If you’re weighing the pros and cons of a certificate of deposit, you’re not alone. While CDs aren’t as common as savings accounts or mutual funds, they’re worth considering based on your investment goals and risk tolerance.
CD Pros and Cons at a Glance
Pros
- Guaranteed returns
- Safety and security
- No market risk
- Flexible options
Cons
- Limited liquidity
- Lower returns compared to other investments
- Inflation risk
- Opportunity cost
What Are Certificates of Deposit?
A certificate of deposit is a savings account that locks up your money for a set period — typically ranging from a few months to several years — in exchange for guaranteed interest rates.
- Fixed terms: Common term lengths include 6-month, 1-year or 5-year terms.
- Earns interest: You’ll receive guaranteed interest over the full term.
- Early withdrawal penalties: Taking money out early usually results in a fee, so it’s important to plan ahead.
Certificate of Deposit Pros and Cons
Understanding the full picture of certificate of deposit pros and cons is key before deciding if this savings option fits your goals. Here’s a breakdown of what to know.
Pros of a Certificate of Deposit
1. Guaranteed Returns
One significant advantage of CDs is their higher interest rates and guaranteed returns, which can significantly exceed those of other savings options.
With a CD, your money isn’t just resting in your account but actively working for you, multiplying over time. The catch is that you must leave it untouched for the agreed-upon term. If you’re prepared for this commitment, CDs can serve as growth catalysts for your savings.
2. Safety and Security
The rock-solid security of a CD allows you to invest with confidence, sidestepping potentially drastic drops in the market that other types of investments might fall prey to.
Here are some key points to keep in mind:
- CDs are a good option for conservative investors seeking peace of mind or those approaching retirement who don’t wish to gamble their hard-earned savings on volatile investments.
- The Federal Deposit Insurance Corporation guarantees CDs, insuring your investment up to $250,000. This means your funds remain secure and untouched, even if your bank faces insolvency or bankruptcy.
- CDs provide a guaranteed return on your investment, allowing you to focus on your financial goals without fear of catastrophic losses. With a CD, you’re not merely investing your money — you’re also investing in tranquility.
3. No Market Risk
Financial markets are often volatile, with stock prices rising and falling at a dizzying pace. This unpredictability might deter some potential investors. CDs offer a comforting counterpoint to this volatility, promising predictable reliable returns.
Once you deposit your money in a CD, you lock in the interest rate. It remains fixed and immune to market influences, allowing you to anticipate how much you’ll earn from your investment.
4. Flexible Options
You can find CDs in a wide variety of term lengths.
- Short-term: 90-day or 6-month CDs
- Medium-term: 1-year or 3-year CDs
- Long-term: 5-year to 10-year CDs
Some banks also offer jumbo CDs for larger deposits.
Good To Know
Including CDs in a diversified portfolio can help offset potential losses from riskier investments. The safety and predictable returns of CDs can provide stability during market downturns.
Cons of a Certificate of Deposit
1. Limited Liquidity
Lack of liquidity is a significant drawback of CDs.
When you commit to a CD, you enter into a financial agreement that doesn’t allow for early withdrawals without incurring a penalty. These penalties can range from a loss of interest earned to being left with a fraction of your original investment.
In such scenarios, the liquidity of checking accounts can be an appealing alternative.
Be Mindful of Emergencies
CDs require you to lock up your funds until maturity. If a financial emergency arises, you may not be able to access your money without paying an early withdrawal penalty.
Always consider whether you might need access to your savings before committing to a CD.
2. Lower Returns Compared to Other Investments
CDs are an easy way to get started with investing in comparison to stocks, bonds and mutual funds. The returns, however, could be smaller.
Knowing that you have a fixed rate almost guarantees you’ll be getting back a gain investment once the term ends. Whereas, a stock investment, for example, may rise and fall with the market.
On an upswing, you could potentially have more to gain with a stock investment vs. a fixed-rate CD.
3. Inflation Risk
If you’ve secured your finances in a CD to steadily grow your wealth, but inflation rates start soaring, tranquil waters can turn into rough seas. Your fixed-interest-rate CD might be insufficient to keep up with inflation.
Though often overlooked, inflation can be a significant drag on your savings.
- When the rate of inflation outpaces the returns on your CD, the purchasing power of your gains diminishes.
- In essence, your money won’t stretch as far as it used to.
- This makes your well-calculated returns less rewarding in terms of real-world buying power.
- While the predictability of CD returns can be comforting, keep an eye on inflation trends before committing your funds to a CD.
4. Opportunity Cost
CDs keep your money safe — but sometimes too safe. While your funds are tied up, you could miss out on higher returns from stocks, bonds or mutual funds.
Riskier investments may outperform CDs, but they also carry more volatility. Weigh your goals and timeline before locking in a CD. In some cases, safety could mean sacrificing higher growth potential.
When Is a CD a Good Choice?
A CD is a good choice for many reasons. Say you need to save up in six months’ time for a vacation. You could lock away the funds in a six-month CD. That will prevent you from spending that money and earn a guaranteed interest rate. It’s a safe choice if you’re a risk-averse investor.
Another way to use a CD is to diversify your investment portfolio. A stock investment is a bit more volatile than a CD, since stock prices fluctuate with the market. Allocating your funds in different ways could be a smart move since you’re not invested in a single type.
FAQ
Here are the answers to some frequently asked questions about CD accounts.- What is the minimum deposit required for a CD?
- The minimum deposit required will depend on the bank or financial institution you choose.
- Many banks allow you to open CDs without requiring a minimum opening deposit. Some of these include Ally and Barclays. Marcus by Goldman Sachs is an example of a bank where you'll need at least $500 to open a new account.
- Can I withdraw my money from a CD early?
- Yes, you can withdraw money from a CD early, but you may have to pay early withdrawal penalties.
- If you need more flexibility here, try opening a no-penalty CD account. Marcus by Goldman Sachs offers a few options with rates up to 3.95%.
- How do CDs compare to high-yield savings accounts?
- You can earn interest on both CDs and high-yield savings accounts, but the right choice for you boils down to how quickly you'll need to access your funds.
- You can withdraw from your high-yield savings account any time you need, while a CD is locked away for a certain term. However, that rate is locked in for that term, whereas the high-yield savings account interest rate could change at any point.
- Is a no-penalty CD worth it for flexibility?
- Yes. Having a no-penalty CD might be worth it if you want to have a locked-in rate of return, but need a bit more flexibility when you'd like to withdraw your money.
Explore More on CD Accounts
- What Is a Certificate of Deposit?
- How To Open a CD Account in 4 Simple Steps
- How Do CDs Work? Start Stacking Your Savings
- How Much Money Should You Keep in a CD Account?
- What Is a CD Ladder? What You Need To Know
- Best CD Accounts
Melanie Grafil and Caitlyn Moorhead contributed to the reporting for this article.