Why I Still Won't Touch a 5-Year CD With a 10-Foot Pole

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KEY POINTS

  • CD rates could get more generous as the Federal Reserve raises interest rates.
  • Even if CD rates climb, a long-term CD is a poor choice for a number of reasons, including interest rates that are still pretty low.

Right now, I think it's a terrible choice.

If you have money set aside for emergency expenses or situations, that cash should stay tucked away in a savings account. That way, you'll pretty much have instant access to that money, and you won't have to worry about losing out on principal for taking a withdrawal at the wrong time -- something you do have to concern yourself with when you invest in a brokerage account.

But if you have cash on hand that you don't plan to use for years and don't need for emergency savings purposes, then you may be inclined to try to earn a better return on that money than what a savings account will give you. And to that end, you might look at opening a certificate of deposit, or CD.

A shorter-term CD may not be such a poor choice right now. But here's why I'd advise anyone to steer clear of a longer-term CD.

Don't stunt your money's growth

CDs come with different terms -- meaning, different lengths of time you're committing to locking your money away for. Most banks offer a 6-month CD, a 1-year CD, and a 5-year CD, among other choices.

If you put your money into a 6-month CD, you might snag a slightly higher interest rate than what your savings account will pay. The same could hold true for a 1-year CD.

If you open a 5-year CD, you'll likely get a substantially higher interest rate than what your savings account gives you. And as interest rates rise this year in response to hikes on the part of the Federal Reserve, longer-term CDs might end up paying even more generously than they do today.

In spite of that, I'd advise anyone with extra cash to avoid a 5-year CD. For one thing, interest rates just started rising recently, but they have the potential to rise more. If you lock yourself into a longer-term CD, you might end up getting stuck with a lower interest rate on your money for a lengthy period of time. And while you could always cash out your CD early in that case, doing so will generally mean getting penalized to the tune of several months of interest.

Secondly, if you have money you don't think you'll need for five years, it pays to invest it in a brokerage account rather than keep it in a CD. While you'll take more risk by investing, you might also snag considerably higher returns -- returns that get you closer to meeting your financial goals.

What if you're super risk-averse?

If you're not comfortable taking on risk, you may be inclined to favor a 5-year CD over a brokerage account, where you might lose money. But keep in mind that locking your money away in a 5-year CD poses another risk -- that you'll lose out on growth opportunities and put yourself in a position where your savings can't keep up with inflation. That's really a risk you don't want to take, which is why I'd say it makes sense to either stick to short-term CDs, or stay away from CDs period.

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