Certificates of deposit (CDs) are time deposits that provide interest earnings while keeping your money safe. You can choose from terms ranging from several months to several years, and you typically earn the same rate each year for the entire term—regardless of whether interest rates rise or fall.
When rates are high, locking in an attractive rate is beneficial. But with low rates, it’s less appealing to commit to a long-term relationship. Still, CDs can make sense in a variety of interest rate environments, and with modern CDs that offer flexibility, you have more options than ever.
Interest rates are currently low by historical standards. The Federal Reserve is keeping rates low in an effort to support the economy, but that situation typically doesn’t do savers any favors.
When rates are low, banks and credit unions typically offer similarly low rates on savings accounts and CDs. As a result, expect to earn very little on your savings for the foreseeable future; however, things could change at any time. Once rates rise, it’s reasonable to expect higher earnings from CDs, although your bank might not always move as quickly as you’d like.
Still, it may make sense to keep money in government-guaranteed bank and credit union accounts despite the low rates.
Pros and Cons of CDs
Avoid market losses
Earn interest on cash
Often higher rates than savings accounts
Risk of being stuck with a low rate if rates rise after you buy
Early withdrawal penalties
Might lose purchasing power to inflation
CDs keep your money safe. When you can’t afford to lose money, earning a small amount from interest may be the best option available. Plus, CDs often pay higher rates than more liquid savings accounts because you commit to leaving the funds untouched during the CD’s term. With a CD, you know how much you’ll earn, and if rates fall more, you keep earning your current CD’s rate.
CDs require you to keep your money in the bank for a specific length of time. If you withdraw funds before then, you may have to pay an early withdrawal penalty. That may be necessary in an emergency, and you might also want to get out of a CD if rates rise and you can earn more interest in a different account. Finally, safe investments such as CDs might not keep up with inflation. Other investments could potentially perform better over the long term, but you can lose money in market downturns when you take more risk.
When Are CDs Worth It?
It may make sense to use a CD when:
- You know you don’t need your money before the CD’s term ends.
- You can find a rate you’re satisfied with.
- You want to keep your money safe and avoid market risk.
- You’re willing to take the risk of seeing rates rise while your money is in a CD.
Unfortunately, there’s no way to predict the timing, direction, and amount of interest rate changes. Rates are low now, and they might remain low for an extended period (or they might not).
Dealing With the Unknown
One way to address this challenge is to use a laddering strategy that spreads your funds out among various CD maturities. By buying multiple CDs, you avoid locking up all your money for the long term. If interest rates rise and a CD matures, you can reinvest into a new CD with better rates.
Another strategy is to use flexible CDs that allow for penalty-free withdrawals or rate increases. You may be able to pull out funds and get a better rate if rates rise, or ask your bank to “bump up” your rate. However, those CDs may start with lower rates because you’re taking less risk.
Alternatives to CDs
Paying Off Debt
If you have outstanding debt, it could make sense to use cash to pay down loan balances. You’ll earn very little in a CD, and it’s likely you’re paying higher rates on your debt. By eliminating interest costs, you could come out ahead in the long run. And once you pay off a loan, you’ll free up cash flow because the monthly payment goes away. You can use that extra cash flow to replenish your cash holdings.
A disadvantage of paying off debts with your cash is that you’ll have less cash. Funds in a CD can be handy in an emergency, and if you use all your spare cash for loan payments, it may be impossible to get money when you need it. That’s especially true if you lose your job or you have less-than-perfect credit.
Savings and Money Market Accounts
As painful as it may be, keeping money in liquid bank accounts might be the best option. In some cases, there’s little benefit to shifting funds to a CD and you might prefer to keep your options open. For example, if your bank’s CDs don’t pay rates that are meaningfully higher than savings account rates, what’s the point of locking up your money? If rates rise down the road, you can reevaluate your options.
If you don't need your money for 10 years or more, consider investing for long-term growth. It’s possible you’ll lose money—at least temporarily—but if you can ride out the ups and downs, you might earn more than you can get from CDs over the long term. However, if you need money from your investments when the markets are down, you might have to sell at a loss, and a CD would turn out to be the better option.
As you research investments, it may be wise to focus on low-cost investments such as broadly diversified index funds or ETFs. Be cautious about narrowly-focused investing strategies like dividend investing. Companies can cut dividends, and you may reduce your exposure to a limited subset of the investing universe.
CDs, savings accounts, and money market accounts keep your money safe. When you use other types of investments, you risk losing money due to market downturns, defaults, and other events.
Frequently Asked Questions (FAQs)
Should I invest in 2021?
Make a plan appropriate for all seasons. You can’t predict the future, and timing the markets is extremely difficult. Decide how much risk (if any) makes sense for you and invest accordingly. Only time will tell if now is the right time to invest. But if you manage your risks and take a long-term perspective, you improve your chances of a successful outcome.
Is there a better alternative?
Without knowing the future, there is no way to know what course of action is best. All you can do is make a decision with the information available today. CDs keep your money safe, while savings accounts and money market accounts provide liquidity and pay interest. Be sure to shop around as you evaluate CDs, as you may find surprising differences between banks. The Balance keeps a list of the best CD rates available nationwide (updated weekly).
How long will interest rates stay low?
There’s no way to predict when interest rates will move. The latest information available suggests that the Federal Reserve might begin raising rates in 2023, but anything is possible. Plus, banks don’t always move in lockstep with the Fed. Some banks are more competitive than others, so it’s wise to compare options when you’re in the market for a new CD.