Certificates of deposit, or CDs, offer the same principal protection as a savings account but often at higher rates. When you buy a CD, you promise to leave your money at a bank for a set term. In return, the bank pays a higher interest rate than you could get on a savings account.
CD rates track the Federal funds rate—the interest rate commercial banks charge each other to borrow money. When the Fed raises the Federal funds rate, banks raise the interest rates on CDs to attract more depositors. Since CDs offer fixed interest rates, you may be tempted to lock in these higher rates while you can—especially with interest rates at record highs.
But remember that CD interest is subject to taxes, impacting your overall returns.
Are CDs worth it right now?
Thanks to the Fed’s rate hikes over the past year, CD rates rose like a tidal wave over the past year. Between June 2022 and June 2023, 1-year CD rates rose by 552%. After a decade of historically low rates, you might feel pressured to lock in these higher rates while you can, but does that mean you should?
According to Steven Conners, founder and president of Conners Wealth Management in Scottsdale, AZ, it does. “A year from now and beyond, I don’t think these rates are going to be as high as they are… unless there is some sort of catalyst to cause inflation to re-emerge.”
Another factor contributing to today’s CD rates? An inverted yield curve. Typically, longer-term interest rates are higher than shorter-term, but the opposite is true today. For example, a 1-year CD currently yields up to 5.50%, whereas a 5-year CD tops out at 4.66%. So today, you can make shorter-term commitments with CDs and still get the highest rates around, improving your liquidity and income.
CD rates are so high that medium-term CDs pay as much as or more than Treasury securities, which typically have some of the highest yields. New 5-year Treasurys only yield 4.36%, 0.3% lower than the highest 5-year CDs.
Looking beyond high APYs
While CDs currently have higher yields than before, they still are only for some investors. After you account for taxes and inflation, the real return on a CD held in a taxable account is pretty low.
The IRS taxes CD interest at ordinary income rates. So to determine if CDs are worth it, you need to calculate your unique after-tax return. To do this, you’ll multiply the CD’s stated interest rate by one minus your tax rate.
For example, if you’re in the 24% (0.24) federal income tax bracket, your after-tax return on a CD yielding 5% is actually 5 times 0.76, or 3.8%. Inflation in July 2023 was 3.2%, which leaves you with a real return of only 0.6%—and that’s before you factor in any state and local taxes.
So really, “as far as a good or bad time (to invest in CDs), it’s irrelevant” because CD rates correspond to inflation, just like all other interest rates, says Peter Casciotta, owner of Asset Management & Advisory Services of Lee County in Cape Coral, FL.
Current APY ranges for the best CDs by term*
Pros and cons of investing in CDs
The trick to determining if CDs are right for you—and whether CDs are worth it in the current economy—is identifying what you want to accomplish with a CD, then figuring out if the pros outweigh the cons or vice versa.
- Principal protection. You can earn a modest return while protecting your principal, which isn’t a bad deal.
- Peace of mind. Knowing that your principal is safe and you’re getting a guaranteed return can decrease financial stress.
- Reduce portfolio volatility. Since CDs don’t fluctuate in value the way other investments do, they can help reduce the overall volatility of your portfolio.
- Early withdrawal penalty. Tapping a CD early will likely incur a penalty that could erase all your returns—and more.
- Low overall return. Once you factor in inflation and taxes, a CD’s return is relatively low compared to many other investments.
- Reinvestment risk. There is the risk that, after your CD matures, you won’t be able to reinvest it at an equal or higher rate.
When CDs are worth it
Conners says the best time to invest in CDs is when there is a surge in inflation. “The silver lining to (the Fed’s) battle against inflation is that the Fed has created an opportunity for conservative investors to finally get paid something.”
Despite higher inflation, CDs are only worth it when they fit your investment goals.
CDs are best for conservative investors or those looking to dampen their portfolio volatility.
As you age, you should shift your investment focus from growth to capital preservation. “It is crucially important and essential that you do not lose principle the closer you get to retirement” because you won’t have time to recoup any losses, Conners says. This makes CDs a good choice for people nearing or in retirement.
But even younger investors who hold primarily stocks can benefit from CDs. CDs can help you put money you’ll need in the future—for a house downpayment or a wedding—at arm’s distance, plus earn a bit of interest along the way. But younger investors should likely avoid investments like CD IRAs, as their yields are generally too conservative to help retirement savings grow at an appropriate pace.
When CDs may not be worth it
CDs may not be worth it when interest rates are low. In these environments, conservative investors are often better off in other fixed-income securities, like municipal or corporate bonds, Conners says.
When interest rates are low, you can boost your bond yields by choosing reliable bonds with a lower investment grade. For example, owning bonds from lower-rated companies with a strong repayment track record could increase your average return without taking excessive risk.
When interest rates are lower, you can explore fixed-income investments like bond mutual funds and exchange-traded funds (ETFs). Actively-managed fixed-income funds might have slightly higher management fees (expense ratios) but can often outperform the greater bond market.
But the real question when deciding if CDs are worth it is this: How much do you need a CD to yield so that you meet your investment goals? If you need to earn 7% to avoid running out of money in retirement, you can’t afford to keep all of your money in CDs paying 5%, Casciotta says.
Frequently asked questions
Are CDs a good investment?
The answer depends. CDs can be attractive for those willing to sacrifice returns for security, especially in higher interest rate environments. However, bonds and bond funds might be more suitable in lower interest rate environments.
Are CDs worth it in 2023?
CDs are worth it in 2023 for the right investor. With recent rate hikes, many of the best CDs yield well over 5%. Those in retirement could also benefit from a CD held in a Roth IRA, which protects your principal and creates tax-free income.
Are CDs FDIC insured?
CDs are FDIC insured when held at an FDIC-insured bank or financial institution for up to $250,000 per depositor, per bank in the unlikely event of bank failure.