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Certificates of deposit traditionally have had the highest interest rates among bank accounts, with the best rates once reaching 2% to 3% in the past decade. But many CD rates fell in 2020, and some banks dropped their CD rates lower than their savings account rates.
In this low-rate environment, are CDs worth it? The answer is, it depends on your short-term savings goals. Here’s an overview of CDs’ pros, cons and when they can be a good fit for you.
Pros to investing in CDs
1. CDs are safe investments. Like other bank accounts, CDs have federal deposit insurance up to $250,000 (or $500,000 in a joint account for two people). There’s no risk of losing money in a CD, except if you withdraw early.
2. CDs have fixed rates and predictable returns. Once you open a CD, you lock in a rate. This lets you know exactly how much money you’ll earn over your CD term, whether that’s months or years. In contrast, banks and credit unions can change rates on regular savings accounts at will.
3. CDs provide a variety of terms that can offer structure to savings goals. CD terms typically range from three months to five years, so they can be tools to set aside some of your savings for future purchases within that time period. In general, the longer the term, the higher the CD rate. And the shorter the term, the more frequent opportunities you have to withdraw or renew a CD.
Cons to investing in CDs
1. You lose access to money in a CD. You can think of CDs as locked storage boxes for some of your money. Once you put a lump sum into a CD for a fixed time, you can’t add or remove any of it until the day the term ends, known as its maturity date. If you break the lock early, that can be costly. (For more details, see how CDs work.)
2. CDs have early withdrawal penalties. Breaking into a CD before it matures usually results in a penalty, which can range from several months’ to a year’s worth of interest. In some cases, the penalty might include some of the money you originally deposited. (See our article CD penalties by bank for some examples.)
3. Having a fixed rate can mean missed opportunities. Having a CD can mean hanging onto a high rate even when banks drop rates on savings accounts and new CD offerings, but the flip side is getting stuck with a low CD yield as rates rise. A fixed rate can be a blessing or curse depending on how future rates fluctuate.
» Want to know where rates are? See our list of current CD rates
3 situations when CDs work best
CDs have historically offered some of the highest guaranteed returns among bank accounts, but that doesn’t automatically make them the best home for your savings or investments.
“You can go golfing with a baseball bat, but it doesn’t work as well as clubs,” says Derek Brainard, director of Education Services at the Center for Education and Financial Capability at AccessLex Institute. Similarly, “a lot of people think of CDs for investing goals, but they might not be the most appropriate.”
CDs can work well in the following three scenarios:
1. Locking up savings for a near-future purchase This may include savings for a down payment on a home or car you plan to buy within five years. Whatever the goal, the money won’t be used until you’re ready and can stay safely out of reach in CDs. (If you have savings goals but don’t want to lose access to your money, consider high-yield savings accounts instead.)
2. Building short-term wealth before investing CDs with short terms, such as three months to two years, might serve you well if there’s a plan to later invest that money. For example, some investors use a strategy called dollar-cost averaging, which involves spreading purchases of stocks or funds over time. In such a scenario, the money waiting to be invested could be held in CDs to potentially earn more interest than it would in a regular savings account.
3. Ensuring returns without market risk Investing in CDs without a future purchase in mind might make sense for those who want to avoid risking their money in the stock market.
But remember that CDs are more for short-term safety than for long-term growth. For retirement savings, financial advisors often suggest an asset allocation that involves holding more stocks than bonds or CDs when retirement is decades away, and shifting to more bonds or CDs as retirement nears, to minimize the risk of losing money.