Certificates of deposit (CDs) are a popular way to generate extra income with minimal risk. Investors simply agree to lock up their cash at a bank for a set amount of time, then receive interest payments at the agreed annual percentage yield (APY).
For example, if you invest $10,000 in a 12-month CD with a APY of 3%, you'll get your $10,000 back with $300 in interest once that year ends (or monthly depending on the CD). Your principal, as long as it doesn't exceed $250,000, will also be fully protected by the FDIC even if the issuing bank fails.
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That's why CDs became so popular when the Federal Reserve raised its benchmark interest rate 11 times throughout 2022 and 2023. Those rising rates drove investors away from stocks, but they significantly boosted the yields of CDs and U.S. Treasuries. As interest rates peaked in late 2023, the average yields of 12-month CDs climbed to 5%-6%. Today, CDs might still look appealing with 12-month APYs of up to 4%. However, it's actually a bad idea to open up a new CD right now for three simple reasons.
1. Declining interest rates
CDs attracted a lot of investors when interest rates rose, but the Fed already reduced its benchmark rate three times in 2024 and once in 2025. The Fed funds rate currently sits at just 4.00%-4.25%, and many analysts expect at least two more rate cuts this year.
As interest rates decline, CDs will become less attractive. You can still lock away some cash in 12-month CDs with a 4% APY, but you won't be able to deploy that cash on more attractive (and higher-yielding) investment opportunities. Once that CD matures, you probably won't find a CD with a comparable yield as interest rates should continue to drop.
2. Dividend stocks could generate higher yields
As interest rates decline, more income-oriented investors will likely pivot toward blue chip dividend stocks that pay higher yields than CDs or T-bills. The telecom giant AT&T (T +2.11%), which recently divested its weaker media assets to focus on expanding its higher-growth 5G and fiber businesses, pays a respectable forward dividend yield of 4.3%.
The tobacco giant Altria (MO +0.15%), which has been expanding its portfolio of smoke-free products to curb its long-term dependence on traditional cigarettes, pays an even higher forward yield of 6.6%.
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Investors who want steady passive income can also invest in reliable real estate investment trusts (REITs) like Realty Income (O 0.38%) -- which simply purchases many properties, rents them out to recession-resistant retailers, and pay out most of that rental income to its investors as dividends. In other words, income investors will gain many more high-yielding options as interest rates decline -- so you probably don't want to lock up all your cash in a longer-term CD as that happens.
3. Early withdrawal penalties
If you want to cancel your CD and put your cash in another investment, you'll likely need to pay an early withdrawal penalty unless it's a special "no-penalty" CD. That penalty is usually around half of the interest accrued so far and won't be deducted from your principal.
That might not seem like much, but you could have avoided that penalty and earned a higher yield by putting your cash in a reliable blue chip dividend stock. It also makes sense to invest in those dividend stocks before the Fed's upcoming interest rate cuts drive up their stock prices and valuations while reducing their annual yields.
CDs are safe, but they're not always the best option
CDs are still a nearly risk-free way to earn extra income. But as interest rates decline, there's no guarantee those CDs will outpace the average inflation rate of 2%-3%. If those yields lag inflation, your purchasing power will wither. If you're willing to take on a little more risk for a higher yield, it makes more sense to buy dividend stocks instead.
