The Pros and Cons of Certificates of Deposit (CDs)

Quick Answer

CDs offer higher interest rates than traditional savings accounts, guaranteed returns and a safe place to keep your money. But it can be costly to withdraw funds early, and CDs have less long-term earning potential than certain other investments.

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A certificate of deposit (CD) is a type of savings account with higher interest earnings than a traditional savings account, plus the security of guaranteed returns. But your money is usually tied up for a set amount of time, such as six months or five years, and you may have to pay a penalty fee to withdraw funds early. Here are three pros and three cons of CD accounts.

Advantages of a CD Account

CD accounts offer a few key upsides when compared to other investment options. These include:

Higher Interest Rates Than a Savings Account

Most CD accounts tend to have annual percentage yields (APYs) that are much higher than a traditional savings account. However, CD interest yields can vary at any given time based on the type of CD you choose, where you open your account and the CD's terms. It's important to shop around to find a CD that fits your savings goals and personal financial situation.

Guaranteed Rate of Return

CD accounts are generally considered low-risk places to grow your money, especially when compared to more volatile options like stocks and bonds. If you're risk-averse, a CD can be a good choice since you'll know exactly how much interest you'll earn over the lifetime of the CD's term, and your money isn't going to be as vulnerable to shifts in market conditions as it would with other investments. CDs can be used to earn interest on funds you're setting aside to save for a goal, like buying a house or paying for a wedding.

Funds Likely Federally Insured

The money in CD accounts opened at most banks or credit unions are protected by insurance. With banks, the Federal Deposit Insurance Corp. (FDIC) provides up to $250,000 per depositor, per institution and account type. Credit unions offer the same amount of coverage but are instead insured by the National Credit Union Administration (NCUA).

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Disadvantages of a CD Account

If you're thinking about opening a CD account, here are some of the downsides you'll want to consider:

No Liquidity

CDs require you to deposit your money for a certain amount of time, with the expectation you don't withdraw any of it until the maturity date. And unlike a savings account, you may not have access to your funds without paying a fee—often a certain number of months' worth of interest earnings. If you need access to quick cash to cover an unplanned expense or you're saving up for a goal that's shorter-term than your CD's maturity date, this option might not be the best choice.

Early Withdrawal Penalty

If you need access to the funds in your CD before the end of the term, you could be slapped with an early withdrawal penalty. However, there are certain types of CDs that may not be subject to this type of fee, like no-penalty CDs. Early withdrawal penalties are often expressed in a number of months' worth of interest earnings, which can be a significant sum depending on the type of CD you have, how much you have invested and how quickly you withdraw your money.

Lower Earning Ability

While CD accounts tend to earn more than a savings account, stocks and bonds are a better option if you're looking to maximize your returns. CDs may not be able to maximize gains in the same way more traditional investment options can, but they can be much less risky since their return rate is fixed and not dependent on economic conditions.

How to Open a CD Account

A CD account can be opened through a bank, credit union or brokerage. If you're considering putting your money in a CD, here's a closer look at what you'll need to do before opening your account.

  1. Choose a type of CD. There are seven types of CD accounts you can consider—including traditional CDs, no-penalty CDs, jumbo CDs, brokered CDs, IRA CDs, bump-up CDs and step-up CDs. The type of CD that may work best for you will likely depend on how you plan to use it, as well as your financial situation. For example, if you think you'll want access to your CD funds early, a no-penalty CD may be a good option. However, they may come with lower interest rates or other types of fees, depending on the financial institution.
  2. Compare interest rates, terms and fees. You'll ideally want to find a CD that has the highest interest rate to get the most return on your money. CDs with longer terms tend to have higher rates, but not always, so be sure to compare different offers closely. It's also a good idea to take a look at any fees you may get charged, like withdrawal penalties, as these can vary widely. Keep in mind that CD interest rates also tend to fluctuate and some financial institutions may offer promotional CD rates, so it can be a good idea to check rates, terms and fees regularly.
  3. Apply for the CD. To get a CD, you'll have to submit an application online, in person or over the phone. Typically, the financial institution will provide you with a disclosure statement that includes details about how the CD works such as how often you'll receive interest payments, how you can expect to receive the payments and if the CD is allowed to be called by the issuer—meaning you'll get your money plus interest back, but the CD account will be closed.
  4. Fund your CD. Once you've opened your CD account, you'll have to put money in it to start earning interest. Typically, CDs require your opening deposit to be made online or in person. And depending on the type of CD, you may also be required to make a minimum deposit amount, often between $500 and $2,500 or more.

The Bottom Line

If you have the ability to put aside some cash for a set time, a CD can be a solid short-term investment option. Although the potential to earn is often lower than with stocks or bonds, your rate of return is guaranteed—meaning your money won't be at risk from market losses. The money in your CD is also protected when you open an account through an FDIC-insured bank or NCUA-insured credit union. But if your budget doesn't allow you to stash cash for any extended amount of time, a high-yield savings account might be a better option. You'll have the ability to earn more than a traditional savings account, plus the flexibility to access your cash without paying a penalty.