Are CDs a Safe Investment?
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Summary:
Stashing some money into certificates of deposit (CDs) is considered as safe as the cash you keep in your savings and checking accounts. Therefore, CDs are considered a very stable investment, albeit not the most lucrative investment strategy. However, when the economy is in a downturn, and the stock market isn’t performing well, some investors may turn to CDs to help balance out their portfolios.
There are so many ways to invest your money that it can be difficult to sort out which ones are the best for you. A lot of it depends on your financial goals, your age, and your tolerance for risk. And it’s never a bad idea to talk to investment professionals before making any serious financial decisions.
Read on to learn more about certificates of deposit, the pros and cons of CDs, and whether or not they fit into your investment or savings goals. We’ll also take a look at a few alternatives to buying CDS.
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What is a certificate of deposit?
A certificate of deposit (CD) is kind of like a savings account that you can’t touch for a while. Instead of having easy access to the cash, you deposit a lump sum of money in exchange for, typically, higher interest rates than you could expect to get with other deposit accounts such as savings accounts or money market accounts.
The main difference between a certificate of deposit account and your savings account is that in order to get the full annual percentage yield (APY), you usually have to leave your money in until its maturity date. Typically the terms run anywhere from three months to ten years.
If you choose to take it out before then, you’ll typically have to pay early withdrawal penalties. That being said, there are some online banks (and a few brick-and-mortar banks) that allow you to make early withdrawals before the CD matures without paying a penalty. CDs often require a minimum deposit of $500 or $1,000, but some have no minimum deposit.
Also, CDs normally get fixed interest rates, although there are “step-up” CDs or “bump-up” CDs where you can request an increase from your original interest rate prior to the maturity date. This allows you to take advantage of possible fluctuations in the interest rate without having to open up a new CD account.
If this sounds like your ideal investment option, start comparing CD accounts with our comparison tool below.
Are CDs safe?
Certificates of deposit are safe, fixed-income savings instruments because your CDs are federally insured by the Federal Deposit Insurance Corporation (FDIC). And, just like your regular savings account, the FDIC insures up to $250,000. If your CD or savings account is for more than $250,000, anything over that deposit amount will not be covered by the FDIC insurance coverage.
Similarly, if your savings accounts, money market account, or CDs are held by credit unions, you’re also insured by the federal government up to $250,000 through the National Credit Union Administration (NCUA). The only real difference between the two types of federal insurance is what type of financial institution you use, be it a bank or credit union.
IMPORTANT! Keep in mind that if you are investing or saving more than $250,000, you would want to have two separate accounts so that each account is fully insured against any disaster.
It’s also good to understand that the FDIC insurance, or NCUA insurance, was put in place to protect your money in case a bank fails, which is rare. In any case, your money is as safe in any of these accounts as if you had physical possession of the cash — safer, actually.
Plus, CDs are not vulnerable to market swings, so they are far safer than stock market investments, for example. They do generally have a low yield, however, so even though they’re perfectly safe, you can’t make a lot of money from buying CDs. You may even lose purchasing power Still, you can’t lose money if you invest in CDs, which can be very attractive to more conservative investors.
Pro Tip
The only real “risk,” which is true of any deposit account, is having too much money in CDs where you don’t earn enough interest to outpace inflation. This simply means you could lose purchasing power over time.
Should you buy CDs as an investment?
Investment professionals would typically advise that CDs are a safe but very conservative investment option. You will typically get better interest rates with CDs than you would with other saving instruments like money market accounts or savings accounts, but you’re still not going to make a pile of money.
Having said that, CDs might have a place in your portfolio. First, it’s important to think about your financial goals. For example, if you’re years away from retirement, buying CDs as part of your retirement portfolio doesn’t make a lot of sense. The younger you are, the more aggressive you can afford to be, and the interest earned from other investments is generally going to be higher compared to CDs.
On the other hand, if you are nearing retirement age — and the market is in a downturn, for example — a CD is a safe place to park your money to help offset the losses. Another reason to buy CDs is simply if your approach to earning interest is more conservative than some investors, regardless of your age.
You may also want to buy CDs if you’re saving for something in the short term and don’t want to tie up your money for very long. Maybe you’re saving for a down payment on a house or buying a new car. In that case, if you don’t need the money for a year or two, a CD can be a great way to save money and earn a little interest in the meantime.
CDs from brick-and-mortar banks vs. online banks
Depending on your perspective, you may be wary of buying CDs from an online bank as opposed to more traditional financial institutions, but there should be no cause for concern. In fact, there are distinct advantages to investing in CDs online rather than with traditional banks.
For one thing, you can often find more competitive interest rates with online banks, largely due to the low overhead that these financial institutions have. If their costs are lower, they can afford to pass on some of those savings to consumers in the form of higher interest earnings.
Do your due diligence first to make sure the online bank you use is part of the FDIC-insured network, but chances are good that it is. Other than that, it’s important to ensure the online bank is taking the necessary steps to keep your data safe, such as using encryption technology and multi-factor authentication.
Alternatives to investing in CDs
As previously mentioned, CDs are safe but not very lucrative. They also may not be the right choice for you for other reasons. For example, maybe you want to be earning interest while having ready access to your cash. Or perhaps you’re saving for retirement and prefer to get more earned interest than a CD can accomplish.
High-yield savings accounts
Particularly online, a high-yield savings account can be a great way to take advantage of more favorable interest rates than traditional banks. Plus, it gives you full access to your money at any time you need it without any early withdrawal penalties.
While having a high-yield savings account isn’t an investment, per se, it’s a great place to stash your cash while still earning interest.
Stocks
Investing in the stock market is a riskier investment than CDs, but it has the potential for much bigger returns. Whether you’re a day trader or just trying to beef up your investment portfolio, stocks can give you some of the highest returns of any investment option.
Make sure you work with a brokerage firm that understands your investment strategy and risk level before investing in stocks. You may find the brokerages below to be especially helpful.
Mutual funds and ETFs
If picking individual stocks isn’t exactly your forte, index funds such as a mutual fund or exchange-traded fund (ETF) might be more up your alley. Both options provide you with a basket of assets, therefore diluting your risk, while still providing a higher rate of return than you could get with a certificate of deposit.
The main difference to make note of is that mutual funds are executed only once a day, whereas ETFs are traded all day long with frequent price fluctuations just like individual stocks. Fortunately, there are several brokerages that specialize in index funds. If you aren’t sure how to start investing in mutual funds or ETFs, take a look at some of the brokerages below.
Pro Tip
If you want to invest in CDs, be sure to research multiple sources to find the best terms and interest rates, keeping in mind that you can often find better CD rates online than with traditional financial institutions.
FAQs
Are CDs safe if the market crashes?
Because a deposit account — such as a CD, savings, checking, or money market account — is federally insured, it’s not subject to the stock market’s ups and downs. If the market crashes, you won’t lose money.
CDs, however, are not immune to changes in the economy. As federal interest rates go up, CD rates tend to follow. Conversely, if interest rates are down, so are CD rates. This means that CDs actually can do better than the stock market during economic downturns.
What is a CD ladder?
CD laddering refers to spreading out your investment over multiple CDs with varying interest rates and maturity dates. Typically, longer-term CDs have higher interest rates, so you can invest in ones that make more money but take longer to mature, combined with others that don’t earn as much interest but will give you faster access to your cash if needed.
As you do this, and certain CDs become mature, you can choose to reinvest the money or cash out if you need to. You can set up a CD ladder on your own or, if you’re not comfortable with that, investing professionals or your chosen financial institution can offer you several different options.
Key Takeaways
- CDs are perfectly safe investment instruments because of insurance from the Federal Deposit Insurance Corp. for banks or the National Credit Union Administration for credit unions on deposit accounts.
- CDs typically have a higher APY than traditional savings accounts or money market accounts. However, you can’t usually touch the money before the CD’s maturity date without incurring an early withdrawal penalty.
- Depending on your financial goals, CDs are usually better for short-term investments when you’re saving up for something, don’t need the money for a year or two, and want to make a little more interest than you could with a savings account.
- For long-term investors, financial advisors might suggest alternative investment options to gain more interest earnings than CDs can bring in.
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