Certificates of deposit may not be the most exciting investments, but it’s their safety and predictability that make them attractive, especially in times of economic uncertainty.
After 11 Federal Reserve rate increases and with top CD yields outpacing inflation, it’s a great time to consider CDs or a CD ladder.
You won’t get rich investing in CDs, but if you’re looking for a place to park funds for a specific period, and you value a guaranteed rate of return, a CD is worth considering — just keep these tips in mind.
Pros of CD investing
CDs from federally insured banks and credit unions are backed by the full faith and credit of the U.S. government up to $250,000 per depositor, per insured bank, per ownership category.
“The return of your money is more important than the return on your money,” says certified financial planner Buz Livingston of Livingston Financial Planning in Santa Rosa Beach, Florida.
According to the Federal Deposit Insurance Corporation, the independent government agency that protects funds deposited in banks, no one has ever lost a single cent invested in CDs it backs. Even if a financial institution is forced to close its doors, your money is safe up to the insured limit.
2. Better returns 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 typically pay CD investors a higher yield in exchange for locking up their money for a set term.
Now that the Federal Reserve has maintained its key borrowing benchmark at the range of 5.25-5.50 percent, investing in CDs continues to be appealing. The best 1-year CDs pay more than the best savings accounts, so locking in a competitive rate with a CD could be beneficial.
3. Fixed, predictable returns
Unlike other types of deposit accounts or investments, savers can count on CDs to deliver a specific yield at a specific time.
Even if interest rates fall precipitously in the broader economy, your rate will remain constant for the full CD term. That guaranteed rate of return makes it easy to do the math and calculate how much interest you could earn through the end of your term, which could be helpful when assessing your financial plan.
4. Wide selection of terms
CDs are available in an assortment of maturities and yields from thousands of different banks and credit unions. You can find CDs with terms ranging from one month to 10 years. This diverse set of options helps investors find a CD that fits their needs.
Given the rising interest rate environment we’re currently in, savers who invest in CDs now, especially by building a CD ladder, can take advantage of better yields.
5. Wide selection of account options
Investors interested in CDs also have unique CD type options. Some banks offer no-penalty (or liquid) CDs, which are ideal for savers who want to snag a decent interest rate with the option to close the account — if needed — without incurring an early withdrawal penalty.
Other CDs you might come across include step-up and bump-up CDs and jumbo CDs as well as add-on CDs that allow more than one deposit. If a traditional CD isn’t a good fit, there may be another option that meets your short-term financial needs.
Cons of CD investing
1. Limited liquidity
One major drawback of a CD is that account holders can’t easily access their money if an unanticipated need arises. They typically have to pay a penalty for early withdrawals, which can eat up interest and can even result in the loss of principal.
“During times of uncertainty, liquidity is often paramount. This liquidity could be used for buying opportunities in a distressed market, or could even be essential for covering spending needs so that other long-term investments don’t need to be sold,” says Alex Reffett, principal and co-founder of East Paces Group in Atlanta.
Though buying a CD is a good way to earn interest on cash that might otherwise be stagnant, consumers must weigh CD yields and terms against a potential need for liquidity.
One way CD investors can increase their flexibility is to create a CD ladder made up of CDs of differing maturities, so portions of your CD savings will be available at regular intervals.
For example, you could build a CD ladder with three rungs: six months, one year and two years. The shorter-term CDs give you access to some of your cash sooner so you can take advantage of higher rates in the future. The longer-term CD lets you earn the higher yields that are being offered now.
2. Inflation risk
CD rates tend to lag behind rising inflation and drop more quickly than inflation on the way down. Because of that likelihood, investing in CDs carries the danger that your money will lose its purchasing power over time as your interest gains are overtaken by inflation.
“You are going to be exposed to inflation any time you lock your money up in a fixed-rate investment,” says Michael Foguth, founder of Foguth Financial Group in Brighton, Michigan.
Rising rates favor savers over borrowers, but when inflation is high like it is now, consumers must consider whether tying up their cash is worth it.
3. Comparatively low returns
Though the yields tied to CDs are generally more favorable than they are for other more liquid bank accounts, returns are typically lower than they are for higher-risk asset classes such as stocks and ETFs. This presents a problem of opportunity risk.
“If something comes along that offers a real opportunity to grow your money and your money is tied up in a CD, then you lose,” says Lamar Brabham, chief executive officer and founder of the Noel Taylor Agency in North Myrtle Beach, South Carolina. “Safety alone is not the only thing to take into consideration.”
A look at historical CD interest rates over the past 30 years shows they have had their ups and downs. In the mid-1980s, five-year CDs boasted yields exceeding 11 percent. More recently, rates were trending mostly downward, falling to very low levels during the COVID-19 pandemic. But, as the economy has recovered, CD rates have been creeping up since June 2021.
With CD rates at their highest in more than a decade, it pays for investors to shop around. In December 2022, the average five-year CD had an annual percentage yield of 1.08 percent. But nine months later, there are several five-year CDs paying almost four times that, according to Bankrate’s national survey of banks and thrifts.
4. Reinvestment risk
When an investor locks in a CD rate, there is a possibility that when the CD matures, yields will have dropped, and if they choose to reinvest, it would be at a lower APY — a result known as reinvestment risk.
Creating a CD ladder of varying maturities with terms on the shorter end of the spectrum is one way to combat reinvestment risk; it allows investors to take advantage of higher rates as their CDs mature.
5. Tax burden
Another downside for CD investors is the taxes they’ll owe on the accrued interest, which could make earnings virtually nonexistent. The same issue comes into play with savings accounts, too.
As long as you’re aware of the impact taxes could have on your savings, it’s possible to plan ahead and make adjustments, as needed.
Is a CD worth it?
A CD is worth it if you have money you won’t need for a while. It’s also worth it if you want to earn a fixed APY. Those who feel like the Federal Reserve is near the end of its current rate-raising cycle might want to deposit money into a long-term CD.
A CD won’t give you the potential returns of certain investments. But those investments could also potentially lose all of their value.
Regardless of what’s happening in the U.S. economy, don’t be swayed by fear and anxiety when it comes to investing in CDs. Instead, consider your time horizon (how soon you’ll need the CD money) and your financial plans and goals before you determine whether a CD is right for you.
–Matthew Goldberg contributed to updating this story. Amanda Dixon contributed to a previous version of this article.