If you’re looking for a get-rich-quick scheme or a way to make easy money, then bank certificates of deposit may not be the investment for you. But if you’re looking to protect your precious savings and earn a guaranteed interest rate, read on. CDs are a more conservative investment than stocks and bonds, but you will always get your money back at the end of the investment period.
Pro: They’re a Safe Investment
Your investment is safe with a CD because a government agency, the Federal Deposit Insurance Corporation, insures it. If the bank fails, your money is protected up to $250,000. Your money is so safe, in fact, that no one has ever lost a single penny invested in FDIC-backed funds. CDs also protect you against interest rate fluctuations since the rate is locked in for the period of the deposit. If interest rates start to fall, your CD's interest rate won't be affected.
Con: No Access to Your Cash
A CD works by locking your money away for a fixed period, such as six months or three years. That period is called a term, and it ends on the "maturity date" when you can take money out. If you need to withdraw the money before maturity, you typically have to pay a penalty, which might be a fixed dollar amount, a percentage of your investment or the loss of a few months’ worth of interest. As such, a CD may not be the right investment for your emergency fund.
Pro: Better Returns than Savings Accounts
Because you’re locking your money away for a set amount of time, the bank will generally pay you a better rate of interest than with a regular interest-earning savings account. Account rates are not especially high in 2020 since the Federal Reserve is holding interest rates near zero. Shop around, though, and you should be able to find CDs returning 0.5 percent to 1 percent, which is better than your money being stagnant.
Con: Loss of Opportunity
Another snag you might hit with CDs is that returns tend to be much lower than for other types of investments such as stocks and exchange-traded funds. The S&P 500, an index of the 500 largest U.S. stocks, returns 7.96 percent per year on average, which far exceeds the rate you’ll get from a CD. So, while your money is safe in a certificate of deposit, it is not working as hard as it could be to maximize your investment returns.
Pro: Wide Selection of Accounts
CDs come in all shapes and sizes and are offered by thousands of different banks and credit unions. You can find CDs with terms ranging from one month to 5 years or longer – some banks, including Marcus by Goldman Sachs, are now offering no-penalty CDs, so you can withdraw your full balance whenever you need it.
Short-term CDs are great if you think you’re going to need access to the money in a few months' time, while longer terms tend to have better interest rates. There are plenty of options, so you’re sure to find a product that meets your needs.
Con: The Risk of Inflation
Locking a $5,000 nest egg away for two years at 1 percent interest is great if inflation is low, but what if inflation rises? In this scenario, your money may actually lose its purchasing power over the CD period as your interest gains are overtaken by inflation. Shorter-term CDs reduce this risk if you think the economy will change course in the near future.
Is a CD Right for You?
There are plenty of pros to CDs if you’re looking for a safe place to keep your money in the short term. On the other hand, if you're looking to grow your money over the long term, then bank certificates may not be the best investment. A good compromise might be to put a portion of your investment into a CD for protection, and the rest into riskier investments that potentially could offer a higher rate of return.
- Federal Deposit Insurance Corporation: Understanding Deposit Insurance
- Bank Rate: Fed Expects to Hold Rates Near Zero Until Economy has Weathered ‘Severe’ Virus Effects
- Business Insider: The Best CD Rates of September 2020
- Wealth Simple: Average Stock Market Return
- Marcus by Goldman Sachs: No Penalty CDs
- Bankrate: The Pros and Cons of CD Investing
Jayne Thompson earned an LLB in Law and Business Administration from the University of Birmingham and an LLM in International Law from the University of East London. She practiced in various “big law” firms before launching a career as a commercial writer. Her work has appeared on numerous financial blogs including Wealth Soup and Synchrony. Find her at www.whiterosecopywriting.com.