3 Surprising Drawbacks of 5% CD Rates

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Today's outstanding CD rates won't be available forever. And a lot of people are bummed to think about them going away.

But while your window for locking in a 5% CD may be narrowing, you should also know that 5% CDs aren't as great a thing as you might think. Here are a few less obvious drawbacks of 5% CD rates.

1. Higher CD rates go hand in hand with higher borrowing rates

There's a reason CD rates are as high as they are today. The Federal Reserve spent a good part of 2022 and 2023 raising its benchmark interest rate to slow inflation. And when the Fed's benchmark rate increases, savings account and CD rates tend to follow.

But the flipside to higher CD rates is that it's gotten more expensive to borrow money across the board. So while you might get a 5% CD rate today, you're also generally looking at a higher interest rate on a mortgage, auto loan, personal loan, or any other type of loan you end up signing.

2. Stocks are still likely to perform better

Earning 5% on your money may be appealing in its own right. But you should know that if you put your money into a stock portfolio, you might snag a much higher return over time. The stock market's average annual return over the past 50 years is 10%. And that accounts for periods where stocks soared and when the market did poorly.

If you put $5,000 into a 12-month CD today at 5%, you're guaranteed to earn $250 in interest. With a stock portfolio, you're not guaranteed any specific return.

But if you instead put your $5,000 into a stock portfolio that delivers a yearly 10% return over the next 20 years, you're looking at growing that sum into about $33,600. That's a gain of $28,600. And if you divide that by 20 years, you get an average gain of $1,430 per year, which is way more than earning $250 from a 5% CD.

To be clear, investing in stocks is something that should be done on a long-term basis. If you only have a one-year window, a 12-month CD is a safer bet, because 12 months doesn't give you a lot of time to ride out a potential market decline. But if you're able to think long-term, then it pays to consider stocks.

3. You still risk an early withdrawal penalty

You may want to open a 5% CD because that return is supposedly yours to enjoy risk-free, right? Well, not exactly.

It's true that if you open a CD at an FDIC-insured bank and keep your deposit to no more than $250,000, you don't risk losing any of that deposit, even if your bank collapses. But if you end up needing your money before your CD's maturity date, you'll generally face an early withdrawal penalty.

Now, your exact penalty will depend on your bank and the length of your CD. But because CD rates are high today, you stand to lose even more money in the event of an early withdrawal penalty.

It's easy to get excited about CDs at 5%. But don't be too disappointed that 5% CDs probably won't be around much longer. If you play your cards right, you can find other ways to earn a great return on your money outside of CDs. And you might benefit from a cheaper mortgage, auto loan, or any other loan you might need.

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