Pros and Cons of CDs

Certificate of deposit (CD) accounts can be used to grow savings for short-term and long-term goals. This type of account can offer some advantages over savings accounts or money market accounts, though there are some potential downsides to consider. Before opening a CD account, it's helpful to look at the pros and cons.

What Is a Certificate of Deposit (CD)?

Certificate of deposit (CD) accounts are time deposit accounts offered by traditional banks, credit unions, and online banks. This type of account allows savers to deposit money, which then earns interest over time. Once the CD reaches a specified maturity date, the saver can withdraw their original deposit and interest earned or roll all of the money over to a new CD.

CD terms can vary, depending on where the account is opened. For example, you might choose a CD with a maturity term as short as 28 days or as long as 10 years. The minimum deposit to open a CD may range from $100 to $500, though other CDs might require $10,000 or more to open. CD rates can vary by the financial institution as well, with online banks typically offering higher rates than brick-and-mortar banks.

Bank-issued CDs can be insured by the Federal Deposit Insurance Corporation (FDIC), while those issued by credit unions can be insured by the National Credit Union Association (NCUA). This means CDs, on the whole, are safe places to keep the money you want to save. There is an exception for brokered CDs, which are sold by brokerages. These CDs, which can be traded on the secondary market, may not be FDIC-insured.

Pros and Cons of CDs

Whether CDs belong in your savings strategy can depend on your financial goals. Like any other savings vehicle, CDs can offer both advantages and disadvantages.

CD advantages

Are CDs worth it? They can be if you're able to get a great rate of return on your money. Here are the main pros of using CDs to save.

• Safety and security: CDs can be a safe haven for savers who want to set aside money with minimal risk of loss. Even in the rare possibility that your bank fails, your CD savings could still be protected by FDIC coverage.
• Higher rates: Saving in a CD could potentially yield a higher interest rate and APY compared to a savings account. The rates you can earn with a CD can depend on where you open it and the type of account.
• Guaranteed returns: CD accounts can offer fixed rates to savers. This means there's virtually no guesswork about how much return you'll get for your money.
• CD laddering: Laddering CDs means buying multiple CDs with varying maturity terms and interest rates. This approach creates flexibility since CDs can mature on a rolling schedule and you're less at risk of missing out on higher rates over time.

CD drawbacks

What's not great about CDs? There are a few key points to keep in mind before opening one.

• Penalties: One of the main drawbacks of CDs is that in most cases you're locked into the maturity term. If you take money from the CD before it matures, you will get hit with a penalty fee equal to at least seven days of the interest earned or even more.
• Inflation: Inflation is an extended period of rising consumer prices. When inflation rises steadily, it can be difficult for CD rates to keep pace, meaning your savings have less purchasing power.
• Lower returns: If you're looking for a way to build wealth, CDs may offer only limited benefits. You could get better returns for your money by putting it into the market and buying stocks, mutual funds, or other investments instead.
• Limited liquidity: Unless you're using a CD laddering strategy, access to your money is going to be more limited compared to what you'd get with a savings account or money market account.

The Bottom Line

Keeping some of your money in a CD account is something you might consider as part of your overall savings plan. Before opening a CD, it's helpful to shop around and look for the best CD rates and terms, taking note of minimum deposit requirements for different options. You can start with your bank first, then branch out your search to include credit unions and online banks. Also, consider whether a laddering strategy is something you might want to try if you're concerned about rates rising or falling over time.