Pros and Cons of CDs

A certificate of deposit, or CD, offers a low-risk way to help grow your savings, particularly in today’s high-rate environment -- but is it the right savings vehicle for your money?

When you open a CD, you lock in a fixed interest rate for a set time frame. And since CDs are usually insured, you won’t have to worry about the risk of losing your hard-earned savings. 

“CDs can be a good way to diversify your portfolio and reduce risk,” said Brandon Juodikis, certified financial planner and founder of BRJ Wealth Management.

But a few drawbacks may make you wonder if it’s the right place to park your cash. Most CDs come with early withdrawal penalties, making them less flexible than high-yield savings accounts. And most CDs only allow a one-time deposit -- which can be frustrating if you want to add money over time. Plus, the rate you lock in when you open the account is the rate you’ll have for the term -- even if rates go up. 

With rates higher than we’ve seen in recent years, there’s a lot to love about CDs. But it’s important to understand how they work and their key benefits and drawbacks before opening a CD account. 

How CDs work

Most CDs work like this: You make a one-time deposit and earn a fixed rate on your savings. You can choose the type of CD and the term that works best for you, but you’ll need to keep the money in the account until the term ends to earn all the interest. CD terms typically range from six months to five years, depending on the type of CD and your bank. If you need your cash sooner, you may pay an early withdrawal penalty, which costs between a few weeks’ to a few months’ worth of interest, depending on the bank. 

When your CD term ends, you can withdraw the balance (including interest) without paying a penalty. Or you can roll the funds into a new CD with a new rate and term. Many banks have a grace period that begins after your CD term ends. If you don’t withdrawal your funds during this period, they may be automatically rolled into a new CD.

Pros of CDs

Federally insured 

CDs (or share certificates, for credit unions) are considered safer investment options -- as long as the bank or credit union is insured by the Federal Deposit Insurance Corporation or the National Credit Union Administration. If so, your CD is protected for up to $250,000 per depositor, per bank. That means that if the bank fails, you won’t lose your deposit or any interest you earned -- so long as it’s under this amount, said Juodikis. Instead, your funds may move to the new bank that takes over, or you’ll get all of your money back from the FDIC or NCUA. 

Fixed interest rate 

Regardless of what happens with savings rates next, your CD rate is typically fixed for the duration of your term. CDs typically come with higher annual percentage yields, or APYs, than savings accounts because you’re locking your money up with the bank for a set period of time. And if you open a CD with an online-only bank, your APY may be even higher since these banks have fewer overhead costs, which means some of the savings get passed down to you in the form of above-average CD rates.

If you leave the money in the account until the term ends, you’ll be rewarded with a guaranteed return based on the rate when you open the account. As a bonus, you’ll know exactly how much money you’ll earn, Juodikis said. You can use a CD calculator to factor your term, deposit and APY to determine your final balance. 

Versatile account options

There are several types of CDs to choose from. For instance, you may choose a no-penalty CD which lets you withdraw your money without paying a fee. Other options include a bump-up CD, add-on CD and step-up CD. 

You also have term options to choose from. You may choose a one-year CD instead of a five-year CD to have access to your money sooner. Since you’ll have more account options, you can pinpoint the CD that’s best for each of your goals without too many limitations other than minimum deposit requirements and early withdrawal fees. 

CD laddering 

Building a CD ladder gives you the flexibility to open several CDs with different maturity dates. When one CD reaches maturity, you can cash out or continue to build your investment by opening another CD with a longer term and higher interest rate. 

“You can spread your money out amongst multiple CDs to ladder the maturity dates,” said Taylor Jessee, a certified financial planner and founder of Impact Financial. For example, if you have $10,000 you want to invest, you could buy three different CDs with different maturity dates. If you lock all $10,000 in a single one-year CD, but interest rates increase over the year, you may miss out on higher interest rates and won’t have access to any of the money until that one CD matures, said Jessee. 

You can choose different CD terms to build your CD ladder, but make sure you won’t need the money before the CDs mature because you’ll still be on the hook for early withdrawal penalties. And if rates go down, your CD ladder may not be as valuable, so consider all savings options before opening a new CD each time. 

Read more: How to build a CD ladder

Cons of CDs

Early withdrawal penalties 

Even though CDs are a low-risk way to earn a return on your money, you risk paying an early withdrawal penalty if you need to withdraw your cash early. 

“If you need your money back before the end of the designated term, you’ll either have to pay an early cancellation penalty fee, or you might be out of luck entirely and have to wait until the end of the term to get your money back,” said Jessee. “For that reason, you should not put money in a CD that there’s a chance you’ll need back before the term is over.”

Usually, the longer the term, the more you’ll pay. Otherwise, you’ll pay a few months’ worth of interest. These fees can eat up any interest earned and may even result in the loss of principal funds. 

Not all CDs have early withdrawal penalties though. If you’re worried about needing your funds sooner, consider a no-penalty CD or open a high-yield savings account instead.

Opportunity risk

Compared to riskier investment options, the rate of return on a CD is usually lower since it’s a safer investment. Even though CDs offer flexibility and security, your money may grow faster with higher-risk assets such as stocks, ETFs and mutual funds. 

“If your goal is to achieve higher returns, then usually investing in the stock market is the way to go,” said Jessee. But it also depends on your time horizon and risk tolerance. Of course, those are riskier instruments that are far more likely to decrease in value than a CD. 

It’s a good idea to talk to a financial adviser before investing directly in the stock market, to help explain your options and risk tolerance.

APYs could increase

One drawback to buying a CD is that if the prevailing interest rate increases, you are locked into your CD purchase, said Jim Eutsler, certified financial planner and wealth adviser at HCM Wealth Advisors. If you want to take advantage of higher rates, you’ll have to risk waiting until your CD term ends, hoping that CD rates will still be attractive. Or you may choose to break your CD early, but you’ll pay a withdrawal penalty that could eat away at the interest you’ve earned.  

Locking in an APY is generally a concern in an environment when rates are steadily rising because you may miss out on better rates that could come weeks later. But when the Federal Reserve plans to keep rates stagnant it’s best to lock in a rate before rates drop. It can also be concerning if you’re building a CD ladder when rates aren’t as attractive or moving up as quickly.

Correction: An earlier version of this article was assisted by an AI engine and it mischaracterized some aspects of CDs and savings accounts. Those points were all corrected. This version has been substantially updated by a staff writer.