Are CDs Really Risk Free?

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KEY POINTS

  • CD deposits are protected as long as your balance doesn't exceed $250,000.
  • While your principal deposit may be safe, there are other risks you bear when you open a CD.
  • If you have to cash out a CD before the term expires, you'll face a penalty, and you might also end up locked into a lower interest rate than you want.

The quick answer? Not entirely.

The Federal Reserve has been raising interest rates in an effort to cool inflation. That's made the cost of things like credit card balances and personal loans rise. But it's also led to higher interest rates for savings accounts and CDs.

You may be thinking of opening a CD to lock in a high interest rate on your money. But are you taking a risk by doing so? To a degree, yes. Here's why.

Your money is generally safe

If you open a CD at an FDIC-insured bank, your principal deposit of up to $250,000 will be protected. And if you open a CD with a joint depositor, like a spouse, then that limit will rise to $500,000.

Since you're probably looking at a smaller CD than that (as most of us don't have a quarter of a million dollars just lying around), it's pretty fair to say that the money you put into your CD is safe. But that doesn't mean you don't bear any risks at all when you open a CD.

Beware these pitfalls

The drawback of putting your money into a CD is that you're required to keep it locked away for a preset period of time. But that's a risky prospect itself.

Even though you shouldn't be putting money into a CD that you might need for emergency expenses, you never know what surprises life might throw at you. You might have a nice emergency fund in a savings account and put separate funds into a CD, only to deplete your emergency fund and need that extra cash. And if you cash out a CD before it comes due, you could face a pretty steep financial penalty.

Now that penalty will hinge on the term of your CD and the bank you choose. But as an example, at Wells Fargo, the penalty for cashing out a 3- to 12-month CD early is three months' worth of interest. For a 24-month CD, it's six months of interest.

And to be clear, you can't just, say, take $1,000 out of a $10,000 CD if that's all the cash you need. You generally have to leave all of your money in there or otherwise cash out your CD entirely.

The other risk you take when opening a CD is locking yourself into a lower rate than you might get by waiting. Let's say right now, you find a 12-month CD paying 4.3% interest. What happens if one month later, that same CD at the same bank becomes available at 4.6% interest? At that point, you're out of luck, because you're committed to that lower interest rate.

Be careful when opening a CD

All told, the money you put into your CD should be safe as long as it's not a tremendous sum and as long as you choose a bank that's FDIC insured. But do be mindful of the other risks of opening a CD. And do your best to minimize them.

A good way to do that is to create a CD ladder. Instead of putting one lump sum of cash into a single CD, spread your money across different CDs with varying maturity dates. That way, you have money freeing up at various intervals, which gives you more flexibility on a whole.

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