Sorry to immediately start by going all middle-aged-money-finance on you here but it’s interesting to me how history repeats itself. When I was growing up and starting to earn some money on my own (thanks Dairy Queen), CDs felt pretty common to me, and was something my parents talked about and something I would put my money into. Then fast forward to late college and me getting out into the real world working, we basically embarked on one of the longest bull markets on record – from 2009 to 2021. Investments only went up, money was cheap to borrow (interest rates in the low 2%s!) and savings accounts paid pennies in interest. Even my ‘high yield’ interest savings account was paying like 2%. During this bull market run, my favorite index fund ($VTI) returned on average 10% per year. With returns like that, any interest that a bank was paying seemed like pennies!

Fast-forward to what now looks to be a (I dread to say it) recession or at least a slow down in the economy, suddenly with the stock market going down and stocks no longer being as ‘safe’ of an investment as they could be, banks and their offerings are suddenly looking more attractive. I’ve seen it in my own friend group and have been giving it more and more thought. Let’s dive in and explore what Certificates of Deposit (CDs) are.

What they are

Queue the joke about CDs being those wonderful discs we put into our cars, our portable players and the boomboxes at home to listen to music! Scratch that (wow another pun right there), CDs, or Certificate of Deposits are a product offered by the bank, similar to checking or savings accounts. Why have you never heard of them? Likely because the interest rates they were paying were so low that they were not really that popular and banks choose to advertise them a lot less. But now with a shakier stock market and interest rates rising, CDs are back!

CDs are a type of savings account that you lock your money into for an extended period of time. Once in this account, you a) know what the interest rate will be and therefore how much you’ll be making and b) not be able to pull money out or put more in during the time frame you selected. So because you are giving your money to the bank for an extended period of time and promising not to touch it, the bank can more confidently go invest that money by lending it out (i.e. mortgages) and because they have more confidence they will pay more interest.

The good news is that CDs are still FDIC guaranteed meaning unless you have more than $250,000 in that one bank, your money is guaranteed. In the face of stocks going down more, suddenly a guaranteed positive return is pretty intriguing!

How they make you money

By agreeing to lock your money up for an extended period of time, the bank can do more with that money and because of that they can give you a higher interest rate. With a savings account in theory you could pull it all out at anytime, so there’s not as much the bank can do with your money. BTW – banks are in fact big lenders just as they are deposit takers. Your money is not just sitting in a vault somewhere, the bank is lending it out. Not a bad thing – this is how banks have operated for their entire existence – but thankfully our government guarantees your money is safe via the FDIC (Federal Deposit Insurance Corporation).

Head over to your banks website and click around until you find “CDs” – likely under savings accounts. I keep some money with Capital One so I’ll use them as an example. On this page of their website they list out their interest rates. These rates will change frequently, depending on the financial markets, but once you lock your money in, that rate won’t change for your personally. What’s nice too is that there may or may not be a minimum so you could put in a small amount like $100 if you wanted to! Capital One is advertising interest rates as follows: 3.3% for a 6 or 9 month CD, 5% for an 11 month CD, 4.15% for a 1 year, 4.3% for a 2, 3 or 4 year or 4.1% for a 5 year CD. That’s as far out as they will go.

So, you pick the term that fits your needs, and put your money in! There are no other fees (unless you pull your money out early, we’ll get to that shortly) and the interest will start flowing. At least Capital One looks like it allows you to pull that interest money out, or reinvest it so that the interest compounds. Their cool calculator lets you know how much you’d make – if you put down $10,000, you’d earn $457 if you kept it there 11 months or $878 if you selected the 2 year CD.

Once the CD matures (i.e. the time you selected elapses), you can choose to reinvest by opening a new CD (although the rate likely will have changed), or pull your money back into a checking or savings account. Easy peasy!

What’s the catch

Really the only catch is the catch that you are locking your money up for an extended period of time. You can ‘break’ your CD early, put you’ll pay a penalty in the form of not getting all the interest you’ve earned. Here’s what Capital One says on their website:

“You can always decide to withdraw your money early. However, like with any CD account, there is a penalty for withdrawal prior to the end of your CD term. For 12 month CD accounts (or less), the penalty for withdrawing early is 3 months of interest. For CD accounts longer than 12 months, the penalty for withdrawing early is 6 months of interest. You also cannot make a partial withdrawal during your CD term.”

So, not the end of the world, you’ll still be earning money but less than you would have. Other than that there’s not really a catch, just giving your money to a bank for a longer time and letting them know you most likely won’t touch it.

How I think about them in my portfolio

CDs are pretty attractive to me right now to be honest. But, readers of the blog will know that in my 2023 Personal Finance Resolutions article, I did set a goal for myself of not opening any new accounts this year. I have a habit of chasing the latest investment trend and as such have money in more places than like and none of them have been much better investment options compared to my tried and true index fund – $VTI. So, I personally do not plan on getting a CD this year.

Also, the Federal Reserve has made decently clear that rates will keep rising; so one downside to locking money up now is that I could lock it up later at a higher rate (potentially). Of course there are no guarantees of what will happen but that thought has crossed my mind. Also though money in cash right now is losing money thanks to inflation so maybe I should just lock it up now?

I talk a lot about putting money into buckets of: short-term, medium-term and long-term investments. CDs would fall into the medium-term bucket, meaning this would be money I don’t foresee needing to spend next year. Right now my medium-term investment money is going into $VTI (I love index funds) but perhaps there could be a world in which I opened a small CD here or there. But I did make that resolution and TBH with how expensive everything is I’ve not had a ton of extra investable cash right now so I think I’ll hold off, but that’s just me personally in 2023, your situation might be different!

TLDR

CDs are a type of a bank account where you lock your money up for a longer period of time in return for a higher interest rate. This money and the income is guaranteed but there is a penalty if you pull your money out before it’s due.