Decades ago, Certificate of Deposits offered more than just appealing interest rates, they offered the security of growing your investment while keeping your money safe and sound. It was a great option for those who wanted to earn higher returns on their savings, but were not big fans of taking risks. Fourteen years ago, the average rate of a 5-Year CD was over 5.40%. Nowadays, that number has plummeted drastically to under 1%. If you’re lucky, the most you can probably obtain, is a solid 1% on a 5-Year CD of $100,000.00 or less. So, why are CDs now considered a bad investment?
For starters, CD rates will vary depending on current mortgage rates, as well as other factors such as economic conditions. When the economy is growing, The Federal Reserve will raise interest rates on CDs, as well as the cost of borrowing money (i.e., loans, mortgages, etc.). When the economy isn’t thriving, CD interest rates will decrease, as well as the cost of borrowing funds. At this point in time, CD yields are barely keeping up with inflation. You’re locking your money away for several years at a rate that doesn’t match the cost of goods and services when your investment matures. In other words, you’re not making money. Actually, you may be losing money, by not investing that capital into an alternative investment option that yields higher returns. Until the economy picks up, which in turn will drive up rates, CDs will continue to remain low and unprofitable.
In addition, CDs have clear penalty fees for early withdrawal. In which case, for the same interest rate, you might as well keep your money in an interest-bearing, savings account where at least you will have the option to withdraw or move your funds. In the event an attractive investment opportunity presents itself, your money is stuck for the duration of your CD term, unless you decide to pay penalty fees to retrieve your funds.
Furthermore, CDs have been a preferred investment for many, because they are FDIC-insured up to the $250,000.00 limit, but anything above this amount is considered “risky” and ineligible for government backing. So if you’re looking to invest a larger amount, you will most probably have to spread it across multiple CDs. Not to mention, you better be sure of what kind of CD you’re investing in, along with any factors that could possibly exclude your investment from being insured by the government.
Lastly, you will have to pay taxes on your investment earnings every year relative to your current income tax bracket. Yes, this means you must plan to have extra disposable cash on hand to cover the taxes on your investment every year (and no, you can’t touch the funds sitting in your CD unless you’re willing to pay a penalty fee for early withdrawal).
Frankly speaking, CDs have become nothing more than a savings account with a special name. From an investor’s perspective, it may actually be a poor investment decision. Although many think it’s a smart move, because it’s a low risk investment product backed by the FDIC, nowadays, CDs might cost you more than you could earn from them. Rather than taking a loss, it may be best to research alternative investment options that work for your financial goals. Some options available may pose a higher risk, but can almost assure a much better return on your money. Isn’t the point behind investing to increase your capital?