3 Reasons to Absolutely Steer Clear of CDs -- Even With Rates at 5%
CD rates are very appealing these days. But read on to see why a CD could be a poor choice for you.
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I know a lot of people who are opening CDs today. And I can understand why.
The nice thing about CDs is that they give you a guaranteed return on your money with pretty much no risk. All you need to do is bank at an FDIC-insured institution, and your money is protected as long as your deposit is $250,000 or less. And with many CDs paying APYs of 5.00% (or more) these days, it's hard to pass up that opportunity.
But while today's CD rates are definitely strong, a CD is not necessarily the best place for your money. And if any of these scenarios apply to you, you should absolutely stay away from CDs right now.
1. You need all of your savings to serve as your emergency fund
As a general rule, you should aim to have enough money in your emergency fund to cover three months of essential expenses -- such as rent, groceries, and utilities. That way, if you were to lose your job, you'd be able to pay your bills for a while without resorting to debt.
If you currently have three months' worth of savings on hand, give yourself a pat on the back. That's a truly great accomplishment. But at the same time, don't stick that money into a CD. You need your emergency fund to be available to you at all times.
There can be costly penalties for cashing out a CD before its maturity date. So you're better off keeping your emergency fund in a regular savings account. The good news, though, is that many online savings accounts are paying APYs above 4.00% right now, so you're not losing out on so much interest compared to a CD.
2. You owe a lot of high-interest debt
The whole appeal of CDs right now is the returns they're offering. But if you have a lot of high-interest debt, you may be losing a lot more money to interest than what you might gain in a CD. So if that's the case, it makes more sense to use your cash to pay off some of your debt.
Let's say you owe $5,000 on a credit card with a 20% APY. If it takes you a year to pay it off, you'll lose $558 to interest. Meanwhile, if you put that $5,000 into a 12-month CD with a 5.00% APY, you're only looking at earning $250 in interest.
3. You're trying to save for retirement
You may be able to get a 5.00% APY on a CD right now. But if your goal in opening one is to put money aside for retirement, you should strongly consider investing that cash instead.
The reason? Over the past 50 years, the stock market's average annual return has been 10%. So you might earn a lot more with a stock portfolio than you will with CDs. And while investing does mean taking on risk, the reward can more than make up for it.
Of course, investing isn't something you want to do over just one year. You need a longer window than that to ride out potential market downturns.
But let's just say that hypothetically, you can get a 5% return out of CDs for the next 20 years. With a $5,000 deposit, that results in close to $13,300. But with a 10% return, in 20 years, your $5,000 could be worth about $33,600. That's about a $20,000 difference.
CDs may be all the rage right now. But think carefully before opening one -- especially if you're looking at tying up your emergency fund, passing up the chance to pay off high-interest debt, or hoping to grow your money for a far-off goal.
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