What Are the Pros and Cons of Certificates of Deposits? (2024)

FAQs

What Are the Pros and Cons of Certificates of Deposits? ›

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.

One major drawback of a CD is that account holders can't easily access their money if an unanticipated need arises. They typically have to pay a penalty for early withdrawals, which can eat up interest and can even result in the loss of principal.

The biggest risk to CD accounts is usually an interest-rate risk, as federal rate cuts could lead banks to pay out less to savers. 7 Bank failure is also a risk, though this is a rarity.

Are CDs safe if the market crashes? Putting your money in a CD doesn't involve putting your money in the stock market. Instead, it's in a financial institution, like a bank or credit union. So, in the event of a market crash, your CD account will not be impacted or lose value.

CDs are safe, low-risk accounts offering competitive interest rates that remain fixed for the CD's term. Many banks and credit unions charge fees for opening and maintaining CD accounts, which can cut into your earnings. These include early withdrawal fees, monthly maintenance fees and broker fees.

Key takeaways. Interest earned on CDs is considered taxable income by the IRS, regardless of whether the money is received in cash or reinvested. Interest earned on CDs with terms longer than one year must be reported and taxed every year, even if the CD cannot be cashed in until maturity.

Low overall return. Once you factor in inflation and taxes, a CD's return is relatively low compared to many other investments. Reinvestment risk. There is the risk that, after your CD matures, you won't be able to reinvest it at an equal or higher rate.

The FDIC Covers CDs in the Event of Bank Failure

But the recent regional banking turmoil may have you concerned about your investment in case of a bank failure. CDs are treated by the FDIC like other bank accounts and will be insured up to $250,000 if the bank is a member of the agency.

Unlike traditional or high-yield savings accounts, which have variable APYs, most CDs lock your money into a fixed interest rate the day you open the account. That's why if you suspect that interest rates will soon drop, it can be a good idea to put money in a CD to preserve the high APY you would earn.

Can I lose my money in a CD account? ›

Standard CDs are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000, so they cannot lose money. However, some CDs that are not FDIC-insured may carry greater risk, and there may be risks that come from rising inflation or interest rates.

In most cases yes, up to a point. CDs are typically insured up to the FDIC limit, though it is possible to buy jumbo CDs above that level. But you could also invest in a US Treasury money market fund, and Treasuries are backed by the full faith and credit of the US government without limits.

This CD will earn $108.33 on $500 over five years, which means your deposit will grow by 21.7%.

CDs have become a more attractive option for savers who want to earn more than most savings, checking, or money market accounts will pay, but without taking on the risk or volatility of the market.

The bank makes profits by charging higher interest on money that is lent out than the interest that is paid to depositors. However, banks are obligated to pay back the depositors' funds whenever they withdraw it. Therefore, there is a risk that many depositors may withdraw their funds simultaneously.

CDs are federally insured by the FDIC. The FDIC insures deposit accounts up to $250,000 per depositor, per FDIC-insured bank and per ownership category. This includes savings and checking accounts as well as money market accounts and CDs.

CD terms can range from three or six months to longer than five years. Often, the longer the CD term, the higher the interest rate. If you need to take money from your CD before the term ends, you pay a penalty, often in the form of a few months' interest. A money market account doesn't have fixed term lengths.

When you sign up for a CD, you agree not to touch the money for a set period of time but there are always unexpected expenses. If you access your money before the CD's term is up, you'll be charged an early withdrawal penalty, often worth a few months of interest.