There’s no doubt that certificates of deposit are one of the safest investments out there. But like any other investment, CDs have strengths and weaknesses that investors should consider before tying up their money.
- Safety: CDs from federally insured banks are backed by the full faith and credit of the U.S. government up to $250,000. It amounts to bank-subsidized investment insurance and is a major benefit to CD investors.
- Better return than savings deposits: Because CD account holders can’t take their money back at a moment’s notice like savings account holders can, CDs are more valuable to banks than savings deposits. Banks accordingly pay CD investors a premium for locking their money up in the form of higher yields.
- Wide selection: CDs are available in an assortment of maturities and terms from thousands of different banks and credit unions. This diverse set of options helps investors find a CD that fits their needs.
- Fixed, predictable return: Unlike savings deposits, savers can count on CDs to deliver a specific yield at a specific time. Even if interest rates fall precipitouslyin the broader economy, your rate will remain constant for the term of the traditional CD.
- Limited liquidity: One of a CD’s major drawbacks is that owners can’t easily access their money if an unanticipated need arises. Usually they’ll have to pay a penalty, which can come in the form of lost interest or even a principal penalty. One way CD investors can increase their flexibility is to create a CD ladder composed of CDs of differing maturities, so portions of your CD savings will be available at regular intervals.
- Inflation risk: CD rates tend to lag rising inflation on the way up and drop more quickly than inflation on the way down. Because of that, investing in CDs carries the danger that your money will lose its purchasing power over time as your interest gains are overtaken by inflation.