Figuring out where to save your money can be overwhelming.
After all, you want to do what’s best with your savings and hopefully grow your money.
Fear not; we’ve broken down the advantages and disadvantages of a certificate of deposit to help you decide if a CD is right for you.
7 Certificate of deposit advantages
A CD is a savings vehicle wherein you agree to keep your money in an account for a certain length of time in exchange for interest. You can’t contribute more money to your CD after you’ve opened it (one deposit is normally all you get), but you can earn a solid amount of interest on your original deposit, especially in comparison to a traditional savings account.* If you want a more robust explanation, check out our Simple Guide to a Certificate of Deposit (and Why You Need One).
There’s a lot of good about CDs, so let’s dig into some advantages of these unique savings options.
1. Easy to open
No need to own a VIP pass to enter the CD club. CDs are offered by most banks, credit unions, and financial services providers. You typically have to have some money to get started (somewhere between $200 to $1,000), but it’s not hard to open one.
With some online financial services providers (like Simple!), you can open a CD completely online and move the money straight from your checking account (much simpler than going in-person to a bank). You can normally also deposit A LOT of money if you want to. The limit is traditionally between $250,000 and $500,000.
2. Better interest rates
Interest rates are where it’s at with CDs. Interest rates are typically better for a CD than a traditional savings account. This means that you earn more money on your deposit.
For example, as of March 2020, the national average rates ranged from 0.46% APY for a 12-month CD and 0.90% APY for a 60-month CD ** (hint: online banks generally have better CD rates). APY, or annual percentage yield, is the total amount your account will grow within a year, thanks to the interest and compounding.
As you can see in the graph above, a 12-month CD gives you a better return than a traditional savings account — in terms of interest, you get more bang for your hard-earned bucks over time.
3. Fixed rates
You can’t count on a lot of things in life (well, other than death and taxes). And here’s a fun fact: you can also count on CD interest rates. With a savings account, interest rates typically go up and down based on the market. With a CD, your interest rate usually stays the same (when you buy your CD, it’s locked in or guaranteed).
You agree to store your money for a certain period of time until the CDs maturity date. In exchange, the CD provider locks in your interest rate. Since your interest rate isn’t at the mercy of the market, you don’t have to worry about losing extra money if interest rates were to suddenly drop.
4. Predictable returns
CDs are a low-risk and predictable savings option, which allow you to forecast and depend on your future earnings. In other words, with a CD, you typically know exactly what your final balance will be, because interest rates are locked in.
CDs work off of compound interest. In short, you earn interest on your interest. This interest might be compounded daily, weekly, or monthly. If you have an online CD account, you can see how much extra you’re earning on your original deposit, thanks to the interest. Knowing exactly how much money you’ll have in CD savings when the CD matures helps you plan ahead!
5. Protected funds
Your money is safe in two ways in a CD. First, as long as the bank or financial institution you’re purchasing from is insured by the FDIC (i.e., protected by the government), your funds are covered up to the legal limit.
Secondly, they’re safe from, well, you. Sometimes it’s hard not to waste money on things like a new TV or smartphone. But because your money is locked away for a certain period of time, you aren’t tempted to spend your hard-earned savings.
6. Shoppable rates
That’s right: you can shop around to find the best interest rates possible for your CD (and earn extra on your deposit). The rates will depend on the provider, but online banks typically offer better rates because their costs are lower.
And you’re not limited to one CD provider: if you want to open more than one CD, maybe with different terms, you can look around at other places to get the best rates.
7. Wide selection of terms
We get it—the thought of locking away your money for a set time can be scary. But fret not. There are many periods (aka terms) that you can choose from for your CD.
Some CDs let you store your money for as short as 7 days; others from 12-months to 5 years. It’s up to you how long you want to lock your money away. You can also choose to open more than one. And there are CD strategies—for example, the CD ladder—that let you get awesome interest rates AND access your money at different points in time.
3 Certificate of deposit disadvantages
Now that we’ve covered CD advantages, here are a few drawbacks of these savings vehicles (well, depending on how you look at it):
1. Early withdrawal penalties
You might think of a CD as essentially locking up your money and throwing away the key. And this perception is true to an extent: it is typically harder to get your savings out of a CD, and in most cases (unless you have a no-penalty CD), you’ll get hit with an early-withdrawal penalty if you take your money out before the CD’s term is up.
In short, though, this penalty simply means that traditional CDs aren’t the best option for short-term savings goals, such as building an emergency fund. The whole point of a CD is to safely let your existing savings grow over time. That’s why CDs are great options for future savings goals, such as starting a business or buying a house.
Note: If you are still worried about locking your money away, you can always choose a no-penalty CD. The interest rates are normally a bit lower for these types of CDs and there are restrictions on when you may early withdraw or terminate your CD, but you can access your savings if absolutely necessary without paying a penalty fee.
2. Interest rate fluctuations
What do we mean by fluctuation? Well, interest rates go up or down, depending on how confident the U.S. Federal Reserve is about the economy. So if interest rates go up, a CD’s fixed interest rate works against you because you’re locked into the lower rate.
Now, if you’re worried about that, you could consider opening a high-yield savings account so your savings will get the best interest rates if rates go up. But then you risk not making as much money if the rates go down. It’s definitely a trade-off that you have to think about.
3. Lower returns compared to things like high-yield checking account
The money you make on CDs is normally better than traditional savings accounts, but perhaps lower than you could earn from other saving solutions such as a high yield checking account.
But here’s the thing: this type of savings option is normally meant for hitting more immediate savings goals like an emergency fund or upcoming purchases, as well as managing your finances; a CD is designed to be a place where you can park your money, earn interest, and feel less tempted to spend your savings so you can achieve future savings goals.
Compare certificate of deposit advantages and disadvantages: is a CD right for you?
Remove the stress of picking out the right savings vehicle for you. If you’re on the fence about putting your money in a CD, the main thing to decide is what you want to do with your money—in other words, what’s its purpose? If you want to use your savings for an emergency fund, a traditional savings account might be a better bet.
But if you want your money to work for you, as we’ve learned from CD advantages, CDs can be a steady and low-risk alternative for saving for your future.
** Check out rates for yourself (based on the March 16, 2020 National Savings and CD Rates): https://www.fdic.gov/regulations/resources/rates/
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