Certificate of Deposit Pros & Cons

Certificate of Deposit Pros & Cons
••• Ryan McVay/Photodisc/Getty Images

A certificate of deposit is a defined, medium-term investment product you can typically get through banks and investment firms. With a CD, you invest a certain amount of money for a few years at a quoted interest rate. To get the full return on your investment, you can't redeem the CD until it reaches its maturity date.

Predictable, Significant Rates

A certificate of deposit is a low-risk, modest-yielding investment product. However, CDs yield much greater returns than you would gain by leaving your money in a savings account. As of September 2013, typical CD rates are right around 1 percent. If you invest $2,000 for three years, you would get a yield of $60 at the end of the term. While this isn't a huge amount, it is more than you would earn if you hold excess money in a savings account.

Safe Investment

CDs are safe, conservative investments. While the interest yield is significantly more than you get for a savings or money market account, a CD is just as safe. The Federal Deposit Insurance Corporation insures CD investments through member banks. This means that if you purchase a certificate through a bank that is robbed, or that closes, the FDIC covers your investment value. If you invest money in stocks or other volatile markets, you could lose most or all the money.

Poor Liquidity

The biggest drawback of a CD is its low level of liquidity. If you buy a three-year certificate, you are obligated to keep your money invested for the three years to avoid an early withdrawal penalty. Even though your $2,000 investment yields a greater return than investing in a savings account with a 0.1 percent return, you can't get to the money. Thus, CDs don't make sense if your money is a rainy day fund or amounts that you need access to at some point in the near term.

Inflation Concerns

A May 2011 Bankrate website article indicated that CDs typically lag other investment markets during periods of inflation. This fact means that you could invest in a CD at a decent interest rate, but you may miss out on opportunities for more profitable investments because you can't gain access to your money.