A certificate of deposit (CD) is a type of savings account that earns interest if you keep your money in it for a specific time period. When a CD reaches the end of its term, or "matures," you can either withdraw your initial deposit plus the earned interest or roll it over into a new CD. Using a CD can be worthwhile if you can secure a high interest rate and don't need to access your deposit during the CD's term.
For years, low interest rates meant consumers weren't getting enough of a return from CDs to justify locking their money away in one. Amid historic inflation, however, the Federal Reserve has raised its federal funds target rate by a total of 5 percentage points since early 2022. These rate hikes have meant rising annual percentage yields (APYs) for CDs, which translates to more money in your pocket when the account matures.
If you're giving CDs a second look, read on to learn more.
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Pros of CDs
There are some key benefits to using a CD.
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. If interest rates drop, your deposit account will earn less money. A CD's interest rate is generally locked in until it matures, so you'll know in advance how much you can expect to earn.
Safer Than Most Investments
Buying a CD exposes you to less financial risk than many other investment strategies. For one thing, you know how much money you'll earn. For another, a CD opened with a bank insured by the Federal Deposit Insurance Corp. (FDIC) or a credit union insured by the National Credit Union Association (NCUA) is insured for up to $250,000 per account holder and ownership category. That means if you have $250,000 in CDs with a bank and $250,000 in CDs with a credit union, your money is insured for the full $500,000.
Cons of CDs
Using a CD to save money has some drawbacks you should be aware of.
Restricted Access to Your Money
To maximize earnings from a CD, you'll need to let it mature. Take money out before the term ends, and you'll generally forfeit some or all of the interest the CD has earned. For greater flexibility, you can use the CD laddering strategy that has you purchase CDs with staggered maturity dates, such as three months, nine months and 12 months. But even a three-month CD could be too restrictive if you need cash unexpectedly (for instance, you lose your job).
Lower Returns Compared With Other Investments
Money tied up in a CD is money you can't use to make more lucrative investments. For example, stocks and 401(k) retirement plans have the potential to earn much higher returns than a CD. Such investments aren't FDIC-insured, making them riskier than a CD. Because a CD's interest rate is locked in, you can also miss out on opportunities to profit if interest rates rise.
May Require a Minimum Deposit
You can generally open a traditional savings account with a very small initial deposit. Some banks and credit unions don't require any deposit at all. However, CDs typically require a minimum deposit, which may be $500 or more. If you don't have a chunk of change to start with, a CD may not be an option for you.
When Is a CD Worth It?
Using a CD may make sense in the following situations.
- You want to take advantage of high interest rates. The earning potential of a CD is tied to interest rates. The higher interest rates rise, the more appealing CDs become as savings options. If you believe interest rates are peaking, buying a CD can help you lock in a high rate before it drops.
- You don't need the money right away. Buying a CD can help you sock away cash for a short-term goal, such as a wedding or a down payment on a home, while earning more interest than a regular savings account would.
- You don't want to dip into your savings. Worried you'll be tempted to tap into a savings account for unnecessary expenses, like trips or shopping sprees? A CD's penalty for early withdrawals could help you resist the urge.
- You're seeking a safe investment. Assuming the financial institution holding the CD is FDIC- or NCUA-insured, you generally can't lose money with a CD. However, you may lose some or all of the earned interest if you withdraw your money before the CD matures.
- You want to diversify your investments. Purchasing a CD with a high interest rate can help diversify your investment portfolio, balancing out riskier investments such as stocks and helping you keep pace with inflation.
Alternatives to CDs
Looking to earn interest on your savings, but don't want to tie up your money for months (or years)? Depending on your savings goals, these alternatives to CDs may make more sense.
High-Yield Savings Account
As their name implies, high-yield savings accounts let you earn more interest than traditional savings accounts. In May 2023, interest rates for high-yield savings accounts hovered in the 4% range—10 times the average APY of a traditional savings account. Due to their low overhead, online-only banks and credit unions tend to offer the highest APYs. You can find high-yield savings accounts with no fees and low or no minimum balance or minimum deposit requirements.
Traditional Savings Account
You can usually open a traditional savings account with just a few dollars—or even with no deposit at all—and most accounts have relatively low minimum balance requirements. To ensure the fastest access to your savings or emergency fund, open a savings and checking account at the same bank so it's easy to transfer money from one account to another.
The downside of regular savings accounts is their low yield. As of May 15, 2023, the FDIC reports the average interest rate on a savings account was 0.40%.
Money Market Account
A money market account is a hybrid between a checking and savings account that typically offers higher interest rates than traditional savings accounts. Unlike other types of savings accounts, money market accounts let you write a limited number of checks each year. You may also be able to access your money with a debit card.
Most money market accounts have minimum deposit requirements; there may also be minimum balance requirements. As of May 15, 2023, the FDIC reports the average interest rate on a money market account was 0.59%.
Money market accounts, savings accounts and high-yield savings accounts are available from most banks and credit unions. Because interest rates on deposit accounts are generally variable, savings in these accounts will automatically earn more interest if interest rates rise. Comparing APYs is a good way to ensure you're comparing apples to apples when weighing your savings or investment options.
The Bottom Line
Rising interest rates can boost your savings, but can also hurt your finances if you have credit card debt. As of March 2023, the average credit card interest rate was 20.92%. And in addition to interest charges, high credit card balances can negatively affect your credit score too. While it might be tempting to invest in a CD, paying off credit card debt first could be a smarter move.
The debt snowball or debt avalanche approach are two popular options for tackling your debt. As you chip away at your balance, consider setting up free credit monitoring so you can see how your efforts affect your credit score.
Learn More About Certificates of Deposit
- Are CDs Insured?
CDs are insured by federally insured banks and credit unions. Learn when deposits may not be covered and how to maximize your insurance protection.
- CD vs. IRA: What’s the Difference?
Choose a CD for a great interest rate on money you don’t need to access everyday. Choose an IRA for tax-advantaged retirement savings.
- How to Open a CD
Before applying for and funding a CD account, choose the right CD for your goals. Then open it online or in person at a bank, credit union or brokerage.
- 7 Types of CDs
CD issuers offer numerous types of CDs, from traditional and no-penalty CDs to step-up CDs and IRA CDs. Here’s how these 7 CDs may benefit you.
- The Pros and Cons of Certificates of Deposit (CDs)
CDs offer better returns than savings accounts and less risk than stocks and bonds, but you could face penalty fees if you make an early withdrawal.
- Short-Term vs. Long-Term CDs: Which Is Best for You?
Short-term CDs are best for savings you need in the near future, while long-term CDs may offer a better return on savings you don’t need for several years.