CDs vs. Stocks: What's the Difference?

It’s more than just risk and returns

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When it comes to investing, two of the more common choices include certificates of deposit (CDs) and stocks. While both can help investors grow their money, these can be very different types of assets that provide very different results.

Traditional CDs are actually savings accounts, but they’re also considered “fixed income” investments. A regular savings account provides a variable interest rate that changes, and you can move your money in or out fairly easily.

In contrast, a CD provides a fixed interest rate based on how long the investor agrees to keep their money invested, which might be a few months to several years. You’ll usually face penalties for early withdrawals.

Stocks provide an ownership (i.e., equity) stake in companies. Stock prices can move up or down depending on a number of factors, and investors can sell their shares at any time. You can also invest in stocks by investing in mutual funds or exchange-traded funds (ETFs), which hold stocks from multiple companies.

CDs and stocks have unique pros and cons, and there can be many variations within these categories. Let’s look in more detail at the different types of investments so you can choose whether CDs or stocks—or both—are right for you.

What’s the Difference Between CDs and Stocks?

CDs and stocks can both be used as investments, but there are significant differences between them in terms of risk, return, fees, and more.

CDs vs. Stocks at a Glance
  CDs Stocks
Investment Returns Generally provide lower returns than stocks, with returns capped Typically have higher returns than CDs, with unlimited return potential
Risk Typically considered to be low-risk investments, with the principal generally protected Can have much higher risk than CDs, including the potential loss of principal
Fees Usually do not have upfront fees, although penalties often apply to early withdrawals Some brokerages charge fees and commissions to make stock trades. Funds that invest in multiple stocks also charge management fees, among other expenses.
Taxes Interest incurs taxes at ordinary income rates If held long term, capital gains from stock can be taxed lower than ordinary income rates
Liquidity Generally lacks liquidity until the CD reaches maturity, unless the investor is willing to pay penalties Can typically be traded at any time when markets are open, without penalties
Volatility Typically provide a fixed rate of return without volatility Can have varying levels of volatility, with some stocks typically being more volatile than others
Complexity Generally easy to understand  Can be easy to invest in, but difficult to conduct an analysis

Investment Returns

Investing in traditional CDs can provide essentially guaranteed returns if you keep your money within these accounts for the full term. For example, a one-year CD might provide a 1% annual return if you keep your money there a year, and a five-year CD might provide a 2% annual return if you keep your money there the whole five-year term. (Keep in mind these are hypothetical examples.)

CD rates can differ significantly based in part on the overall interest-rate environment, but the returns are set in advance, so you can plan accordingly. That said, CDs generally provide lower returns in the long run than assets such as stocks.

In theory, stocks have unlimited return potential, but you also could conceivably lose your entire investment. Unlike CDs, there’s no fixed rate of return with stocks, and different stocks can have significantly different returns. Even for stocks that pay dividends, which can provide regular income, rates can fluctuate.

Risk

CDs are typically considered to be lower-risk investments compared to stocks. That’s because you typically can’t lose your initial investment with traditional CDs. If you pull out your money early, you might pay a penalty, but often, that is interest you earned. CD holders typically receive FDIC insurance to protect their principal up to $250,000 if the bank fails.

In contrast, stocks tend to be riskier because you can more easily lose money. Some stocks are riskier than others. Small start-ups, for example, have more dramatic price swings than large, well-established companies.

Fees

Banks usually offer CDs without any upfront fees, but if you pull out your investment before the CD matures, you could pay penalties. In many cases, those fees just reduce the interest you would have otherwise earned instead of reducing your principal, but it’s still a cost to consider.

Investing in stocks, on the other hand, can entail a range of fees, including brokerage fees for each trade. That said, stock trading fees have declined in recent years, and some platforms offer fee-free/commission-fee trades.

If you invest in stocks via assets such as mutual funds or ETFs, you’ll likely pay an annual percentage of your investment as a fund management fee, among other potential expenses.

Taxes

When you earn interest from CDs, that money counts toward your ordinary income, so you’re taxed at ordinary income rates. Stocks earnings can have different tax implications.

When held short term, meaning a year or less, any gains are taxed as ordinary income. But when held long term, or more than one year, gains can be taxed at long-term capital gains rates, which are often 15%—a rate that’s often lower than ordinary income tax rates.

Losses on stocks can even reduce your taxable income.

Also, stocks profits don’t incur capital gains until you sell them, so you can delay paying taxes on gains. Stocks that pay ordinary dividends, however, do incur taxes at ordinary income tax rates for the year in which dividends are paid out.

Liquidity

CDs are not as liquid as stocks because if you take your principal out early, you won’t earn the full interest and you will likely pay penalties. That said, if you do withdraw early, it’s a fairly straightforward process.

Stocks, on the other hand, often have strong liquidity if they’re publicly traded. When exchanges are open (during most weekdays), you can often buy or sell stock almost instantly.

Some types of stocks, however, have very low trading volume, so it might take longer to find a buyer or seller. And if you want to take cash out, it might take a few days for the transaction to settle so you can transfer money from your brokerage to your bank account.

Volatility

Because CDs tend to offer fixed rates of return, there’s generally no volatility. If you have a five-year CD with a set interest rate, for example, then you know each year, you’ll earn that exact amount of interest.

Stocks, however, have volatility. Some days they might move up a few percentage points and the next, they might fall by a few percentage points. Stocks can even move up or down by double-digit percentages within a single trading day. So if you invest in stocks, plan to weather some ups and downs.

Complexity

CDs could be considered less complex than stocks in the sense that you can relatively easily compare CD rates among different providers to choose the one you want. With stocks, though, past performance is no guarantee of future results.

Just because one stock went up by 10% one year doesn’t mean it will the next year. Overall, stock analysis can be much more complex, with multiple factors to consider, such as a company’s financial performance, sector trends, and overall economic forecasts.

Special Considerations

A certain type of CD called a market-linked CD is an asset that can be considered a mix of CDs and stocks. Market-linked CDs differ significantly from traditional CDs because rather than paying a fixed interest rate, they’re tied to an underlying market, such as the S&P 500 stock index. In that case, the market-linked CD can have varying returns depending on the stock market performance, and different terms can apply, such as for early withdrawals.

The Bottom Line

Both CDs and stocks can help investors grow their money, but they do so in very different ways. If you’re looking for a relatively low-risk, low-return asset, CDs might be the way to go. For example, a retiree might prefer the steady returns CDs can provide. If you’re looking for a higher-return asset and are willing to take on more risk, stocks might be more ideal.

Keep in mind that you can adjust your risk/return levels through different strategies, such as diversifying, including by investing in both CDs and stocks.

Frequently Asked Questions (FAQs)

What’s the main difference between investing in CDs versus stocks?

CDs generally provide fixed rates of return in exchange for keeping your money invested for a given period. CD returns are lower than stock market returns in the long term. Stocks are more volatile and their returns less predictable, but that risk tends to yield higher returns.

Are stocks riskier than CDs?

Stocks are generally considered to be riskier than CDs because you can lose money with stocks, whereas with CDs, you have principal protection. That said, CDs do have some risks. For example, they are subject to inflation risk, where you could effectively lose money if your returns don’t keep up with the rate of inflation. Still, there’s no guarantee that stocks will earn returns—but they often do well in inflationary environments.

What makes someone choose CDs over stocks?

You might choose a CD over a stock if you want a low-risk investment to protect your wealth.  Perhaps you need to rely on a certain amount of interest, in which case, a CD might provide the certainty you’re looking for compared with a stock that is volatile. You may choose stocks over CDs if you want to try to earn higher long-term returns.

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Article Sources

  1. U.S. Securities and Exchange Commission. “Certificates of Deposit (CDs).”

  2. U.S. Securities and Exchange Commission. “Stocks.”

  3. FINRA. “Certificates of Deposit (CDs).”

  4. FDIC. “FDIC: Deposit Insurance.”

  5. IRS. “Topic No. 409 Capital Gains and Losses.”

  6. Raymond James. “Exploring Market-Linked CDs.”