Security vs. Liquidity: Here’s What You Should Consider Before Investing in a CD

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In this moment of uncertainty and financial hardship, the appeal of stability is clear.

Certificates of deposit aren’t the most exciting bank accounts on the market, but they can provide security and a guaranteed return that other account types won’t. Still, CDs have limitations: their terms and interest rates are fixed and early withdrawal could cost you.

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 in which you don’t expect to need it, 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.

Fixed Interest Rates

Interest rates on deposits have taken a dive in 2020, and many banks continue to steadily lower their APY offerings on interest-earning deposit accounts. Locking in a fixed interest rate with a CD now can earn you a few extra bucks on your savings as rates fall on other account types. This is a benefit you should keep in mind for the future; locking in a fixed rate is a great strategy in an environment where rates are high but just beginning to fall.

Pro Tip

CDs can be helpful tools within your overall financial plan, but pick a CD that suits your savings strategy and specific needs for the money you plan to deposit wisely. In today’s low rate environment, CDs don’t offer much interest difference from more liquid high-yield savings options, so consider whether the tradeoffs are worth it for you.

Different Types of CDs

Another advantage of CDs is the wide range of options from which to choose. Whether you’re looking for a no-penalty version, one 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 high-yield savings account, for example, consider this before locking in your term.

Less Liquidity

The idea of locking your money away in a CD can be daunting, and 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 they’re 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 a 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.

Timing complications

Having money in a CD with a low APY could keep you from benefiting from additional growth when high-yield savings or money market APYs rise in the future. Given today’s rock-bottom rates, for example, if you open a five-year CD now, but rates begin climbing in two or three years, you’d risk the opportunity to earn a better yield in that environment. 

But this isn’t an easy scenario to predict. One solution 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.