3 Little-Known Drawbacks of CDs

With the Fed cutting interest rates and a bunch of banks trimming their APYs, it's actually a great time to take a closer look at CDs. Some of the top offers right now are still above 4.00% APY, which can be perfect for short-term savings.

But as good as they can be, CDs still have a few quirks that don't always make it into the conversation. Before you park too much cash in one, it's worth understanding these hidden trade-offs.

1. Lower long-term returns vs. other investments

CDs protect your money, but that safety comes with a ceiling.

Even with a top APY today of 4.00%+, long-term returns just don't stack up next to what the stock market has delivered over decades. Over the past 50 years, the market has averaged about 10% annually.

That gap compounds into a massive difference over time. Here's an example:

• If you invest $10,000 in CDs for 10 years at a 4.00% APY, you'll have $14,802.
• If you invest $10,000 in stocks for 10 years and get a 10% annual return, you'll have $25,937.

The downside for investing in stocks is that returns aren't guaranteed. And you have to stay invested through downturns to actually capture that long-term upside.

That's why CDs shine for short-term goals and for money you'll need within a few years. But for anything longer than that, CDs aren't a great long-term investment.

2. CD interest is taxable income

Another thing people don't always talk about: every dollar of CD interest gets taxed as ordinary income. You'll owe federal taxes, and if you live in a state with income tax, it'll take a cut too.

That reduces your true return, even if you're earning a healthy APY.

If taxes are a concern, Treasury bills (T-bills) can sometimes be a smarter alternative. They offer competitive short-term yields and skip the state income tax entirely. That tax advantage alone can boost your after-tax return, depending on where you live.

CDs are still perfectly good -- they just don't get to keep every penny they earn you once tax season comes around.

3. Rates aren't always guaranteed -- and renewals can sting

Most people open CDs because they love the certainty. And with traditional CDs, that's true. But not all CDs play by those rules.

Callable CDs, for example, look tempting because they sometimes offer higher APYs. The catch is that the bank can "call" the CD early, which basically means your high APY is only guaranteed during the call-protection window, which can be as short as a few months. After that, you're at the mercy of the bank.

One more thing that sneaks up on people is automatic renewals. When your CD matures, many banks quickly roll it into a new term unless you intervene. And that new term might carry a dramatically lower rate.

In any case, fully understanding the CD type and staying on top of maturity dates matters. Keeping money temporarily in a high-yield savings account can make sense while you are shopping for the right CD investment.

When CDs make sense

CDs are great when your timeline is short and you want zero surprises. They're perfect for money you'll need in the next year or two (like for travel, a home project, or a safety buffer) and they give you a stable return.

They also work well when rates are declining, since locking in a short-term CD protects today's yield before it slips lower.

To find the best fits for your near-term goals, check out today's top CD rates.