There’s a big rush to open certificates of deposit (CDs) while rates are high. And I get it — the idea of getting a 5% return on a CD is appealing, considering you’re not taking on the risk of, say, investing in stocks. Also, the Federal Reserve is likely to start cutting interest rates this year. Once that happens, CDs could start paying less.
But even though you may be eager to take advantage of today’s 5% CD rates, a CD is not automatically your best choice. Here are three reasons not to open a CD at 5%.
1. You’re looking at putting your emergency fund into a CD
If you have money earmarked for emergency expenses sitting in a savings account, you may be earning less interest than what a CD might pay you. You also run the risk of seeing your interest rate drop once rate cuts happen.
With a CD, the interest rate you lock in is set in stone. So even if we end up with several rate cuts in the next year, if you open a 12-month CD at 5%, you’re getting that 5% on your money no matter what.
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But that still shouldn’t prompt you to move your emergency fund into a CD. That money needs to be available to you at all times in case you need to use it.
If you put the cash into a CD and then need to pull it out early, you’ll generally face an early withdrawal penalty. That penalty could negate a lot or all of your interest earnings. So you’re better off sticking with a regular savings account, even if it means less interest all in.
2. You’re dealing with your retirement savings
CDs are a good bet for short-term savings. But if you have funds you want to set aside for retirement, you should probably invest them in stocks instead. Even though CDs are currently paying 5%, the stock market’s average annual return is 10% over the long term. That’s a huge difference.
Getting 5% interest on a $10,000 CD over the next 20 years (which is very unlikely since today’s rates aren’t likely to last) means growing your balance to about $26,500. At a 10% return, your $10,000 could grow into a little over $67,000. And again, 5% CD rates are not the norm, so chances are, the difference would be greater.
Now, you might be saying, “But I don’t plan to open a CD for the next 20 years. I just want to open one for 12 months to get a great rate.” And again, that’s OK if you’re saving on a short-term basis. But there’s no reason not to put money you’re earmarking for retirement into stocks. The sooner you do, the more it can potentially grow.
3. Your job situation is uncertain
Despite a fairly strong economy, many companies are still laying off workers or making plans to do so. If there are rumors at your company about downsizing, you may want to hold off on opening a CD until things settle down.
Losing a job could mean more than just having to raid your emergency fund. It could mean having to bear the cost of relocating if you’re unable to find a suitable new job in your current city.
Or, if you work remotely now, it could mean having to get a car to make an office job accessible. It’s best to pass on those 5% CD rates if you’re in a complicated job situation and aren’t so confident your position has staying power.
It’s easy to see the appeal of 5% CDs. But in these situations, opening one is a big mistake.
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