Are CDs Still Worth Buying?

How Do CDs Work?

Not to be confused with your dad's prized collection of Pink Floyd compact discs, a certificate of deposit is a savings account where you keep a specific amount of money for a set time period. Known as the term, this is typically anywhere from three to 60 months. The interest rates on most CDs stay the same throughout the CD's term. You can buy CDs from banks, credit unions and online banks.

If you leave your money in the CD until it reaches the end of its term, or "matures," you can either withdraw your initial deposit (plus the interest it earned) or roll it over into a new CD. You can also withdraw money from a CD before its maturity date, but you'll have to pay a penalty—usually a certain number of months' interest.

In exchange for restricting access to your money, CDs offer a higher annual percentage yield (APY) than you'd get from a traditional savings account. Another appealing aspect of CDs is their reduced risk compared with other investments, such as stocks.

Pros and Cons of CDs

When thinking about buying a CD, consider the upsides as well as the downsides.

On the plus side, CDs offer:

• Guaranteed rate of return: Interest rates on deposit accounts—including savings accounts, money market accounts and high-yield savings accounts—are usually variable, meaning they may change at any time. In most cases, a CD's interest rate is locked in until maturity.
• Security: Buying a CD is a less risky financial move compared with other investment strategies. A CD opened with a bank insured by the Federal Deposit Insurance Corporation (FDIC) or a credit union insured by the National Credit Union Administration (NCUA) is insured for up to $250,000 per institution and type of account.

There are also some negative aspects to CDs:

• Limited access to funds: If you need to tap money in your CD before the maturity date—if you lose your job, for example—you'll give up some of your accumulated interest. You can minimize this risk by purchasing several CDs with staggered maturity dates—for example, a three-month CD, nine-month CD and 12-month CD—to give you greater flexibility. If you need your savings available for an emergency, however, even a short-term CD may be too restrictive.
• Lower returns compared with investments: Investments such as stocks and 401(k) retirement plans have the potential to earn much higher returns, but they aren't FDIC-insured, which means they carry more risk than a CD. When your money is tied up in a CD, you miss out on potentially more lucrative investments. In addition, if interest rates rise, your CD is still locked in at the lower rate.
• Minimum deposit required: You can open many traditional savings accounts with a very small initial deposit. In comparison, CDs often require a minimum deposit of $500 or more. If you don't have a chunk of change to start with, a CD may not be an option for you.

Alternatives to CDs for Saving Money

Interest rates on CDs reached their zenith in December 1980, when a three-month CD had an average APY of 18.65%, according to the Federal Reserve Bank of St. Louis. Interest rates have declined since then, and in March 2020, the Federal Reserve reduced its target interest rate to a historic low in response to the ongoing pandemic. As of March 8, 2021, the average APY for a three-month CD was just 0.06%; for a 60-month CD, it was only 0.31%.

Given their current low rate of return, how do CDs stack up against other savings methods? If you're looking to stash your cash for five years or less and want to earn interest, but don't like the idea of tying your money up in a CD, the following alternatives let you access your savings whenever you want with no fees or penalties. All three can be opened at most banks or credit unions, are insured by the FDIC up to $250,000 per account holder and limit you to six withdrawals per month.

• Regular savings account: Traditional savings accounts can often be opened with just a few dollars, and typically have fairly low minimum balance requirements. Opening a savings account and checking account at the same bank or credit union makes it easy to transfer money from one to the other, and offers maximum flexibility and access to your emergency fund. The downside of regular savings accounts is their low yield: As of March 8, 2021, the FDIC reports the average interest rate on a savings account was 0.04%.
• Money market account: A money market account is a hybrid between a checking and savings account that boasts higher interest rates than traditional savings accounts. Unlike other types of savings accounts, you can write a limited number of checks on a money market account per year and, in some cases, access money using a debit card. Money market accounts generally have minimum deposit requirements and may also require a certain minimum balance. As of March 8, 2021, the FDIC reports the average interest rate on a money market account was 0.06%.
• High-yield savings account: As the name implies, these accounts offer a higher yield than traditional savings accounts. As of March 2021, the top APYs for high-yield savings accounts hovered around 0.50%—more than 10 times the average APY for traditional savings accounts. In exchange for a higher rate of return, these accounts often have minimum deposit amounts and minimum balance requirements. High-yield savings accounts from online banks and credit unions tend to have higher APYs than those from brick-and-mortar banks.

Is Buying a CD a Good Idea?

The earning potential of a CD is tied to interest rates, which are at record lows right now. When interest rates rise, CDs may become more appealing as a way to save, but currently, there are other options that will likely be more lucrative.

If you want to sock away cash for a not-so-distant goal and worry you'll be tempted to tap other types of savings accounts too soon, a CD's penalty for early withdrawal could keep you from spending your savings. If you're setting aside an emergency fund, on the other hand, you'll want the money readily available. In that case, a traditional savings account, high-yield savings account or money market account is probably a better solution.

No matter your savings goal, making a budget, reducing your expenses and sticking to a savings plan can help you reach it—as can the right savings account.