder, per institution, meaning your funds are protected. 

If you need maximum liquidity or want to earn higher interest on your regular monthly expenses, choose a money market account. 

Bonds

Bonds are debt securities issued by the government or corporations as tradable assets. Like CDs, bonds usually pay a fixed interest rate to debt holders. Interest rates vary by type of bond and term to maturity. While bonds are low-risk investments, they are not risk-free. Interest rates may also be higher than average CD interest rates with low risk. Government savings (low-risk) bonds currently have an interest rate of 4.3%. 

Use bonds to balance risk in a portfolio with other high-risk investments like stocks or as an alternative to CDs when you want to earn a higher interest rate and don’t mind some risk. Check out some of the best online brokers for bonds. 

Mutual Funds

A mutual fund is a type of investment account. Unlike CDs, these investments carry risk. In a mutual fund, many investors pool money to purchase securities. Mutual funds are professionally managed to diversify risk and reach performance returns targets, making them a strong opportunity to earn higher interest rates than CDs or even high-yield savings accounts, but this isn’t guaranteed. 

Many mutual funds have investment minimums. While some mutual funds have no minimums, others require $500, $5,000 or $1 million to invest. Choose mutual funds for long-term growth and higher average long-term interest rates than CDs. When picking a mutual fund, look for mutual fund managers with a strong history of fund performance and a fund that matches your investment interests and goals. 

When are CDs worth it?

While CDs don’t always offer competitive interest rates, there are times when they are still a practical savings vehicle. If you have short-term goals, need a safe place to stash cash or can put a larger amount into a jumbo high-yield CD, using a CD as a savings vehicle still makes sense. In addition to investment accounts, individual retirement accounts (IRAs), 401(k)s, high-yield savings accounts and money market accounts, CDs are a tool you can use to save for short- and long-term financial goals. Consider also the best investments for people on a fixed income here.

Frequently Asked Questions