An important part of setting savings goals is deciding where to keep your money. Opening one or more certificate of deposit (CD) accounts is something you might consider if you're interested in potentially earning higher interest rates. Saving in a CD can have some potential drawbacks, however, which are important to consider when deciding if they're worth it.
- Certificates of deposit (CDs) are time deposit accounts that can be used to save for short- or long-term goals.
- There are different types of CDs that may or may not be more suitable for certain situations.
- Depending on where you open a CD account, you may be able to earn a higher annual percentage yield (APY) on deposits than you might with a savings account or money market account.
- Withdrawing money from a CD before its maturity date could result in a penalty.
- Creating a CD ladder can offer some flexibility with withdrawals and possibly help you to leverage changes to interest rates.
What Is a Certificate of Deposit?
A certificate of deposit or CD is a type of time deposit account in which you add money, which you can then withdraw at a later maturity date. The money in a CD can earn interest and there may be a penalty for withdrawing money from your account before maturity. Traditional banks, credit unions, and online banks can offer CDs to savers with varying rates and requirements.
A CD isn't the same thing as a savings account. With a savings account, you can deposit money and earn interest but there's no maturity date or set term that you're required to save for. You can withdraw money from savings as needed or make transfers from savings to checking.
While savings accounts aren't subject to early withdrawal penalties like CDs, your bank may limit the number of withdrawals you're allowed to make each month.
Types of CDs
There are different types of CD accounts savers can open, which can be divided into three categories: standard CDs, specialty CDs, and brokered CDs. Standard CDs allow you to deposit money for a set time period and earn interest. When the CD matures, you can withdraw your initial deposit and the interest earned or roll the entire amount over to a new CD. Standard CDs can have maturity terms ranging from seven days to 10 years.
Specialty CDs also allow savers to deposit money and earn interest but they have features that distinguish them from standard CDs. Examples of specialty CDs include:
- Traditional CDs: These CDs have a fixed interest rate and term. The term can range from a few months to several years, and you normally cannot withdraw the cash without paying a penalty until the term expires.
- Jumbo CDs: These CDs have a higher minimum deposit requirement than ordinary CDs, typically $100,000 or more. Jumbo CDs often offer a higher interest rate in exchange for a larger deposit.
- Callable CDs: These CDs allow the issuing bank to call or redeem the CD before it matures. Callable CDs may pay a greater interest rate than standard CDs, but if interest rates fall, the issuer may call the CD back, leaving you with a lower rate of return than you expected.
- "Raise-Your-Rate" or Bump-Up CDs: These CDs allow you to "bump up" the interest rate on your CD to a higher rate if interest rates rise during the CD term. However, bump-up CDs typically have a lower initial interest rate than traditional CDs in exchange for its flexibility.
- Add-On CDs: These CDs allow you to make extra deposits during the term, allowing you to maximize your earnings. Interest rates on add-on CDs are often lower than those on standard CDs.
- No-Penalty CDs: These CDs allow savers to withdraw money prior to maturity without triggering a penalty. This feature may be added to any CD mentioned above.
In addition, brokered CDs are CD accounts that are offered by a brokerage, rather than a bank or credit union. These CDs may have higher minimum deposit requirements than standard or specialty CDs. For example, you may need $10,000 or more to open one. Brokered CDs can potentially generate much higher returns than bank CDs since they can be bought and sold on the secondary market.
While bank- and credit-union-issued CDs can be Federal Deposit Insurance Corporation (FDIC)-insured, brokered CDs don't always enjoy this protection.
Advantages and Disadvantages of CDs
CDs can offer both advantages and disadvantages to savers. Before opening a CD, it's important to understand the pros and cons.
Pros of Certificates of Deposits
CDs may be more appealing to certain types of savers than others. Here are some of the benefits of saving in CDs.
- Better rates: Depending on where you open a CD account, you may be able to earn a better rate compared to savings accounts or money market accounts.
- Safety and protection: CDs offer a safe place to keep the money you don't plan to use right away. Accounts can be protected up to the FDIC coverage limits.
- Guaranteed returns: CD interest rates are typically fixed, meaning you have some predictability in calculating how much your money is likely to grow.
- Laddering: A CD ladder is a strategy that involves opening multiple CDs with varying maturity terms and interest rates. This can help you take advantage of rising rates over time while keeping your savings liquid.
Cons of Certificates of Deposits
While CDs can work well for some savers, there are a few sticking points that could make them a mismatch for your savings plan. Here are some of the key drawbacks to know.
- Early withdrawal penalty: Banks and credit unions can assess an early withdrawal penalty if you take money from a CD early. This penalty could be a flat fee or up to all of the interest earned.
- Minimum deposits: While some CDs have low minimum deposits, others may require a larger amount of money to open in order to earn a higher rate. For example, brokered CDs may require $10,000 or more.
- Less liquidity: By nature, CDs are meant to hold money that you won't need for the entirety of the maturity term. A savings account, on the other hand, can be more accessible if you need to make a withdrawal.
- Inflation: Rising inflation can shrink purchasing power and even a CD that earns an outstanding rate may not be enough to keep pace with higher prices.
CDs can potentially offer higher interest rates than savings accounts.
Saving in a CD is safe and secure, with virtually zero risk of loss.
CDs can offer a guaranteed rate of return on your money.
A CD laddering approach can help you to capitalize on changing interest rates.
Savers may be penalized for withdrawing money from a CD before maturity.
Earning higher rates with a CD may mean making a larger initial deposit.
CDs offer less flexibility and liquidity than savings accounts.
Even the highest CD rates may not be enough to keep pace with inflation.
When Saving With CDs Is Worth It
Opening one or more CD accounts could be worth it if you're able to lock in a great rate on your savings and you don't foresee any need to withdraw the money before the maturity term ends. When comparing CDs, it's important to consider:
- Minimum deposit requirements
- Interest rate and APY
- Early withdrawal penalties
- CD terms
If you're concerned that rates might rise after you open your CD, you could opt for a raise-your-rate or step-up CD. This way, you won't miss out on a better rate later. And you could choose a no-penalty CD if you want to have an out in case you do need to withdraw money before maturity.
Consider how much of your money you want to save in CDs. If you're comfortable taking more risk, you could earn higher returns by putting some of the money you plan to save into the market and investing it instead. Investing in stocks, mutual funds, or other securities can be the better option for building wealth versus saving for short- or long-term goals.
Online banks may be a better choice for opening CD accounts as they can offer higher rates than traditional banks.
Alternatives to Certificates of Deposit
If a CD isn't quite worth it for you, there are similar types of accounts or investment products that may prove to be a strong alternative. Alternatives to CDs include:
- High-Yield Savings Accounts: High-yield savings accounts typically offer higher interest rates than traditional savings accounts and allow you to withdraw your money at any time. These types of accounts have higher liquidity.
- Money Market Accounts: Money market accounts provide a greater interest rate than standard savings accounts. Money market accounts are comprised of short-term investments such as Treasury bills that have low risk and high liquidity.
- Corporate Bonds: Corporate bonds are debt securities issued by corporations and can offer higher yields than government bonds. Though these come with higher risk, there may be short-term investment opportunities.
- Mutual Funds: Mutual funds allow investors to pool funds to diversify a portfolio across stocks and bonds. Though the risk profile of mutual funds is much higher than a CD, it may be a better option for those prioritizing returns.
- REITs: Real estate investment trusts (REITs) is not a common alternative to a CD. However, it may offer perpetual, reoccurring, stable cashflow via dividends from rental or operating income. In addition, when rates fall and CDs tend to lose their value, current real estate valuations may increase as the present value of cash flow models increase with lower discount rates.
Are CDs Worth Buying?
CDs are worth buying if you know what you want to use them for and you're able to get a good interest rate and APY. Parking large amounts of money in CDs when rates are low, on the other hand, could mean missing out on the chance to earn better returns in the market.
Are CDs a Good Way to Make Money?
CDs are generally used for saving money, not creating an income stream. You could net a decent amount of interest over time if you're consistently saving in high-yield CDs. If you're looking for a way to use CDs to make money that entails a bit more risk, you might consider purchasing brokered CDs.
Are CDs Worth It in 2023?
With the Federal Reserve having raised rates, savers can finally make money with CDs. However, be mindful that there is risk in 2023 in buying CDs, as the Federal Reserve may be poised to lower rates in the future (even a few years out). Still, if the Fed lowers rates in 2025, those holding a five-year CD purchased in 2023 may be able to capture higher rates that would no longer be available. CDs may be worth it for savers who believe rates are finished increasing or are looking to diversify their portfolio across higher-yield insured deposits.
When Might a CD Not be Worth It?
CDs may not be worth it if you're looking for liquidity. Some CDs can not be broken, or they may only be broken by paying a large fee. For savers looking to have access to funds at a moment's notice, a high-yield savings account may be a better idea.
The Bottom Line
Certificates of deposit can help you to achieve your savings goals. Before choosing a CD, it's important to shop around and see what kind of terms and rates different banks are offering. The best CD rates may be offered at online banks. Also, consider CD alternatives such as high-yield savings accounts or money market accounts to see which one has the best interest rate.