3 Reasons Why CDs Aren’t As Risk-Free as You Think

There’s a reason CDs are such a popular choice for preservers this year. For most of the year, CDs were paying 5% or even a little more. While CD rates are now down slightly following the Federal Reserve’s interest rate cut in mid-September, many CDs are still paying close to 5%.

So, it’s still possible to get a great deal, especially if you shop around. For a list of today’s highest CD rates, click here.

But if you’re going to open a CD, you should understand the risk you’re taking. You may assume that CDs are a risk-free savings option. But that doesn’t tell the whole story. That’s why CDs aren’t as risk-free as you might think.

1. There is a risk of early withdrawal penalties

It’s common for banks to charge early withdrawal penalties for taking money out of a CD before it matures. The good news is that your bank cannot penalize you. It should explain what your penalty will be when you open your CD.

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But let’s say you invest $10,000 in a 12-month 4.5% CD, and the penalty for early withdrawal is three months’ interest. This means you risk losing $112.50.

And while you can to think You won’t have to withdraw early, you never know what challenges life will throw at you. You may want to stick with a top-rated, high-yield savings account, even if it means earning slightly less interest on your money and not having a guaranteed interest rate like a CD gives you.

2. You could technically lose money if you choose the wrong bank or deposit too much

With a CD, you generally don’t run the risk of losing money if you don’t withdraw early. However, this assumes you have chosen the right bank and are not depositing too large a sum of money.

If you bank somewhere that is not FDIC insured, your deposits will not be protected; So make sure your bank is a member of the FDIC. You should be able to find the documentation somewhere on the website.

Also, keep your deposit under $250,000 as this is where FDIC protection is maximized. For most of us, this isn’t a problem. But you may be parking a large amount of cash in a CD with the goal of purchasing a home in a year or two, so be careful with that limit.

And remember, if you put $250,000 into a CD and it starts earning interest, you’ll be over that limit, so be careful. However, this $250,000 limit is valid for a single account holder. If you have another account holder on your CD, your FDIC insurance limit doubles to $500,000.

3. You may miss out on better returns in a stock portfolio

Even though these 5% rates are no longer widely available, CDs still pay handsomely today. But consider this: Over the last 50 years, the S&P 500 has rewarded investors with an average annual return of 10%.

When you invest in stocks, you run the risk of losing money. With a CD, you won’t lose a dime as long as your account balance doesn’t exceed $250,000, you deposit money somewhere FDIC insured, and you don’t withdraw your money early.

But with a CD you take a less obvious risk; you lose out on a higher return over time and disrupt your financial goals. Before investing a large sum of money in a CD, consider how much better you could do with a stock portfolio. Also remember that investing for the long term helps reduce the risk of owning stocks.

As an example, if you have $10,000 to put into a CD, buying stocks instead and earning 10% of that money over 20 years would leave you with $67,275. Even if you earn 4.5% of your $10,000 worth of CDs over the next 20 years, which is extremely unlikely, you’re looking at $24,117.

But that extra $43,000 and money could do a lot of good for your long-term financial situation. So it’s not money, you should give up quickly.

CDs have the potential to be a technically risk-free investment. But frankly, there are some hidden risks that may apply to you as well. It’s important to know about these so you can make a more informed decision about opening the CD.