When you hear the word “investing,” you probably think of the high-risk, high-reward world of the stock market. But investing can take a number of different forms, from mutual funds and ETFs, to bonds, to even more conservative vehicles like certificates of deposit (CDs).
CDs offer a guaranteed interest rate that’s typically higher than a savings account, and you get the safety of FDIC insurance to ensure your money will be there when you need it. They’re not right for every situation, but they can be an effective way to save for short-term goals or create a predictable stream of income..
5 advantages of investing in CDs
CDs have a number of benefits that can make them a helpful complement to the rest of your investment portfolio, or a good way to invest for a specific goal.
1. Selection
One of the biggest benefits of investing in CDs is the variety of term options available. CD terms can range from one month to 10 years, with longer terms typically offering higher interest rates, allowing you to choose the length and rate that works for your goals.
There are even special types of CDs that provide additional flexibility as you navigate ever-changing goals and circumstances. For example, bump-up CDs allow you to increase your interest rate in the middle of the term, and no-penalty CDs allow early withdrawals without penalties.
Ultimately, the key to picking the right CD lies in understanding your goals and shopping around to find the right CD or mix of CDs to help you reach them.
2. Safety
While brokered CDs can fall in value if interest rates rise during the CD’s term, bank CDs guarantee that you will at least get your initial investment back. The only risk is the potential for lost interest if you redeem the CD before maturity.
This is especially important if you’re saving for a short-term goal with a specific financial need, when you can’t afford to take the chance that your investment might lose value.
CDs are also deposit products that are protected by FDIC insurance up to $250,000. This coverage applies per bank, which means that you could have $250,000 invested in CDs at several different banks, and all of that money would be protected against the possibility of bank failure.
“FDIC insurance brings a lot of peace of mind for people knowing that it's backed by the government,” says Kyle Newell, CFP®, Owner of Newell Wealth Management in Winter Garden, FL. “Especially now that we're actually getting really good interest rates relative to other riskier asset classes.”
In other words, CDs are considered very safe investments.
3. Fixed rates
While there are some CDs that offer variable rates, in most cases they’re fixed. So if you take out a 5-year CD with a 5% APY, you know that you’ll earn that rate as long as you hold the CD for that entire term.
That certainty can make it easier to plan ahead, and it can be especially valuable if interest rates drop over the term of your CD, since you’ll be earning more than you would from something like a savings account with a variable interest rate.
4. Higher returns
Since you’re agreeing to lock your money up for a period of time, CDs generally offer higher interest rates than even high-yield savings accounts, although in today’s environment there are many savings accounts offering attractive rates as well. If you can be sure you won’t need to touch the money, you can often get a little more bang for your buck.
5. Excellent for income planning
Because you know exactly how much you’ll earn from a CD once it matures, they can be a great way to plan ahead for income you’ll need in the future.
For example, you could create a CD ladder where you buy multiple CDs with different terms. As each CD matures, you’ll receive a predictable amount of income that you can either spend or reinvest. We’ll explain more about CD ladders and how they work below.
3 drawbacks of investing in CDs
Like most investments, CDs come with their share of drawbacks as well. Here are some of the main downsides.
1. Too conservative a strategy
While CDs typically earn better interest rates than savings accounts, over the long-term your returns will likely be lower than what you’ll get from a diversified investment portfolio that includes stocks and bonds.
For that reason, it’s risky to rely too heavily on CDs for your long-term investments. The returns may not be high enough to make your money last as long as you need it to.
2. Inflation
While a CD’s fixed interest rate offers certainty, it also means that your interest could be outpaced by inflation, especially over longer periods of time. Which means that the money you earn may not be as valuable when you receive it.
“I call CDs certificates of depreciation, because a lot of times they don't keep up with inflation,” says Jonathan P. Bednar, II, CFP® with Paradigm Wealth Partners in Knoxville, TN. “That doesn't mean it's bad. It just means you need to be aware that while you're earning something, you may be eroding some purchasing power over time.”
3. Taxes
Unless your CD is held in an IRA, the interest you earn will be taxed as ordinary income in the year you earn it. Depending on your federal and state income tax brackets, that could significantly reduce the net return you actually earn, especially when compared to a diversified investment portfolio held within a retirement account like a 401(k) or individual retirement account (IRA).
How to invest in CDs: 3 strategies to try
While you can certainly just buy and hold a single CD, that’s not the only way to use them. There are a number of different strategies you can use when investing in CDs, each of which help you achieve different goals.
CD ladder
With a CD ladder, you spread your investment over a number of different CDs, each with a different term. Then, as each CD matures, you can choose to use that money as income or reinvest it into a new CD.
This strategy can provide a predictable stream of income, as you will regularly receive the proceeds from each newly maturing CD. This can serve as a nice complement to the rest of your investment portfolio, particular as you navigate retirement.
“What we're trying to do with a CD ladder is have money coming due every year to support that year's income,” says Bednar, II. “Then the rest of your investment portfolio can weather whatever storms may be going on, and you can also stay invested knowing that you have five years of income set aside.”
As an example, let’s say you have $20,000 that you want to invest in CDs. Instead of putting it all into a single CD, you could purchase five different CDs, all with a $4,000 investment, with terms of one, two, three, four, and five years. Your ladder would then work like this:
| Start | Invest $4,000 each in five different CDs with terms of 1–5 years |
| End of year 1 | 1-year CD matures. Either spend or reinvest the $4,000 plus interest. |
| End of year 2 | 2-year CD matures. Either spend or reinvest the $4,000 plus interest. |
| End of year 3 | 3-year CD matures. Either spend or reinvest the $4,000 plus interest. |
| End of year 4 | 4-year CD matures. Either spend or reinvest the $4,000 plus interest. |
| End of year 5 | 5-year CD matures. Either spend or reinvest the $4,000 plus interest. |
CD bullet
A CD bullet is a little like dollar-cost averaging into an investment portfolio. The goal is to collect a portfolio of CDs that all mature at the same time, but spread those investments out over a period of time.
“You might do this if you have a specific goal that you want to save for, like if you knew you were going to be buying a car in three years,” says Newell. “You might not have all the money all at once, but as you're saving you're buying CDs that mature at the same date in the future.”
For example, if you have $20,000 that you want to invest and you want it all to mature in five years, a CD bullet could look like this:
| Start of Year 1 | Invest $4,000 in a 5-year CD. |
| Start of Year 2 | Invest $4,000 in a 4-year CD. |
| Start of Year 3 | Invest $4,000 in a 3-year CD. |
| Start of Year 4 | Invest $4,000 in a 2-year CD. |
| Start of Year 5 | Invest $4,000 in a 1-year CD. |
| End of Year 5 | All five CDs mature. Spend or Reinvest the $20,000 plus interest. |
CD barbell
With a CD barbell, you split your investment into two different CDs, one with a shorter term and one with a longer term. This could be useful if you are saving for two goals with different timelines, or if you want the higher interest rate of a longer-term CD while maintaining the flexibility offered by a shorter-term CD.
“I see people use this as a hedge because they're unsure of what interest rates will do down the road,” says Newell. “They want to have access to money soon to potentially reinvest at a higher rate, but they also buy some longer-term CDs to hedge their bets if interest rates fall.”
If you have that same $20,000 to invest, a CD barbell could look like this:
| Start | Invest $10,000 in a 1-year CD and $10,000 in a 5-year CD |
| End of Year 1 | 1-year CD matures. Either spend or reinvest the $10,000 plus interest. |
| End of Year 2 | 5-year CD matures. Either spend or reinvest the $10,000 plus interest. |
How to find the best CDs to invest in
The best CD rates are often found through online banks or brokerage firms, though your local bank or credit union could have some good offerings as well. The key is to shop around and find the right CD or mix of CDs to match your needs and timeline.
Investing in CDs won’t provide the long-term returns that you’ll get from a diversified investment portfolio, and factors like taxes, inflation, and early withdrawal penalties can reduce the benefit of the higher interest rate they provide.
But if you’re saving for a goal with a specific timeline, or if you’re trying to create a predictable income stream, they can be a great way to earn a guaranteed interest rate and protect you from bank failure or the ups and downs of the stock market. They won’t make you rich, but they’re a safe way to make your money work for you.
Frequently asked questions
How risky is a CD investment?
CDs are very safe. Most CDs will never lose value and are protected by FDIC insurance up to $250,000.
Should I invest in CDs or bonds?
CDs are often helpful for short-term savings goals or near-term income needs. Bonds are often helpful as part of a diversified investment portfolio.
How much should you invest in CDs?
The amount you invest should depend on your specific goals and needs, but you should be careful to stay below the $250,000 FDIC insurance limit per bank.
