Certificates of deposit (CDs) may seem like a pretty great investment right now. CDs are safe because they are FDIC-insured. There are tons of them out there with no minimum investment requirement. Plus, you can earn rates above 5.00%.
But just because an investment might seem like a good idea doesn't mean it's right for everyone. In fact, there actually may be more reasons not to buy CDs than to spend your cash on one. Just check out these five reasons you should steer clear of CDs.
1. There are better investments out there
It's true that many CDs are offering rates above 5.00% right now, according to The Ascent's guide to the best CD rates. But do you know what's better than earning 5.00%? Earning 10.00%.
You can reliably expect to earn a 10.00% average annual return if you open a brokerage account and put your money into an S&P 500 index fund. Now, this does mean taking on a little more risk since you can always lose money when you invest. However, the risk is really low in the right circ*mstances.
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Capital One 360 Performance Savings
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The S&P 500 is a financial index made up of 500 of the largest U.S. businesses from all different industries, so you're basically betting on the U.S. economy. And the track record of S&P funds is very consistent over the long term. If you have time to wait out downturns should you be unlucky enough to invest at a bad time, the chances of losing money are slim.
As long as you won't need your money in the next couple years, choosing the higher returns an S&P fund offers is likely to be a way better financial choice than a CD.
2. You don't get any tax benefits
If you're not comfortable taking on the risk of an S&P fund or your investing timeline isn't right, there's still another reason to steer clear of CDs: You won't get tax benefits when you buy them, but you will if you choose T-bills instead.
T-bills, or Treasury bills, are backed by the U.S. government so you don't have to worry about losing money when you buy them. The rates they're offering are really similar to CDs right now, and those rates are fixed for the length of the term just like CDs. However, you won't pay state taxes on the interest you earn from T-bills. You are taxed on that income from CDs.
Why give the government a cut of your money if you don't have to? Treasury bills can be slightly more complicated to buy since you have to purchase them at auction, but it's not difficult to do that online. Just go to TreasuryDirect.gov to get started.
3. You have to lock up your money
CDs require you to keep your money invested for the entire duration of the CD term to avoid a penalty. In other words, you're giving up your liquidity for a mere 5.00%. If you need the money for something, like a surprise expense, you're stuck with a fee to break your CD early.
Giving up access to your money and risking a penalty is a big deal. Before you even consider doing it, make sure you won't regret your choice. If there's a chance you're going to need the funds before the CD matures, that makes investing in certificates of deposit absolutely the wrong choice.
4. Returns aren't that impressive after inflation
Now, you may be looking at those 5.00% CD rates and thinking you're willing to give up access to cash to earn such a great return. Remember, though, that inflation is eating away at the value of your dollars right now. And it's going to keep doing so once you've bought your CD.
The U.S. inflation rate as of April of 2024 was 3.40%. You need to earn that much just to not lose ground. So your 5.00% CD isn't increasing your buying power by that much. After taking inflation into account, you're earning only 1.60%. Not so impressive when you look at it that way -- and likely not worth giving up your liquidity for.
5. Savings accounts are offering competitive yields right now
Finally, there's the basic fact that savings accounts are offering comparable rates to CDs right now. Of course, it's true that savings account rates are variable and subject to change. However, since inflation is higher than the Federal Reserve's target rate of 2.00%, the Fed may not cut interest rates for a while. So there's no reason to expect a drastic reduction in savings account yields any time soon.
Since you can get the same returns while keeping your money available to you, CDs aren't the right fit for every situation. Don't let the high rates lead you to make a mistake and jump into an investment that just doesn't make sense for many people. Stick with savings, opt for T-bills, or put your money into a brokerage account instead.
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