Pros and Cons of CD Investing
A certificate of deposit (CD) is an investment tool that enables individuals to put money into an account for a period of time and earn a set rate of return once that period is over. Readily available through many banks and credit unions, CD investing has a wide range of benefits to most people. Are they right for you? To find out, consider both the pros and cons of CD investing.
Pros of CD Investing
There are numerous benefits to investing in CDs, especially for those who want versatility and predictability. Here is everything you need to know from the U.S. Securities and Exchange Commission.
#1: They are safer than other investments
CDs are backed by the federal government for up to $250,000 per depositor, per insured bank, and per ownership category. That means that the money you put into them will not ever be less than what you deposited, thanks to FDIC protection. Even if the financial institution shutters, the government pays the value of the CD. That eliminates the risk for many.
#2: They offer expected and predictable returns
CDs provide an expected rate of return, meaning that you know how much you will earn from the CD as long as you keep the funds in the account as agreed. You know how much you can receive on maturity, how long it will take, and what level of interest you will be paid because of this guaranteed rate of return.
There are very few other investment methods that give you that type of level of prediction. Most of the time, you can expect and even plan for the CD to pay you at a specific level, and if you decide to do so, you can continue that term for longer, increasing the amount you earn if you do.
#3: Choose the length of time that fits your needs
Unlike a savings account or other investment strategy, CDs are money invested for a very specific timeframe. This can range from as short as 30 days or up to 10 years. Critical to remember is that the money must remain in the account for that period of time in order to yield the expected rate of return.
#4: You can extend that period over time
If you decide to leave your funds in the account, longer, you can do so. This could help you to extend or renew the CD longer, allowing you to continue to see growth.
#5: You have the ability to remove the funds if you need to
Keep in mind that if there is an emergency, you can withdraw the funds from your CD to use. There are fees for this, but it is possible to access your funds in situations where there is a need to do so.
#6: Several types of CDs are available
Experian notes there are 7 types of CDs you can select from:
- Traditional CDs
- No-penalty CDs
- Jumbo CDs
- Bump-Up CDs
- Step-Up CDs
- Brokered CDs
- IRA CDs
They differ in structure and contributions. Make sure you learn about each type to choose one that fits your needs.
#7: You can shop around for interest rates
CDs are paid based on an interest rate earned over the deposit period. You can find some financial institutions that offer better rates than others. Since most people can open a CD without having an account at a brokerage, bank, or credit union, it’s easy to select the best rate.
#8: Earn more than savings accounts
Typically, a CD will earn more than a traditional savings account. It may have a slightly higher interest rate, depending on the length of time the account remains in place.
Cons of CD Investing
There are a few drawbacks you should consider about CDs as well, and these can impact your ability and desire to use them.
#1: They do not have the best earning rate
CDs have a higher interest rate than a savings account, but not necessarily much higher than other types of investment accounts. By putting your money here, you may be limiting its growth potential if another, often higher-risk strategy pays out.
#2: They can be costly to liquidate
If you need to withdraw money from them early, it is possible. However, many accounts have a penalty for doing so, which can drastically reduce the amount of earnings you receive.
#3: They do not keep up with inflation
One key factor to consider is the way that inflation impacts your investment methods. While investing in other types of strategies could help you earn more as inflation increases, CDs typically lock in the same rate for the entire length of the term. They do not increase over time.
#4: Reinvestment is not always ideal
There are some situations in which reinvestment of your CD is a good thing, allowing you to set up a new term. However, reinvestment does not always lead to a higher interest rate. In some situations, reinvestments are paid lower than initial interest rates.
#5: Taxes are a factor
Depending on how much your account earns, you may have to pay accrued interest on the funds. That means that in the year you earn the interest, you may have to pay taxes on it.
#6: Some charge fees
There are some financial institutions that may charge setup and maintenance fees for these types of investment strategies. That can reduce any income earned.
#7: You may have to see a bank representative to cash them out
Most of the time, you do not have access to the funds in a CD without going into the bank or credit union and requesting your future. While there are online versions, you may have no access to the cash immediately if you need it.
#8: They do not offer tax advantages for retirement
Some people may do better by putting these funds into a retirement savings account where they have the potential to earn more over time as long as they leave the funds in place. If you are looking for a higher rate of return and fewer taxes, an IRA or 401(k) may be a more desirable method.