How to invest with CDs: Growing your savings safely

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Looking for a way to grow your money without the ups and downs of the stock market? Certificates of deposit (CDs) might be your answer. These accounts offer stable, fixed returns, making them ideal for conservative investors or those saving for specific goals. 

Understanding the different CD offerings and how they work can help you decide if they suit your financial strategy.

How CDs work

A certificate of deposit (CD) account is a deposit account that allows you to lock in the interest rate for a specific period, known as the account’s term. Terms on CDs can range from a few months to several years. 

Throughout the CD's term, your initial deposit earns interest at the agreed-upon rate. Accessing your funds before the CD matures (reaches the end of its term) typically results in an early withdrawal penalty, which can eat into your earnings. 

“CDs are good for conservative investors who don’t want exposure to market volatility,” says Brandon Renfro, certified financial planner and financial advisor. “It’s also a great option for those who need a secure way to set aside money for an expected future expense. You’ll still earn some interest but won’t risk losing principle.”

CDs are considered safe investments because deposits are often FDIC-insured up to $250,000. 

Types of CDs

The above description is accurate for traditional CDs. However, some CD accounts come with unique features. Here are a few of the varieties you may encounter.

• Bump-up CD: These CDs offer a unique feature: If interest rates rise during your CD's term, you can request a 'bump' to a higher rate. This helps offset the risk of being locked into a lower rate if market rates increase. Banks typically limit how often you can use this feature, often to just once per term
• Jumbo CD: These CDs require a larger opening deposit, though they often offer better interest rates than most. While institutions may accept higher deposits, FDIC insurance only covers up to $250,000 per depositor.
• No-penalty CD: While most CDs penalize early withdrawals, no-penalty CDs do not. You can withdraw funds penalty-free typically starting one week after opening the account. The bank or credit union may limit how many withdrawals you can make or what portion of the original deposit you may withdraw before maturity.
• Brokered CDs: Brokered CDs are offered by brokerage firms rather than banks or credit unions. They function similarly to regular CDs but often provide more flexibility in terms of rates and maturity dates. 
• Callable CD: This account allows the issuing bank to “call”, or “redeem”, the CD back from you earlier than its maturity date. You’ll receive interest (usually at a higher-than-market rate) for the period you invested your money.
• Add-on CD: You can deposit more money to an add-on CD during the account’s term. Lower interest rates may offset this advantage. 
• Foreign currency CD: These CDs can hold multiple foreign currencies, not just U.S. dollars. They carry additional exchange-rate risk as your returns can vary based on how well the dollar performs against the other currencies in the account.

Benefits and drawbacks of investing in CDs

CDs offer a solid savings vehicle for conservative investors with low risk tolerance, but they don’t suit everyone. Before investing, consider the benefits and drawbacks of CDs.

Pros of investing in CDs

• Guaranteed rate of return: You don’t need to wonder how much money you’ll make on your investment. With a CD, the interest rate stays the same for the length of the term. 
• Higher interest rates: According to FDIC data, all but the shortest CD terms offer higher average interest rates than savings accounts. For example, the average savings rate is 0.46%, but a 6-month CD offers 1.82%. 
• Safety: Unlike most investments, CDs carry very little risk if you get one from a bank with FDIC insurance (or a credit union with NCUA insurance). FDIC or NCUA protects your deposits up to $250,000 per person, per account. 
• Stability: CDs don’t expose you to market risks. They won’t take you on the emotional rollercoaster of ups and downs like stocks can.

Cons of investing in CDs

• Opportunity cost: By choosing a CD, you might miss out on potentially higher returns from riskier investments like stocks. While CDs offer guaranteed returns, these returns are typically lower than what you might earn in the stock market over the long term.
• Lack of liquidity: Banks lock away funds in a CD, and you cannot access them before the maturity date without paying an early withdrawal penalty, usually a portion of the earned principal.
• Interest rate risk: Your interest rate doesn’t fluctuate when you open a CD, but market interest rates may. If rates increase, you may miss out on better returns because you cannot access your money.
• Inflation risk: If the CD’s interest rate doesn’t keep pace with inflation, you could effectively lose principal because inflation would erode its earning power. 

CD investing strategies 

While simply opening a single CD is straightforward, many investors often use more advanced strategies involving multiple CDs. These approaches aim to balance higher returns, access to funds, and protection against interest rate changes. Let's explore three popular CD investing strategies:

CD ladder strategy

CD laddering is a strategy where you invest in multiple CDs with staggered maturity dates. For instance, you could invest $1,000 each in a one-year CD, a two-year CD, a three-year CD, a four-year CD, and a five-year CD. This method ensures that you’re never too far out from being able to access your money. 

Once each CD matures, you can pull the funds or roll them over to a new five-year CD to keep earning interest.

CD barbell strategy 

In this arrangement, you split your funds between short-term and long-term CDs, skipping the middle ones in the laddering strategy. For example, if you have $10,000, you may put half in a six-month CD and half in a five-year CD. This strategy gives a portion of your investment plenty of time to grow while a portion is reasonably accessible should you need it sooner. 

Unlike a real-life barbell, you don’t have to evenly distribute your cash to use this strategy. If you have a solid interest rate, you can put more money in a long-term CD; if you need more liquidity, put more in a short-term CD. 

CD bullet strategy

The CD bullet strategy involves purchasing multiple CDs with different terms but the same maturity date. For instance, you might buy a 5-year CD now, a 4-year CD next year, and a 3-year CD the year after. This way, all CDs mature simultaneously, giving you a lump sum at a predetermined future date. 

This method is particularly useful for people saving up for a significant future expense, such as a down payment on a house. 

How to pick the right CD for you

When choosing a CD, investigate the interest rates different financial institutions offer, the term lengths, and the deposit minimums. 

While chasing the best CD rates might be tempting, the maturity date and investment requirement should match your financial goals. Be realistic when considering your need for access to your funds. Seek a balance between liquidity and potential returns that aligns with your needs.

Incorporating CDs into your investment portfolio 

Incorporating CDs into your investment portfolio can be a solid choice for conservative investors with a low risk tolerance. However, it’s wise to consider the opportunity cost of potentially lower returns that CDs offer over a long time horizon when compared with more aggressive investment options like stocks or mutual funds. 

CDs can balance out riskier investments, providing a predictable, steady income even for investors with a higher risk tolerance or lengthy time horizon. The portion of a portfolio occupied by this conservative investment will differ from person to person. It may change over time to reflect the need for cash preservation as investors approach retirement. 

Review and adjust the distribution of your portfolio’s funds to reflect your ideal asset allocation before your CD's maturity date. Many CDs automatically renew after maturity, so note this date on your calendar if you plan to change your account.

CDs and retirement planning 

In retirement, a key concern is to preserve the principal of the nest egg you’ve worked so many years to save. CDs allow you to generate a steady income on your money without risking the principal. 

Renfro suggests that this makes CDs a helpful component of a retirement portfolio. “If you’re using a CD ladder to fund ordinary recurring expenses in retirement, you might want to stagger the CDs so that some mature every year or every few months. CDs offer fixed maturity dates, so make sure that you align those maturities with your cash flow needs.”

You can hold CDs inside retirement accounts such as an IRA. Some banks offer special IRA CDs. The interest on retirement CDs is treated like other dividends and income inside the retirement account.

Frequently asked questions

The bottom line 

CDs are an important wealth-building tool for the conservative investor. They allow modest growth without risking the principal investment. You can use multiple CDs together in strategies to maximize returns, provide a steady income source, and create greater liquidity for the invested funds. 

While CDs are a conservative investment, they have a place in a long-term investment plan, providing a stabilizing force against volatile market returns. Consider whether the predictable returns of a CD deserve a spot in your investment portfolio.

Editorial disclosure: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.