Are CDs Worth It? – NerdWallet
Certificates of deposit have traditionally had the highest interest rates among bank accounts, with the best rates once reaching 2% to 3% over the past decade. But many CD rates fell in 2020, and some banks lowered their CD rates lower than their savings account rates.
In this low bandwidth environment, are CDs worth it? The answer is, it depends on your short term savings goals. Here’s a look at the pros, cons of CDs and when they may be right for you.
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Benefits of investing in CDs
1. CDs are safe investments.
Like other bank accounts, CDs have federal deposit insurance up to $ 250,000 (or $ 500,000 in a two-person joint account). There is no risk of losing money in a CD unless you withdraw early.
2. CDs have fixed rates and predictable returns.
Once you open a CD, you lock in a rate. This lets you know exactly how much money you’ll be making over the life of your CD, whether it’s months or years. In contrast, banks and credit unions can change the rates on regular savings accounts at will.
3. CDs provide a variety of terms that can structure savings goals.
CD durations typically range from three months to five years, so they can be tools to set aside some of your savings for future purchases during that time. In general, the longer the duration, the higher the CD count. And the shorter the duration, the more frequent the opportunities to withdraw or renew a CD.
Disadvantages of investing in CDs
1. You lose access to money from a CD.
You can think of CDs as locked storage boxes for a chunk of your money. Once you’ve placed a lump sum in a CD for a fixed term, you can’t add or remove any until the day the term ends, known as the expiration date. If you break the lock early, it can get expensive. (For more details see how CDs work.)
2. CDs have early withdrawal penalties.
Breaking a CD before it matures usually results in a penalty, which can range from several months to a year of interest. In some cases, the penalty may include some of the money you originally deposited. (See our article CD sanctions by bank for some examples.)
3. Having a fixed rate can mean missed opportunities.
Having a CD can mean hanging on to a high rate even when banks cut rates on savings accounts and new CD deals, but the flip side is getting stuck with a low CD yield as you go. as rates go up. A fixed rate can be a blessing or a curse depending on how future rates fluctuate.
3 situations where CDs work best
CDs have historically offered some of the highest guaranteed returns among bank accounts, but that doesn’t automatically make them the best home for your savings or investments.
“You can play golf with a baseball bat, but it doesn’t work as well as clubs,” says Derek Brainard, director of education services at the Center for Education and Financial Capability at the AccessLex Institute. Likewise, “a lot of people think of CDs for their investment purposes, but they may not be the most suitable.”
CDs can work well in the following three scenarios:
1. Block savings for a short-term purchase
This can include savings for a down payment on a house or car you plan to buy within five years. Whatever the goal, the money will not be used until you are ready and can stay safe out of reach in CDs. (If you have savings goals but don’t want to lose access to your money, consider high yield savings accounts rather.)
2. Build up short-term wealth before investing
Short-term CDs, such as three months to two years, might come in handy if there is a plan to invest that money later. For example, some investors use a strategy called cost averaging in dollars, which involves spreading purchases of stocks or funds over time. In such a scenario, the money waiting to be invested could be held in CDs to potentially earn more interest than in a regular savings account.
3. Guarantee returns without market risk
Investing in CDs without having a future purchase in mind can make sense for those who want to avoid risking their money on the stock market.
But remember CDs are more for short term security than long term growth. For retirement savings, financial advisors often suggest a asset allocation this means holding more stocks than bonds or CDs when retirement is decades away, and switching to more bonds or CDs as retirement approaches, to minimize the risk of losing money. money.