Why I Don’t Love CDs
Picture this: It’s the summer of 2009. Windows down, sunglasses on, and a custom medley of Weezer, Blink 182, and Fallout Boy echo from the dashboard panel. Life is good—courtesy of your new custom playlist on your recently burned compact disc. That CD is great—but today we’re going to be focused on another type of CD, the Certificate of Deposit.
Usually flying under the radar, CDs have gained traction recently due to rising interest rates. I get asked about Certificate of Deposits about twice a year and I never get very excited by them for two main reasons:
Early withdrawals mean penalties, potentially wiping out earned interest.
CD interest rates aren't significantly better than more flexible options.
Quick Breakdown on How CDs Work
A Certificate of Deposit is a type of account that will pay you interest if you keep the money in the account for a set period of time. You can always take the money out, but you could lose the interest you were earning if you do. To make up for this lack of flexibility, they will pay you a little more interest than you would get in a savings account, which is usually how they tempt you, especially if you are a maximizer who likes to try to squeeze every percentage point out of your dollars.
One common misconception: shorter-term CDs supposedly offer higher interest. Not true. Interest rates are quoted in terms of Annual Percentage Yield (APY), regardless of the duration. For example, a 3-month CD at 4% APY yields only ~1% over those 3 months.
Better Alternatives
A high-interest savings or money market account is the answer for most people, most of the time. They offer comparable (sometimes even better rates) with better liquidity. I love the idea of optimization for your needs instead of trying to guess when you’ll need the money and hoping for the best. If you’re willing to take a few extra steps, short-duration bond funds or ETFs are an even better option for your cash within a brokerage investment account, which typically provide even higher yields (I help clients with this too).
What is the goal behind the savings?
The question I always ask before discussing what type of investments we want to select is what are you trying to achieve? I always think it makes sense to align your dollars with your goals. If you’re not investing in the stock market, it is usually because you have a short-term goal and want to have access to money without the ups and downs. This is why I don’t love CDs. They don’t really meet this need. Their lack of flexibility doesn’t work with changing goals or unexpected cash needs, eliminating the benefit of slightly higher interest.
