3 Questions You Must Ask Before Buying a CD
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There are a lot of great reasons to buy a CD, especially since rates are above 5.00% right now. But you don't want to rush into opening one before you make absolutely sure that it's right for you.
To do that, ask yourself these three questions before you consider adding a CD to your list of assets.
1. Can I afford to lock up my money for the CD term?
The first and most important question to ask yourself is whether you can make a commitment to keep your money invested for the required length of time.
When you buy a CD, you must agree to leave your money alone for the duration of the CD term. While there are some one-month CDs, it's far more common to find terms ranging from three months to five years. So, you're looking at locking your money up for a while -- and potentially as long as half a decade.
If you cash in your CD early, you could face penalties that equal several months interest. This can really add up. In fact, if you cash in too soon, you could wind up walking away with less money than you put in -- despite the fact that CDs are usually seen as a risk-free investment since they're FDIC insured.
Take the time to think very carefully about whether any scenario could cause you to need the money you're investing sooner than planned. If there's a realistic possibility you'd have to break your CD before it matures, you're probably better off putting the money in savings instead (especially as savings accounts are also offering really high yields right now).
2. Have I shopped around for CD rates?
The national average rate on a 6-month CD is 1.57% as of April 15, 2024. But the best 6-month CD rates on The Ascent's list have APYs above 5.00%.
This huge discrepancy shows just how much variation there can be when it comes to the rate you're offered on a CD. And since your goal is to earn the highest possible returns, it's crucial that you shop around before you invest your money.
You should specifically look for high-yield CDs, many of which are offered by online banks. And you should compare factors including the APY, term length, penalties, and how often interest compounds (daily is best). If you don't check out multiple options to find the best CD rates before you buy, you could leave a lot of money on the table.
3. Would this money be better off in a brokerage account?
Finally, the last big question is whether the money you are investing in a CD would actually be better off in a brokerage account. If you won't need the funds for at least five years, the reality is that you are most likely going to end up better off if you invest it in the stock market instead of a CD.
You can buy shares of an S&P 500 index fund that comes with pretty low risks and that has very consistently produced 10% average annual returns over the last 50 years -- and you don't need any investing knowledge to do it. This is a better return than even the best CDs offer -- with the caveat that past performance is no guarantee of future returns and that this strategy is best employed over the long term.
By making sure you answer these three questions, you can put your money in the best possible place, and maximize the chances of earning the best return on investment available to you.
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