If you’ve invested in any product tied to the stock market, you’ve likely lost money at some point. Investing is inherently risky, but the lure of big returns keeps investors going back for more.
When it comes to investing in certificates of deposit, the risks and returns tend to be less climactic than those of other investment vehicles. That’s because CDs are fixed-income investments, which means they typically pay a set rate of interest over a fixed period of time. In addition, CDs are comparatively flexible, liquid and FDIC-insured.
Risks of CDs
Like most financial products, CDs do carry some degree of risk, so you should make sure you know what they are before you invest in them. Some of the risks associated with CDs include:
- Early-Withdrawal Penalty: If you take your money out before the CD matures, you’ll likely be subject to some penalty fees, which can diminish your return, and in some cases, even your principal.
- Tax Liability: Your CD might be taxable at your normal tax rate, so make sure you check with a tax professional if this is a concern.
- Inflation: It’s possible for inflation to eclipse your interest earnings on a CD. If interest rates go down and your high-interest CD account matures, you might have to roll it over at the lower rate.
Potential Returns of CDs
A CD is really a savings product — so it’s a low-risk investment by design — but a CD can effectively help you build your financial worth. Some of the potential returns you can expect from a CD investment include:
- Higher Interest Rates: CD rates are typically higher than regular savings account rates. In addition, CD rates are predictable, which enables you to plan ahead.
- Rate Increase: If you buy a CD with a rate-increase option, you can usually switch to a better rate when it becomes available. The number of times you can exercise this option varies among financial institutions, but typically it depends on your CD’s term.
- No-Penalty Option: If you choose a no-penalty CD, you can withdraw all your funds — including the interest you’ve earned — without any early-withdrawal penalty.
Weigh the Risk vs. Return Potential Before Investing in CDs
As with any financial product, CDs offer a number of risks and returns. Although these safe investments will likely feature a better interest rate than a regular savings account, you stand the risk of paying penalties for early withdrawal. And although inflation can outpace your CD interest earnings, you might be able to switch to a higher interest rate if it increases, provided you invest in a CD that allows that.
Before you commit to a CD investment, be sure to speak with a financial advisor and have him walk you through all the details. Then decide for yourself what level of risk you’re comfortable carrying.