Is a CD worth it?

Compact disc

I’ve talked about savings accounts and checking accounts and when you want to put money in one versus the other. I’ve also talked about how you can benefit from using an online savings account to get a better interest rate than you can normally receive anywhere else.

But there is one type of account I’ve never talked about before: the “certificate of deposit”, or CD.

Why haven’t I mentioned it? Good question.

Not a compact disc

The Certificate of Deposit is an investment vehicle where your money is “periodically liquid”. This means that there are times where you can remove your money without penalty, and other times when you can’t. There is almost always a regular term, some number of months.

The longer the schedule, the higher rate of return usually. Which makes sense when you consider the unspoken agreement between the bank and you: you give your money to the bank, and they invest it or lend it out, and pay you a bit for the privilege. The more dependable that money is for the bank, the more that can be done with it, and the more the bank can pay you for the privilege.

CD sampler

My credit union’s savings account rates aren’t anything special. They might be higher than Bank of America’s, but that’s not really saying all that much.

My credit union’s savings rates.

The rates for CDs are a little bit better:

My credit union’s CD rates.

Note that the longer the term, the higher the interest rate. Also, the higher the amount, the higher the interest rate.

So if you had $100,000 and didn’t need it for 60 months, you could earn 3% on it.

But would you want to?

CD vault

If you had $100,000 but didn’t need it for 5 years, you could probably invest in a broad-based index fund. Part performance is no guarantee of future results of course, but if you look at the history of 5-year rolling averages, at least three quarters of them (depending on how you track inflation) in the past almost 100 years have been positive.

If you needed a guarantee, 3% is about the best you could offer. However, you could make much more than that if you allowed for a certain amount of risk. And we all pretty much need to be able to make more than that, as there’s pretty much no other way for most people to save up enough to retire.

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It’s scratched

The problem with CDs is that they are neither a very good investment vehicle nor a good insurance vehicle. CDs do nothing particularly well.

It is important to have liquid savings, money that you can use on short notice, for either emergencies or to pay for that vacation you’ve been saving up for for the past year.

But CDs aren’t that liquid. If you try to withdraw money before the term is up, you’ll pay a penalty, sometimes a hefty one.

You would do better finding an online high-yield savings account. You can find them earning around 2% these days. And these are 100% liquid.

On the other hand, if you truly have time to let the money sit, and if it won’t be used in emergencies, then there are better, higher-yield investments such as index funds that can help you earn more over the long run.

Look at all these rolling averages to see how over the long term you’ll probably be net positive on an broad-based investment.

Skip the CD

[perfectpullquote align=”full” bordertop=”false” cite=”” link=”” color=”” class=”” size=””]The problem with CDs is that they are neither a very good investment vehicle nor a good insurance vehicle.[/perfectpullquote]

In short, the reason why I haven’t talked about CDs on this site yet is because there isn’t much of a good use case for them. They’re not terrible, and you’re not wrong for using them, but there are better uses for your money.

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