If you’ve ever considered investing in certificates of deposit (CDs), you’ve probably heard that they have a big downside: You lose liquidity of your cash when you put it into CDs. While CDs are pretty low-risk investments and they offer great rates right now, this one big disadvantage keeps many people from buying them.
But what if that “downside” is actually a good thing for some savers? Here’s why that just might be the case.
Is this really a downside of CDs?
Every CD has a term length, often ranging from three months to five years. You’re guaranteed to get paid the promised yields for the entire CD term. But the catch is that you have to keep your money invested for that whole time. If you take your money out early, you’ll pay a penalty (and if that penalty amounts to more interest than you’ve already earned, you could lose some of your principal balance).
This is viewed as a huge disadvantage. After all, your money is trapped in the CD. You can’t take it out if you decide you need it for something else. That’s very different from a savings account, where you can take your money out at any time.
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But while many people are hesitant to lock up their money, this penalty can be a good thing for some savers. Specifically, it could be enough to stop you from taking money out of your account if you don’t have the willpower to keep it there otherwise.
Let’s say you put money into your savings account to save up for a big purchase you’re planning to make next year, but you have a really hard time keeping your hands off it. You end up withdrawing a little bit here or there when there’s a big sale at your favorite store or your friend suggests taking a weekend trip.
In the end, you could find yourself without the money you need when it comes time to make your purchase. It was just too easy to take it out since you could access it at any time. If you had the money in a CD, though, you’d probably face a penalty that could cost around 90 days to 365 days of simple interest.
The threat of that fee might convince you not to take withdrawals while you’re trying to save. The penalty could be the outside influence you need to stick to your plan — just like people use outside motivators to achieve goals, like getting an accountability buddy to help them eat healthier.
Is investing in certificates of deposit right for you?
Ultimately, investing in a CD makes good sense if you have money you won’t need for at least a few months and you don’t want to put it into the stock market because your investing timeline isn’t long enough. Since you usually won’t want to put money in the market if you’ll need it in the next five or so years, CDs are a good place for the cash you’ll need for short-term and medium-term goals. For money with a longer timeline, investing via a brokerage account is a better option.
And you shouldn’t be deterred by the possibility of an early withdrawal penalty either, especially if it helps you stay motivated. Obviously, you don’t want to put money in a CD if you know you’ll have to break the term early. But if you have no solid reason an early withdrawal would be necessary, then take a look at our best CD rates list to see if one is right for you.
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