Don’t Climb the CD Ladder

Certificates of deposit (CDs) are the default investment option for many people’s savings. However, they’re rarely your best choice. Yes, they are essentially riskless investments but you pay for that peace of mind with meager returns and limited flexibility.

What is a CD?

A CD is a bank deposit in which you commit to leave the funds for a period of time that ranges from a few months to a few years (the “term”). The interest rate is locked in for that term and typically, longer terms offer higher rates. You can get access to your funds early but you’ll pay a penalty to do so. The two main attractions of CDs are convenience and FDIC insurance.

What are better options?

Assuming you want a low-risk choice for your savings, you have two other options — a regular bank savings account and a so-called money market fund. Let’s compare some numbers…

As of this writing, my favorite bank — Ally Bank — offers the following rates:

  • 6 month CD:  1.0%
  • 1 year CD:      2.0%
  • 3 year CD:      2.1%
  • Savings account:  1.8% (rate can change any day)

(Most traditional banks have lower rates than these.)

My favorite money market fund — Vanguard Prime — has a rate of 1.84% (also changes slightly each day).

The 1- and 3-year CD rates typically offer a small premium to the savings rate (because you’ve locked up your money) and the money market fund is usually slightly higher than the savings account.

The money market fund and the savings account are better choices. Your money is always accessible, there’s no paperwork, no renewals to manage, etc. The 6-month CD is a silly choice and longer-term CDs seem ill-suited if your goal is to have the money quickly accessible.

How about a CD ladder?

You may have heard about this. You purchase multiple CDs with different terms so they come due at different times and you presumably roll them over if you don’t need the money. I guess the idea is that you’ll never be too far away from an expiring CD so you won’t have to wait too long if you need your money. I can’t think of any circumstances in which this is a good idea versus a high-yield savings account or a money market fund.

Don’t climb the CD ladder.

What is your investing time horizon?

If you expect this money to be long-term savings then all of these options are too conservative and I wouldn’t do any of them. Instead, you should invest your savings in an appropriate mix of low-cost stock and bond index funds. Over the long term, you’ll generate returns that are higher than CDs, bank savings, or a money market fund.

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