There’s a reason CDs have been such a popular choice for savers this year. For much of the year, CDs were paying 5% or even a bit more. And while CD rates are now down a bit following the Federal Reserve’s mid-September rate cut, many CDs are still paying close to 5%.
So all told, it’s still possible to get a great deal, especially if you shop around. Click here for a list of the top CD rates today.
But if you’re going to open a CD, you need to understand the risk you’re taking on. You might assume CDs are a risk-free savings option. But that doesn’t tell the whole story. Here’s why CDs aren’t as risk-free as you’d assume.
1. There’s the risk of an early withdrawal penalty
It’s common for banks to charge an early withdrawal penalty for removing money from a CD before it matures. The good news is that your bank can’t just spring a penalty on you. It has to disclose what your penalty will be when you open your CD.
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But let’s say you’re putting $10,000 into a 12-month, 4.5% CD and the penalty for an early withdrawal is three months of interest. That means you’re at risk of losing $112.50.
And while you might think you won’t end up having to take an early withdrawal, you never know what curveball life might throw at you. You may want to stick to a top-rated high-yield savings account, even if it means earning a bit less interest on your money and not having a guaranteed interest rate like a CD gives you.
2. You could technically lose money if you choose the wrong bank or deposit too much
With a CD, you generally don’t risk losing money if you don’t take an early withdrawal. But that assumes you choose the right bank and don’t make too large a deposit.
If you bank somewhere that’s not FDIC-insured, your deposit isn’t protected, so check to make sure your bank is an FDIC member. You should be able to find documentation somewhere on its website.
Also, keep your deposit to under $250,000, since that’s where FDIC protection maxes out. For most of us, that’s not a problem. But you may be parking a large sum of cash in a CD with the intent to buy a house in a year or two, so be mindful of that limit.
And remember, if you deposit $250,000 into a CD and it starts earning interest, you’ll be over that limit, so be careful. However, that $250,000 limit applies to a single account holder. If you have another account holder on your CD, your FDIC insurance limit doubles to $500,000.
3. You could miss out on better returns in a stock portfolio
CDs are still paying generously today, even if those 5% rates are no longer widely available. But consider this: Over the past 50 years, the S&P 500 has rewarded investors with an average annual 10% return.
When you invest in stocks, you run the risk of losing money. With a CD, you won’t lose a dime as long as your account balance doesn’t exceed $250,000, you bank somewhere that’s FDIC-insured, and you don’t withdraw your money early.
But with a CD, you take on a less obvious risk — losing out on a higher return over time and stunting your financial goals. Before you put a large sum of money into a CD, consider how much better you can do with a stock portfolio. And remember, too, that investing over a long period helps reduce the risk of owning stocks.
As an example, if you have $10,000 to put into a CD, buying stocks instead and earning 10% on that money over 20 years leaves you with $67,275. Even if you were to earn 4.5% on your $10,000 in CDs over the next 20 years, which is highly unlikely, you’re looking at $24,117.
But that extra $43,000 and change might do a world of good for your long-term finances. So that’s not money you should be quick to give up.
CDs technically have the potential to be a risk-free investment. But clearly, there are some hidden risks involved that may end up applying to you. It’s important to know about them, so you can make a more informed decision about opening a CD.
