As continuing concerns about inflation and the rise of interest rates have people searching for safe places to store their money, a lot of attention is shifting to the certificate of deposit, or CD. Over the past two years, CD rates have been insanely low, hovering below the 1% mark for one-year CDs for much of 2020 and 2021.
But CD rates are looking quite different today. The Federal Reserve’s recent interest rate hikes have paved the way for a surge in interest rates for CDs, and some short-term CDs are paying impressive yields in the neighborhood of 5%.
Still, that doesn’t necessarily mean you should rush to open one. With concerns about having to pay an early withdrawal penalty if you withdraw your money before the CD matures, and a potential for a bigger return in dividend stocks, you’ll need to think long and hard about the best moves for your money. As you weigh your options, be sure to educate yourself on CD alternatives.
Alternatives to CDs
CDs aren’t the only way to help you earn interest on your money. There are plenty of alternative investments, but there are trade-offs: Some traditional savings accounts, such as money market accounts, pay less interest, while others come with bigger risks than can lead to you losing money. Whether you’re building an emergency fund or saving money to pay down high-interest debt, there are multiple ways to save.
High-yield savings account: The rising interest rate environment has also spelled fantastic news for high-yield savings accounts, which are available through traditional and online banks, and at some credit unions. Right now the interest rates on some of the best high-yield savings accounts are running alongside some of the best yielding CD rates. While the annual percentage yield, or APY, might be a bit lower than CDs, you’ll have convenient access to your cash whenever you need it. The downside: The interest rates on these high-yield bank accounts are variable. So, though a CD interest rate is locked in for the entire term, a high-yield savings account rate fluctuates.
Money market account: A money market account is like a sibling to a high-yield savings account in that it earns a higher amount of interest, but it also provides check writing privileges. The average interest rate on a money market account today is 0.59%, according to the Federal Deposit Insurance Corporation’s most recent National Rates and Rate Caps report.
Both types of savings accounts, however, tend to come with restrictions about the number of transactions you’re allowed to make in a statement period, typically no more than six. Both pay higher interest rates than a standard checking or traditional savings account, though.
Dividend stocks: Just as CDs pay a steady interest rate on a recurring basis, dividend paying stocks offer regular payouts. However, these are stocks, so there’s significantly higher risk involved, mainly in the form of stock market volatility. The dividend payout is a fairly certain bet; established companies work to make sure this money is paid out to retain the faith of shareholders, though they can opt not to pay if they fall on hard times. But the actual performance of dividend stocks -- and the safety of your initial investment -- isn’t guaranteed.
Bonds: Be they Treasury, savings or municipal, bonds are another option for growing your money, and they’re generally perceived to be less risky than dividend paying stocks. However, not all bonds are created equally. Governments and corporations issue bonds to help them raise capital. So, if the company goes bankrupt or the government struggles to pay its bills, you can wind up losing money. Still, that’s fairly rare. According to research from Fidelity, the default rate for five-year municipal bonds is just 0.1% since 2012. Corporate defaults are significantly higher, though, at 7.2%.
To help combat inflation, there are Treasury bonds designed to protect investors from a drop in the purchasing power of their cash: Treasury Inflation-Protected Securities, or TIPS. These government bonds are indexed to inflation. So, as inflation rises, so too does the price of the TIPS in order to maintain its real value. The bottom line: The principal of Treasury Inflation protected securities is protected, as investors won’t get less than the original amount of their principal. This makes for a less risky investment.
CDs vs. I bonds
Series I savings bonds, or I bonds, which are government bonds issued by the US Treasury, are a common alternative to CDs. Both are great matches if you’re looking for a safe place to store your cash, but there are some key differences to understand as you determine whether a CD or an I bond is a winner for your saving strategy. The biggest difference is that a CD is a fixed-rate savings account for the entire term, while an I bond has a fixed rate and a variable rate that changes twice each year, in May and November. The current interest rate on a Series I savings bond is 4.30%, which includes a fixed interest rate of 0.30%.
Another key distinction: You can’t cash in an I bond until at least one year after the date you purchase (with additional restrictions around your interest earnings). So, if your horizon is shorter than one year, you’re better off looking at three-month, six-month or nine-month CDs.
| CDs | I bonds | |
| Minimum amount | Varies by bank | $25 |
| Maximum amount | $250,000 per account is insured at a federally insured bank by the FDIC, or at a federally insured credit union by the National Credit Union Administration, but you can deposit more | Annual purchasing limit: Up to $10,000 in electronic bonds and $5,000 in paper bonds with your tax refund |
| Interest rate | Fixed | Fixed rate, plus a variable rate that is set twice each year to keep pace with inflation |
| Who sets the rate | The bank or credit union | The government |
| Term | Varies -- typically from 3 months to 5 years | 30 years |
| Withdrawal terms | Typically forfeit a certain amount of interest if withdrawn prior to maturity | Can cash in after 12 months -- however, if you cash in the bond in less than 5 years, you lose the last three months of interest |
When does a CD make sense?
CDs can be a smart move for your finances. Here’s a rundown of some of the key scenarios that can make a CD worth it -- as long as you’re confident you won’t need the principal until the maturity date arrives.
You know exactly when you’ll need the money: Consider someone who’s planning to get married next fall. With a firm date in mind, a certificate of deposit that matures shortly before they’ll need the cash can be really helpful. First, it can help generate additional funds needed for the expense. Second, it can help lock the cash away to avoid the temptation to spend it elsewhere.
You don’t have much of an appetite for risk: For certain savers, putting loads of money in the stock market will only lead to sleepless nights given the degree of stock market volatility in today’s market. CDs will help eliminate worries about wild swings of the market.
You need a steady return to help cover some living expenses: CDs can be great for retirees who need to generate some extra cash on a regular basis. For example, if you invest $100,000 in a CD with a 5% APY, you may be able to regularly withdraw your earnings each month to help pay for your essential expenses.
The bottom line
If you’re looking at CDs and CD alternatives to help you build an emergency fund or save cash to pay down high-interest debt, it’s important to note that you don’t have to pick one or the other. Instead, you might want to deposit some money in a one-year CD -- some of which are paying very high rates right now -- while depositing some cash in a high-yield savings account to make sure you have easily accessible funds and avoid the risk of an early withdrawal penalty. At the same time, it’s smart to analyze your risk tolerance to determine if you should chase bigger rewards found in dividend stocks. The more you can diversify your savings accounts, the more likely you’ll be positioned for long-term financial wellness.