Despite how reliable CDs can be, they aren’t always the right choices when it comes to investing your money. Learn more about how CDs work, when opening one is an ideal investment, and what other options may be worth considering.
How Does a Certificate of Deposit Work?
A certificate of deposit (CD) is also known as a time deposit. The way a CD works is you agree to put a certain amount of money into a CD for a set period of time. Generally, you can’t remove the funds before the time period ends without paying a penalty. Once the time period is over, you can remove your funds from the CD or can choose to roll over those funds into a new CD. At the date of maturity, you will receive a fixed amount of interest. CDs have some unique advantages and disadvantages worth considering. To start, they tend to offer higher interest rates than normal savings accounts. Their guaranteed return also makes it easy to plan your investment’s growth. Most CDs are insured by the FDIC or NCUA (if you get yours from a credit union), and therefore are considered to be safe investments. On the flip side, CDs aren’t very flexible. You usually can’t remove your funds from the CD before the maturity date without facing a penalty. This can tie up your money for months or years at a time. If market conditions improve and interest rates on savings accounts and CDs go up, your funds might be tied up in a CD with a lower interest rate.
4 Reasons To Open a CD
Whether or not a CD is a good investment choice for you depends on your unique financial situation and market conditions. Let’s look at a few scenarios when opening a CD may make sense.
You’re Working Toward a Long-Term Savings Goal
CDs can be great ways to earn interest for near-term savings goals such as a down payment on a house or saving money to put toward a bigger investment in the near future. This investment option often makes more sense when you’re younger and working toward major financial milestones. For example, if you know you are a few years off from buying a home, putting your down-payment money into a CD can help you earn interest on your savings and grow the amount you’ll have when you’re ready to take the next step.
You Want a Low-Risk Investment
One of the reasons CDs are so popular is because they are known to be low risk and pay a guaranteed rate. If you buy them through a federally-insured bank, they are insured up to $250,000. Because of this security and the guaranteed return, CDs are low-risk investment options, which can make them good fits for growing money that has high stakes attached to it (like a college fund). Investing money in a brokerage account, for example, can be much more risky. While CDs might not offer as strong of a return as other investments, they are considered a conservative investment, which may be a trade-off worth making.
You Don’t Need Immediate Access to Your Money
CDs tie up your money for a set period, and there are penalties for early withdrawal that will eat into your returns. Accordingly, this investment may only make sense if you don’t think you’ll need to access your funds during the allocated time period. Be sure you have cash available for your needs before you stow money in a CD. There is a risk with CDs that inflation will grow faster than the funds held in a CD, which is another reason it can be frustrating to tie up money in a CD.
CD Rates Are Good
There are times when CD rates may be too low to serve as a worthwhile investment, so it’s a good idea to make an assessment based on market conditions. For example, if CD rates are at 0.1% when you go to open one, it wouldn’t make sense to lock into that rate for five years when market conditions are likely to improve during that time. If the CD rates are sky-high at 10%, you would likely want to lock in an investment at that amount.
Alternatives to CDs
A CD is just one savings and investment option available to you. Here are a few other options you may wish to consider:
Money market account: A money market account often is more flexible than a CD since you can withdraw funds from it up to six times a month. High-yield savings account: A high-yield savings account works like a normal savings account but offers a higher interest rate and may come with other benefits, such as no fees or a low account balance.
Are CDs Worth It?
Whether or not a CD is worth it depends on where you stand financially and current market conditions. If a CD comes with a high interest rate and you don’t need to access your funds for a set period of time, it can be a safe and effective way to grow your money. If current CD rates are low or you need more liquidity, you may want to pursue a more flexible investment option instead. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
