Certificates of Deposit (CDs) are a type of savings account that allows you to earn a high fixed interest rate for locking up your funds for a set period of time.
CDs offer a safe way to invest your cash while earning more than your regular checking or savings account — some are currently paying over 5% APY
But are CDs worth it?
With some account restrictions and possible penalties, CDs aren’t for everyone. We’ll cover the pros and cons of CD accounts, show you how much you can make, and also be clear on who they are NOT for.
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- CDs allow you to deposit funds and pay out a fixed interest rate over a set period of time.
- There are usually early withdrawal penalties for accessing funds from a CD early.
- CDs are currently paying out nearly 5% APY, depending on the term length chosen.
- CDs are seen as a risk-free investment, as they don’t lose money (unless you withdraw early) and they are FDIC-insured.
How CDs work
CDs are deposit accounts that allow you to earn interest on a set deposit amount, but you lose access to your funds for a period of time. The amount of interest you can earn is typically correlated with the amount of time your funds are locked away.
For example, a 6-month CD may pay 5.5% APY, while a 12-month CD pays 5.65%. But the best 5-year CDs are only paying around 4.6% APY.
While CD rates are typically higher for the longer term, the sudden increase in interest rates by the Federal Reserve has caused shorter-term to offer very high rates as well. 5-year CDs are now paying less than 1-year CDs, which is typically unheard of.
Once you choose a CD term length and deposit your funds, you will be unable to access those funds without penalty. Federal law requires a penalty of seven days’ simple interest if you withdraw funds within six days of deposit. But every CD has its own penalty terms, so it’s important to read through them before making a deposit.
Once the CD matures at the end of the term, you will receive your deposit back, plus interest earned within the CD as well. You can choose to roll the funds into another CD or withdraw the funds.
Read CIT bank review: Earn up to 5.05% APY
Pros of CDs
CDs provide a way to grow your money without subjecting it to the inherent volatility of the stock market and offer several advantages for savers and investors.
Risk-free returns
CDs are seen as one of the safest investments. Outside of an early withdrawal, which would be subject to an early withdrawal penalty, you cannot lose money on a CD. Plus, your funds are protected with FDIC insurance — up to $250,000 for individual accounts and $500,000 for joint accounts.
Higher rates
CDs typically pay higher rates than any type of savings account. This is because your funds are locked up for a while and the bank can use them to offer financial products to other customers. In return, CDs are now paying over 5% APY in many cases. This is a fantastic return with very little downside.
Lots of term options
While CDs do lock your money away for a while, there are many CD term lengths and options to choose from. This lets you create a savings plan that works with your goals and still earns a healthy return.
CDs laddering
One strategy for maximizing CD returns is called the CD ladder. The idea is to buy multiple CDs with different term lengths to extend your returns over time. For example, you can buy 1-year, 2-year, 3-year, 4-year, and 5-year CDs, giving you access to your funds each year while earning a great return over a longer period of time.
Cons of CDs
While CDs are a great way to earn interest on funds you don’t need access to for a while, they also come with some drawbacks that potential investors should consider:
They are less liquid
CDs pay great rates in exchange for locking your funds away. This means you can’t access your money during the term without paying a penalty. This makes them a poor place for emergency fund savings and money you need access to. Instead, use a high-yield savings account for your emergency fund.
Early withdrawal penalties
If you withdraw money from your CD, you will most likely be hit with an early withdrawal penalty. These penalties vary but usually result in lost interest earned.
High minimum deposits
Many CDs have a minimum deposit, with some requiring thousands of dollars to sign up. This can be a barrier to entry for many depositors, making it harder to earn the high rates CDs offer.
Returns aren’t as good as investing
While these are offering solid returns right now, over the long term, investing in the stock market produces stronger returns. And while 5% APY is great, it is barely keeping up with inflation currently, making the rate not as attractive as it looks.
Long-term rates are lower right now
In most markets, the longer your CD term, the higher the rate. However, because of the rapid rise in federal interest rates, short-term are offering higher rates than long-term CDs. For those hoping to benefit from longer-term CD rates, especially when building a CD ladder, this inversion can be costly.
When are CDs worth it?
CDs are great savings vehicles for future expenses that are far enough away that you won’t need access to the money in the meantime. While CDs don’t let you add additional funds once they are established, if you already have the money set aside, locking the funds into a CD can earn you extra money while you’re waiting for an upcoming expense.
With rates so high, these can be a great option for retirees who want a safe place to park their funds while still earning a solid return. For example, retirees who want to have a few years of money in cash set aside can utilize CDs as a way to earn money on those funds. If they create a CD ladder, as those CDs mature, they’ll have access to the funds needed for their living expenses, while the rest of their cash is earning up to 5% APY.
Finally, if you are simply a more risk-averse investor, CDs offer virtually risk-free returns that are insured by the FDIC. While it may not quite keep up with stock market returns over a long time period, with rates over 5% APY, CDs are now a viable fixed-income option that is safer than bonds and other investments.
When are CDs not worth it?
To put it plainly — if you need access to your funds, CDs are not a great option. Your funds will be locked up for months (or even years) and you'll likely be subject to an early withdrawal penalty if you need the cash before then. This means CDs are not an ideal place for accessible cash. While there are flexible CDs that allow you to withdraw without penalty, they pay a lower interest rate.
If you want to earn a higher interest rate than a regular savings account but don't want to be locked into a CD, consider a high-yield savings account. High-yield savings accounts can offer rates approaching 5% APY or more but give you more ready access to your funds than a CD account.
These are also not a replacement for long-term investing. While the rates are great right now, they could go down in the future. For a growth-oriented investment that outpaces inflation, investing in the stock market and other assets will outperform CDs.
FAQs
Is a CD a good investment?
CDs are a great place to park your savings that you don’t need access to. Shorter-term (one year or less) are now paying up to 5% APY or more, making them a decent option for earning money on your savings. But this does not outperform the stock market over long periods of time, and should not be your only investment for long-term goals, like retirement.
How much does a $10,000 CD make in a year?
With current CD rates around 5% APY for one-year terms, a $10,000 deposit can earn $500 in a single year. To figure out exactly how much your chosen CD can earn, multiply your total deposit by the interest rate. In our example, if you multiply $10,000 by 5% (0.05), you get $500.
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