Advantages and Disadvantages of a CD (2024)

FAQs

What are the advantages and disadvantages of CDs? ›

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.

1. Early withdrawal penalty. 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.

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.

Disadvantages of investing in CDs

Once you decide on the term of the CD, whether it's six months or 18 months, it can't be changed after the account is funded. As noted previously, since CDs have a set interest rate and maturity date, you typically can't withdraw the money from the CD without paying a penalty.

Is it worth putting money into a CD? For some people, it can be worth putting money into a CD. If a person is seeking a riskless investment with a modest return, CDs are a good bet—you'll earn a higher rate than you would with a checking or savings account, but you'll have to commit your funds for a fixed period.

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.

If interest rates fall before the CD expires, the bank is out of luck and must give you the rate it quoted. If rates climb, you're stuck with the lower rate you agreed to when you opened the account. And if you take your money out before a CD matures, you'll pay a penalty -- typically three months of interest.

CD rates may not be high enough to keep pace with inflation when consumer prices rise. Investing money in the stock market could generate much higher returns than CDs. CDs offer less liquidity than savings accounts, money market accounts, or checking accounts.

What happens to CD if the bank collapses? ›

Checking accounts, savings accounts, money market accounts, and certificates of deposit are covered by FDIC insurance. Brokerage accounts holding investments are not covered.

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.

The deposit amount won't be prohibitive

But you'll still earn hundreds and possibly thousands of dollars worth of interest with that manageable deposit. For example, a $5,000 deposit into a 5-year CD with a rate of 4.35% (available right now) will result in a $1,186.32 profit upon maturity.

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Cons of investing in CDs

Early withdrawal penalties can cost a flat fee or a percentage of the interest earned, depending on the financial institution. Inflation can hurt returns: You'll need to be careful when investing in CDs during changes in interest rates or you could effectively lose money.

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

CDs lack flexibility compared to a savings account. Like savings accounts, CDs are typically FDIC- or NCUA-insured. Stocks, bonds, or other investments could offer a higher return than CDs.