Here's What Everyone Gets Wrong About CDs

Certificates of deposit (CDs) have been getting a lot of attention in the personal finance world lately, and for good reasons. The best CDs pay APYs of 5.00% or higher (as of March 26, 2024), and if the Fed cuts interest rates soon, opening a CD today could turn out to be a smart move.

But CDs are sometimes complex and mysterious for people to understand. Many people want to save more money and earn higher yields on their savings, but they are vulnerable to a few big misconceptions about CDs.

Let's look at a few of the biggest misunderstandings and misguided beliefs that people tend to have about CDs -- and what you should do with your money instead.

1. "CDs are always better than a savings account"

If you've recently managed to save up a decent amount of cash, or have received a one-time windfall of "extra" money like a bonus at work, or a big tax refund, you might have heard through the grapevine that people with cash should open a CD. As if CDs are inherently "better" than a bank savings account.

The truth about CDs: High-yield savings accounts sometimes have higher APYs than the best CDs. As of March 26, 2024, the best CD rates are 5.00% APY or higher, depending on the CD term. But the best savings accounts offer up to 5.36% APY. And savings accounts don't make you lock up your money; you can access your cash anytime without penalty.

2. "CDs work the same way as a savings account."

Differences in APY are not the only difference between CDs and savings accounts. Certificates of deposit require you to make a one-time, upfront decision about how much cash to deposit all at once, and then you have to leave that money locked up until the end of the CD term. Savings accounts are more flexible -- you can add different amounts of money to your savings account each month, based on your changing income, budgeting, and spending patterns.

The truth about CDs: Sometimes CDs can be a better choice than a savings account. But you have to be willing to commit your money to a CD for a certain amount of time. And make sure you understand the rules for early withdrawal penalties. There is also a special kind of CD called an add-on CD that lets you "add" additional cash to your deposit after opening the CD -- but most banks don't offer it.

3. "Only people with lots of money can open a CD"

Do certificates of deposit seem exclusive or "fancy" somehow? Like they're only for "serious investors"? Sometimes people have a misconception that opening a CD is only for the wealthy, like you need to have $1 million in the bank before you can open a CD. But this isn't true!

The truth about CDs: Many of the best CDs have low (or zero) minimum deposit requirements. There is a special category of CD called a "jumbo CD" that requires a large minimum deposit of $100,000 or more. But even if you don't have six figures of cash sitting around, you're still welcome to use your savings to open a CD.

4. "CDs are a good long-term investment"

Some people (wrongly) think that savings accounts are just a place to keep cash, and CDs are a more serious long-term "investment." Even though some CDs pay higher interest than savings accounts, CDs should not be considered a long-term investment for most people's goals.

The truth about CDs: If you put your money into a long-term CD, such as a 5-year CD, you're likely to lose money to future inflation. The best 5-year CDs (as of March 26, 2024) are only paying 4.35% APY. Even if inflation comes down during that long-term commitment to a CD, your money probably won't grow as much as it could have if you would've invested that cash in stocks. The S&P 500 has delivered a compound average annual growth rate of 10.7% for the past 30 years. Invest more aggressively if you want bigger growth.

Bottom line

Certificates of deposit (CDs) provide fixed rates of interest for a guaranteed length of time. This can make them a good choice for some people who want to lock in a high APY on their cash savings. But don't assume that CDs are always the right choice. If you want more flexibility for your cash, opening a high-yield savings account can give you most of the upsides of a CD, without the restrictions.