Money you have socked away to cover emergency expenses should sit in a savings account. That way, you have easy access to it at all times.
But if you have money you don't need for emergencies, you might consider putting it into a certificate of deposit, or CD. The upside of going this route is that you'll commonly snag a higher interest rate on your money compared to a regular savings account. And the interest rate you sign up with is guaranteed throughout the term of your CD (whereas the rate on your savings account could fall at any time).
Plus, as long as you limit yourself to a $250,000 deposit and your bank is FDIC insured, your principal CD deposit is safe. So if you put $10,000 into a CD and your bank fails, you're guaranteed not to lose a dime of that $10,000.
But while CDs might seem like a risk-free endeavor based on all of this, the reality is that they can be more risky than you'd think. Here's why.
You could end up getting hit with a penalty
When you open a CD, you're committing to keeping your money there for a preset period. So if you cash out your CD early, you should expect your bank to impose a penalty.
Now, the extent of that penalty will hinge on where you bank and the duration of your CD. At Capital One, for example, CDs with a term of 12 months or less impose a penalty equal to three months of interest for cashing out early. Your bank might have a different policy, and it's always a good idea to ask about penalties before opening a CD.
You can minimize the risk of facing a penalty by laddering your CDs rather than putting all of your extra cash into a single one. In the case of a $10,000 deposit, dividing it into four and opening 12-month CDs in the amount of $2,500 each at three-month intervals will have portions of your money freeing up regularly. But even then, you risk an early cash-out penalty if your financial circ*mstances change and you need that money immediately.
You could lose out on growth
The nice thing about CDs is that you don't risk losing out on principal the same way you do by investing your money. But instead, you face another risk -- not meeting your financial goals in the long run due to limiting your money's growth.
Over the past 50 years, the stock market's average return, as measured by the S&P 500 index, is 10%. If you put $10,000 into CDs over the next 20 years that pay you 5% interest (which is feasible today but a high rate historically), you'll end up with about $26,500. Invest that money in stocks over 20 years at a 10% return instead, and you'll be looking at a little more than $67,000. That's a huge difference.
CDs are generally considered to be a risk-free option for parking your cash. But be mindful of these pitfalls before you commit to one.
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FAQs
You could lose out on growth
Are CDs more risky than stocks? ›
CDs are low-risk, low-return financial vehicles that are best suited for short-term savings and risk-averse investors. Stocks have higher potential returns and higher potential losses. They are suited to long-term investors who can ride out price fluctuations. Individual stocks vary greatly in their level of risk.
How safe are CDs right now? ›
CDs issued at federally insured banks and credit unions are protected by federal deposit insurance, meaning your money is protected up to $250,000 per depositor, per insured institution, per ownership category.
Are CDs safe in a market crash? ›
Yes, CDs are generally still safe even if a stock market crash occurs. CDs are a type of bank account. Many accounts offer a set rate of return for a specific timeframe that won't fluctuate.
Are CDs safer than treasury bills? ›
Security: Both CDs and Treasuries are very high-quality investments. CDs are bank deposits that pay a stated amount of interest for a specified period of time and promise to return your money on a specific date. They are federally insured and issued by banks and savings-and-loans institutions.
Why are CDs less risky? ›
Safety: CDs are often considered safe because they are typically insured up to certain limits by the Federal Deposit Insurance Corporation (FDIC) in the United States. This means that even if the bank goes bankrupt, your principal investment is protected up to the insured limit.
Why are CDs considered low risk? ›
Why are CDs considered low-risk? The return on a CD is tied to the interest rate you are offered. CDs usually feature fixed interest rates, which means overall volatility will not impact the performance of your savings. This is opposed to the price of a security, like a blue-chip stock.
Why am I losing money on CD? ›
The most common way people lose money through a CD account is by withdrawing their funds before the term ends. When you take money out of your CD account before the maturity date, you'll typically have to pay an early withdrawal penalty.
Why should you put $5000 in a 6 month CD now? ›
While longer-term CDs may tie up your funds for years, a 6-month CD allows you to access your money relatively quickly. If you suddenly need your $5,000 for an emergency or a more lucrative investment opportunity arises, you won't have to wait years to access your funds without incurring hefty penalties.
What is a downside of CDs? ›
Penalties: One of the main drawbacks of CDs is that in most cases you're locked into the maturity term. If you take money from the CD before it matures, you will get hit with a penalty fee equal to at least seven days of the interest earned or even more.
The risk of having a CD is very low. Unlike how the stock market or a Roth IRA can lose money, you typically cannot lose money in a CD. There is actually no risk the account owner incurs unless you withdraw money before the account reaches maturity.
Are CDs safe in 2024? ›
With higher APYs and possible interest rate cuts coming, certificates of deposit (CDs) could be worth adding to your personal finances in 2024. CDs are safe investments when you put your money in FDIC-insured banks (or NCUA-insured credit unions).
Should I buy a CD now or wait? ›
If you're in a position to save in today's higher interest rate environment, investments like CDs could help accelerate your savings. CD rates have skyrocketed since 2022: 1-year CD rates have increased more than twelve-fold, with 3-year and 5-year CDs up nearly six-fold and five-fold, respectively.
Are CDs safer than cash? ›
A CD is a safe investment that provides guaranteed returns for a fixed term. “It's a great way for consumers to save money at higher interest rates than you would get from traditional savings,” says Droesch, “and they're very safe.”
What is safer bonds or CDs? ›
CDs are usually best for investors looking for a safe, shorter-term investment. Bonds are typically longer, higher-risk investments that deliver greater returns and a predictable income.
Should you buy T-bills? ›
Whether you invest in Treasury bonds or bills depends on your time horizon and risk tolerance. If you'll need the money sooner, a Treasury bill with a shorter maturity might be best. If you have a longer time horizon, Treasury notes with maturities of up to 10 years might be better.
Is it better to put money in CD or stocks? ›
Stocks have an average return of about 10% per year, which is well ahead of current CD rates (generally 5% to 5.5%). Because CDs offer fixed interest rates, they're better for short-term financial goals where you don't want any risk of losing money.
Which is a safer investment a CD or a stock? ›
Putting money into a CD is safer than investing in the stock market. The returns are often higher when you invest in the stock market. Your financial goals will determine which option is best.
What is the biggest negative of investing your money in a CD? ›
The biggest disadvantage of investing in CDs is that, unlike a traditional savings account, CDs aren't flexible. Once you decide on the term of the CD, whether it's six months or 18 months, it can't be changed after the account is funded.
Should I move money from stock market to CD? ›
When deciding between a long-term CD or putting money in the stock market, always take into account your goals and how long you'll need to achieve them. For long-term plans like retirement, the market offers better returns than locking up your cash in a CD.
