4 Alternatives To CDs: Ways to Get Better Returns Than CDs
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Summary:
Though CDs are a great option for risk-averse investors, they do offer lower returns than most investment vehicles. If you’re looking for a way to earn more from your investments, you may want to consider bonds, dividend-paying stocks, peer-to-peer lending, or real estate investments instead. However, these higher returns also come with higher risks, so be sure you understand the potential downsides before making any final investment decisions.
A certificate of deposit (CD) is always a safe place to stash some money and earn a little interest in the meantime. However, the low risk also means low returns due to typically low interest rates, even though they do offer better interest rates than a traditional savings account. Still, there are a number of other investing vehicles that can earn more money than you can get with CD rates.
As with any investment decision, it’s important to assess your own risk tolerance, combined with your overall investment objectives. In order to take advantage of better returns than CDs, investors usually need to assume a bit more risk to reap those rewards.
Today, we’ll discuss a number of different investment options that can maximize your investment dollars and help you to reach your financial goals. In addition, we’ll take a look at some personal finance strategies to make the most of your income and achieve overall financial health.
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CD alternatives that (usually) offer better returns than CDs
CDs are not a bad investment, per se. After all, you get a guaranteed, risk-free return with a fixed interest rate in exchange for locking up your money for an extended period of time. The only real “risk” you run is incurring an early withdrawal penalty if you cash in early, and even that can be avoided with some thorough planning.
But there are more effective ways to get a better annual percentage yield (APY) and still maintain some liquidity. That being said, you’ll have to take on a higher risk than what’s required for simple CD investments.
Dividend-paying stocks
While everyone knows the stock market can be risky, it’s also one of the best ways to earn high returns and build up your retirement account. However, because of stock market volatility, it’s important to think of stock market investing as a long-term strategy rather than a get-rich-quick scheme.
Having said that, there are many companies that issue dividend-paying stocks, such as Verizon, Best Buy, Ford Motor Company, and Philip Morris, to name a few. Many established utility companies pay dividends as well and are usually considered safer in economic downturns.
Ideally, you can purchase a stock that not only pays dividends but also shows gains in its share price. Otherwise, you risk losing out on your principal investment. For example, even if shares of certain corporate stocks pay dividends, if you paid $50 a share six months ago and now the share price is down to $40, you’ve already lost 20% of your initial investment.
It can also be very tricky to pick individual stocks that pay out well. A safer way to invest in dividend-paying stocks is to buy into a mutual fund — an index fund or exchange-traded fund (ETF) — that holds dividend stocks. This way you can spread out the risk over multiple stocks. If you’re not sure where to start investing in index funds, try contacting one of the brokerages below.
Bonds or short-term bond funds
Bonds are another option to bring in a regular income stream. The three main types are municipal bonds, corporate bonds, and high-yield bonds, also known as junk bonds because of their higher interest rates but larger risk.
There are many variations of bond investments as well. This includes short-term bond funds, where the funds hold bonds that mature in less than five years. Although these are less vulnerable to interest rate fluctuations, they also have lower yields. Another option is an international bond fund, which could help an investor ride out U.S. stock market volatility at times.
More adventurous investors looking for bigger returns could look into emerging market bond funds, but those are much riskier than U.S. corporate or government bonds. Of course, the higher the risk, the greater the reward (if all goes according to plan).
Bonds can be attractive because they provide a predictable income stream. Most pay interest twice a year. Plus, if you hold the bond until maturity, you get the principal back, making them a good way to preserve capital and earn interest.
Bonds are usually considered more conservative investments than stocks, which generally carry bigger risks. With that in mind, they can be a good addition to an investment portfolio designed to produce long-term retirement funds. But it’s important to note that certain types of bond investments are not without risks as well because, unlike CDs, your principal is not always insured.
To make sure bonds or bond funds are best for your situation, speak with an investment advisor about the best way to finance your retirement.
Real estate
Real estate investing often offers the opportunity to reap better returns than you could get with CDs (and many other investments).
If you can swing a down payment on a rental property, for example, that’s a great opportunity. There is excellent potential to collect a regular income stream through traditional rental income or Airbnb-style short-term leasing.
If buying an investment property isn’t in the cards, you could try investing in real estate investment trusts (REITs). REITs make it feasible for anyone to invest in portfolios of real estate assets just like you would with stocks or mutual funds. However, with an REIT you don’t have to purchase or maintain a property of your own.
Related reading: For a more in-depth discussion about the benefits and drawbacks of real estate investing, take a look at our guide on the subject.
Peer-to-peer lending
Another option — for those with a higher risk tolerance — is peer-to-peer lending (P2P lending). This is where investors and borrowers come together for mutual benefit, essentially skipping the middleman of banks or credit unions as a lender.
How does P2P work? An investor deposits a sum of money into an account and loan applicants post financial profiles that are assigned various risk categories based on credit scores. As an investor, you can then choose who you’re willing to invest cash in and make offers. The website will set rates and terms and borrowers can decide whether to accept that much money on those terms or not.
Because the websites that offer P2P lending organize investing options in different risk categories, you can decide how much risk you’re willing to accept based on whether a borrower has good or bad credit. Obviously, you’ll get higher returns from those with less-than-perfect credit, but there’s also a substantially larger chance for default on the money invested.
Pro Tip
Some peer-to-peer lending sites also cater to specific types of loans, such as for small businesses, medical expenses, and real estate, for example. This gives the investor opportunities to not only choose based on the borrower’s creditworthiness but also the reasons for the loan.
Personal finance strategies
There are a few other things to do that, while technically not something to add to your investment portfolio, should be considered an investment in your current personal financial situation and your future. Once your immediate needs are in better shape, you can explore riskier investments to help build up your retirement accounts or reach other financial goals.
Paying off high-interest debt
Having student loan debt, mortgages, and car payments are pretty much a part of life, but lugging around a load of high-interest credit card debt doesn’t have to be. Paying off that credit card debt should be one of your highest priorities because those high interest rates really drag down your overall financial health.
Look at it this way: If you’re carrying a balance of $5,000 at an 18% interest rate while simultaneously investing another $5,000 in a CD earning an annual percentage yield of 3%, you’re not doing yourself any favors. Instead, take that $5,000 in cash and invest in yourself by paying off that high-cost debt today. You just saved 18% in interest payments.
Build your emergency fund
Having money set aside in an emergency fund is arguably just as important to your financial security as getting rid of that high-interest debt. If something unexpected happens, like a job loss, illness, or major expense, you risk getting back into high-interest credit card debt unless you have some emergency funds to fall back on. Most financial experts advise that you have at least three to six months of living expenses socked away for an emergency — possibly even more if you’re single without a partner’s paycheck to fall back on.
A good place to store emergency funds is in a high-yield savings account, which often has an interest rate as high (if not higher) than most CDs. This makes them an excellent option for storing your money, earning some interest, and having the advantage of liquid savings that you (usually) can’t get with CDs.
However, you’ll often find a better interest rate with online banks’ high-yield savings accounts because those banks have virtually no overhead compared to traditional banks and credit unions. If you do go with a high-yield savings account, be sure to get one that comes with a debit card for quick access to your savings account.
If you prefer the brick-and-mortar style of banking, you might look into opening a money market account with a bank or credit union to store your liquid savings. You’ll get a better interest rate than with a traditional savings account and might beat average CD rates as well. Plus they come with checking account features such as debit cards and checks, making your funds easily accessible.
Key Takeaways
- CDs appeal to many people because of their fixed interest rate and guaranteed risk-free return, but the low risk also comes with low returns.
- There are plenty of ways to get better returns than CDs offer. These include dividend-paying stocks, municipal bonds or bond funds, and real estate investments.
- Investments that have higher returns than CD rates allow for also carry bigger risks, but they’re ultimately more suitable for long-term retirement funds.
- Saving money to build an emergency fund in a high-yield savings account and paying off debt with a double-digit interest rate should take priority over investing cash that could be put to better use.
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