How to Invest With CDs

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CDs have gotten a lot more interesting this year, following a series of federal interest rate hikes

With interest rates topping out around 3% APY, certificates of deposit aren’t the most exciting investment vehicle on the market — especially considering the much higher historic annual return you can get investing in the stock market. Plus, they have fixed terms and interest rates that can further limit your flexibility and earnings. But CDs can also provide security and a guaranteed return that other account types won’t.

If you’re thinking about putting away some cash in a CD, here are a few advantages and disadvantages you should consider:

Pros of CD Investing

Security

Sometimes, peace of mind is worth more than high returns. If you’re not too worried about growing your cash and simply looking for somewhere safe to park it for a period of time, a CD is a great option. 

Up to $250,000 of deposited cash in a CD is FDIC-insured (or NCAU-insured if you open a CD with a credit union), so even if the bank fails, your money is safe.

Plus, you don’t have to worry about any losses to your principal due to market fluctuations like you might in a riskier investment account. Just make sure you’re familiar with any penalties you may incur for early withdrawal—though even these typically apply to earnings, not principal.

Different Types of CDs

Another advantage of CDs is the wide range of options, which can help eliminate some of the drawbacks of traditional CDs. Whether you’re looking for a no-penalty CD, a CD that allows contributions beyond the initial deposit, or even the option to take on a bit of market risk in exchange for higher interest, there’s no shortage of CD types to suit your specific goals.

To offset the downside of locking your cash in for a fixed term, a no-penalty CD may be an especially good option for savers today, since they offer added flexibility.

“They’re a nice middle ground option for people,” says Adam Stockton, director of consumer pricing at Novantas, an advisory firm for financial institutions. “Everyone has to make the trade-off of how much they value the rate versus the access to their funds, but it can be a best of both worlds option in some cases.”

Variety of Term Lengths

In addition to customizing your savings through different CD types, you can also compare CD term lengths to suit your goals. While a CD requires locking your money away until your maturity date, the freedom to choose your term length can help guarantee a timeline that aligns with your goals—whether that’s three months or five years.

Cons of CD Investing

Penalties

Perhaps the biggest downside of CDs is the potential to incur penalties. If you put your money into a CD for a fixed term, but circumstances change and you need access to your cash before the term matures, you’ll likely face a penalty for early withdrawal.

The good news is this penalty doesn’t often cut into your principal balance. Instead, you’ll forfeit some or all of the interest you’ve earned up to that point. Because potentially higher interest is one of the biggest reasons to open a CD over a more flexible option, like a high-yield savings account, for example, consider this before locking in your term.

Less Liquidity

Locking money away in a CD might not be the best option for everyone. If you’re looking for somewhere to store your emergency savings fund, for example, which you’ll want to keep highly accessible, a more liquid high-yield savings or money market account is a better option. 

Especially for younger savers, high-yield savings accounts are a better bet than CDs, says Lamar Watson, a financial planner and founder of Dream Financial Planning in Reston, Virginia.

“Most folks in their late 20s to early 40s, they’re going to look to those accounts for an emergency fund,” says Watson, who works primarily with younger clients. “That’s something you don’t want to take any risk with. If they’re going to need this money for anything and their timeframe is less than five years, I just don’t feel comfortable recommending that they invest in CDs.”

Lower Returns than Investing

In exchange for the safety guaranteed by CDs, you’ll give up some return in yield on cash that you could potentially grow by investing in the market; for example, a sum you don’t plan to touch for 10 years directed to a brokerage account.

If the money going into your CD is designated for a specific, short-term purpose, such as a down payment or an upcoming vacation, keeping it in a lower-earning but secure CD is the right move. But you wouldn’t want to depend on CDs for long-term investments such as retirement savings, and lose out on the growth you can gain over time.

Fixed Interest Rates

Especially in a rising rate environment like today’s a CD with a fixed APY could mean losing out on potential interest earnings in the future. For example, if you open a five-year CD now at 3.5%, but rates keep climbing over the next year or so, you’d risk the opportunity to earn a better yield before your CD matures. 

But, of course, the opposite can be true when interest rates are falling. You could lock in a great APY before rates fall, then still benefit from those earnings while accounts with variable interest rates decrease. One solution than can help you weather changes is to integrate a CD ladder into your savings strategy. This allows you to divide your savings into multiple CDs which mature at different intervals, so you’re regularly able to take advantage of the best available rates; or, in a falling rate environment, enjoy having locked in higher rates in the past.