Are CDs Worth the Risk, or Should I Stick to a Savings Account?

The Federal Reserve has been raising interest rates for over a year in an attempt to slow the pace of inflation. That's been bad news for borrowers, as it's driven the cost of everything from personal loans to auto loans to home equity loans upward. But it's been beneficial to savers with money in the bank.

These days, savings accounts are paying quite nicely. You might earn an interest rate of around 4% in a high-yield savings account with no minimum deposit requirement, or a small minimum in the ballpark of $100.

But if you want an even higher interest rate on your money, you may be tempted to open a certificate of deposit, or CD. With a CD, you might earn upward of 4% and maybe closer to 5%. Granted, to snag these rates, you may need to meet a deposit minimum requirement of $1,000 to $2,500, depending on your bank, but in some cases, you can get away with less.

So should you put money into a CD and tie it up for a period of time? Or are you better off with a savings account? It depends on what your money is for.

Don't put emergency savings into a CD

It's always important to have money set aside specifically for emergencies -- things like home repairs or medical bills you can't always anticipate. The money that's supposed to serve as your emergency fund should not sit in a CD. That's because CDs don't usually let you withdraw funds -- you either have to leave your entire CD alone or cash out your entire balance early in a pinch. And if you cash out early, there could be steep penalties.

Now, the extent to which you'll be penalized for cashing out a CD will depend on your specific bank. For example, the penalty for cashing out a 6-month or 1-year CD early could be three months' worth of interest. It's important to read the fine print before putting money into a CD.

Stick to a shorter CD term

You might think you're okay to lock your money away in a CD, only for your needs to change. Plus, we don't know whether CD rates will continue to rise from where they are today. And if you lock your money away in a two-year CD, you might lose out if rates increase in a few months.

That's why if you're going to open a CD, you're probably best off sticking to a 6-month or 1-year term, and not longer. It's also a good idea to ladder your CDs so you have money coming due at different times.

Instead of opening a single $5,000 CD and committing to a 1-year term, what you may want to do instead is open five different $1,000 CDs with a 1-year term, signing up for each one two to three months after the previous one. This way, you'll have $1,000 freeing up every two to three months.

CDs may be more risky than a savings account because you're committing to leaving your money where it is for a certain amount of time, and you're also locked into the same interest rate. You can minimize the risks involved by not putting your emergency fund into a CD, sticking to short-term options, and laddering CDs rather than opening just one.