Certificates of deposit, or CDs, offer a chance for you to keep your cash safe from loss of principal — and potentially earn a higher interest yield than what you’d get with a savings account.
With a CD, you commit to keeping your money locked up for a set amount of time, and a bank or credit union rewards you by paying a higher yield. The flipside, however, is that you could end up with penalties and fees if you withdraw your money early.
Before you incorporate CDs into your investment strategy, here are a few things to keep in mind:
CD rates are declining
CD rates are influenced by interest rate moves by the Federal Reserve. The U.S. central bank’s key rate has been pegged at zero percent since March 2020 in an effort to stimulate the economy during the COVID-19 crisis, and subsequently, CD rates are low.
Morgan Blackman, a wealth coach and investor and founder of Holistic Bucks Coaching, says monetary policy is focused on keeping interest rates low to encourage people to borrow instead of save. When people spend money, it keeps the economy moving, so Blackman doesn’t see rates rising dramatically anytime soon.
There are exceptions. Fred Jacobs, education specialist at Ent Credit Union, Colorado’s largest credit union, points out some financial institutions try to offer higher rates than their competitors in an effort to attract new deposits. Even with the desire to bring in new deposits, however, rates remain relatively low.
Pros of investing in CDs
- Potentially higher yield than savings accounts
- Principal remains protected
- With a CD laddering strategy, it’s possible to add long-term stability to a portfolio
Cons of investing in CDs
- Money isn’t as liquid as a savings account
- Penalties for withdrawing money early
- Yields don’t always beat inflation
When investing in a CD is worth it
One of the biggest reasons to use CDs is for security. You don’t have to worry about losing your principal because the money is usually held in an insured account.
“If you don’t need access to your money for several years, a longer-term CD would typically provide a substantially better return than keeping your money in a standard savings account,” Jacob says.
For those looking to keep a portion of their portfolio in a principal-protected investment for the long-term, using a laddering strategy — in which your CDs mature at different points — can be one way to add stability.
CDs can also be useful for short-term savings needs of six to 18 months. Blackman points out that locking up some of your money in a CD can prevent you from dipping into your funds for other purposes and making sure the money goes to the proper goal.
When investing in a CD is not worth it
While CDs are stable and safe, the reality is that you might not get the best return for your money. On top of that, both Jacobs and Blackman point out, even with a high yield, you’re not likely to beat inflation with a CD investment.
So, while CDs can provide some guaranteed returns over time and some level of security, it’s not likely to provide you the returns needed to build wealth for retirement over time. Instead, it might make more sense to build wealth with other assets and only use CDs for a portion of your portfolio.
Alternatives to CDs in 2021
Rather than investing in CDs, Blackman suggests looking into government bonds, such as Treasury Inflation-Protected Securities (TIPS), which provide some protection against inflation while being fairly safe.
“Consider low-risk mutual funds as well,” Blackman says. “They aren’t as risky as stocks, but they can still yield better returns than CDs.”
Jacobs suggests looking into money market accounts and mutual funds, as well as bonds and dividend-paying stocks.
Finally, another option that might make sense is a fixed annuity. If you already have a large chunk of capital and are looking for something stable, a fixed annuity might provide better returns than a CD.
“The most important factors to consider are your risk tolerance and how potential returns compare among CDs, stocks, bonds, mutual funds, and other products that would provide you with a rate of return for your money,” Jacobs says.
As part of a portfolio that includes cash, CDs can provide stability and security. However, CDs are unlikely to provide you with the returns you need to build wealth for the future or live off the interest — unless you already have a large amount of money and ladder your CDs to avoid penalties.
“I recommend speaking with a financial adviser to compare your options,” Jacobs says. “Discuss your risk tolerance and timelines, and determine the best products for your individual situation.”