When you hear the word “investing,” you probably think of the high-risk, high-reward world of the stock market. But investing can take many different forms, from mutual funds and exchange-traded funds (ETFs) to more conservative investments like bonds and certificates of deposit (CDs).
CDs offer a guaranteed interest rate that’s typically higher than a savings account, and you get the safety of Federal Deposit Insurance Corp. (FDIC) insurance, so you don’t have to worry about losing your money in the event of a bank failure. 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 several 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 terms available. CD terms can range from one month to 10 years, allowing you to choose the length and rate that work for your goals.
Longer terms typically offer higher interest rates. However, this isn’t always the case. In 2022, the yield curve inverted, which resulted in short-term CDs offering higher rates than longer-term ones. You’ll want to find a CD that aligns with your investment time horizon.
These banks and credit unions offer some of the best CD rates, which come in a variety of terms and offer annual percentage yields (APYs) well above the national average rates:
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 annual percentage yield (APY) in the middle of the term if interest rates in the economy rise. No-penalty CDs allow early withdrawals without penalties.
2. Safety
CDs are very safe investments—bank CDs essentially guarantee that you’ll get your initial investment back. The only risk is the potential for lost interest if you redeem the CD before maturity. If you need to retrieve your money early, you’ll be subject to an early withdrawal penalty, which is usually worth a few months’ interest.
CDs are also considered deposit accounts, so they’re 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.
“FDIC insurance brings a lot of peace of mind for people knowing that it’s backed by the government,” says Kyle Newell, Certified Financial Planner (CFP) and owner of Newell Wealth Management in Winter Garden, Florida. “Especially now that we’re actually getting really good interest rates relative to other riskier asset classes.”
3. Fixed rates
Unlike savings accounts which are variable rate accounts, CDs allow you to lock in a rate over a fixed period. 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 be especially valuable if interest rates drop over the term of your CD.
4. Higher returns
If you can be sure you won’t need to touch the money, you can often get a little more bang for your buck. Since you’re agreeing to lock your money up for a period of time, CDs generally offer higher rates than high-yield savings accounts.
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 for the income you’ll need in the future.
For example, you could create a CD ladder where you buy multiple CDs with different terms.
3 drawbacks of investing in CDs
Like most investments, CDs come with their share of drawbacks as well. They may be too conservative for someone looking to make higher yields, there’s a risk of inflation, especially for longer-term CDs, and the income you make from your investment in a CD will be taxed.
1. Too conservative
While CDs typically earn better interest rates than savings accounts, your returns would likely be lower than what you’d earn from a diversified investment portfolio over the long-term, including stocks and bonds.
For that reason, it’s risky to rely too heavily on CDs.
2. Inflation
While a CD’s fixed interest rate offers certainty, APYs may be outpaced by inflation, especially over longer periods.
“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, Tennessee. “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 individual retirement account (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, taxes could reduce the net return significantly, especially compared to a diversified investment portfolio held in a tax-advantaged retirement account like a 401(k) or IRA.
How to invest in CDs: 3 strategies to try
There are some different strategies you can use when investing in CDs, each of which help you achieve different goals: You can use a ladder, a bullet, or a barbell to get more out of your investments.
CD ladder
With a CD ladder, you spread your cash over multiple CDs, each with a different term. Then, as each CD matures, you can choose to use that money as income or reinvest it in a new CD. This strategy can provide a predictable stream of income, which can be a nice complement to the rest of your investment portfolio—particularly 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. “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 in a single CD, you purchase five different CDs, all with a $4,000 investment, with terms of one, two, three, four, and five years. Your ladder works like this:
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:
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.
“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 reinvest at a potentially 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:
How to find the best CDs to invest in
The best CD rates are often found through online banks or credit unions. The key is to shop around and find the right CD 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 taxes, inflation, and early withdrawal penalties can all end up cutting into your return.
But if you’re saving for a goal with a specific timeline or trying to create a predictable income stream, they can be a safe way to earn a guaranteed interest rate.
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 useful for longer-term investment goals and some even offer special tax advantages.
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.
About the contributors
Trina Paul covers all subjects related to personal finance, from bank deposit products and credit cards, to investing. Her bylines can also be found at CNBC Select and the Skimm. She graduated from Swarthmore College with a degree in economics.
Matt Becker is the founder of Mom and Dad Money, a fee-only financial planning practice, and a certified financial planner (CFP) who is dedicated to helping new parents build happy families by making money simple. His work has been featured in numerous publications, including The New York Times, NPR, The Washington Post, and Money Magazine.
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