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CDs explained: Certificates of deposit, or CDs, have traditionally been considered one of the safest means of increasing savings without subjecting funds to the risks of the stock market. They provide fixed interest rates for a specified period, commonly with more payback than a standard savings account. However, although CDs are low-risk, they're not entirely immune to loss.

What Can Cause a CD to Lose Money

As a recent report has shown, numerous factors may lead a CD to lose money or decrease its potential return, from penalties for early withdrawal to inflation and shifting interest rates.

Early Withdrawal Penalties Can Eat Into Your Earnings

One of the largest threats to CD holders is that of withdrawing funds prior to the maturity of the account, as per a Yahoo Finance report. The majority of CDs feature early withdrawal penalties intended to prevent savers from dipping into funds too early. These penalties can devour, or even eliminate, the accumulated interest, and in some instances, tap into the principal balance itself. For individuals concerned about having access to cash, no-penalty CDs are a possibility, although typically with reduced interest rates.

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Are Your CD Funds Safe During a Bank Failure

Another infrequent but severe risk is bank failures. If a bank or credit union fails, depositors may lose their funds, unless their institution is covered by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), as per the Yahoo Finance report. These entities insure up to $250,000 per depositor, per bank, per ownership type, as per the report. Deposits outside federally insured banks may not be insured in the case of a failure.

Brokered CDs Offer Higher Returns, But More Risk

The report also found that not all CDs are equal. Brokered CDs, which are bought with brokerage houses instead of banks, pose extra risks. They provide higher yields and can even be resold before maturity, but their market price can change, as per the report. If the rate goes up or the CD is sold prematurely, investors could lose money. Some brokered CDs come with extra fees and complicated terms, as per the Yahoo Finance report.

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How Fluctuating Interest Rates Impact CD Returns

Fluctuating interest rates are another problem. Although locking in on a CD rate can be secure, it can also equal missing higher returns should interest rates increase during the CD term, as per the Yahoo Finance report. Although this doesn't equate to an actual loss, it does represent an opportunity cost, investors might have profited more somewhere else. Step-up or bump-up CDs permit interest rate increases during the term but tend to begin at lower base interest rates, as per the report.

Inflation Can Quietly Reduce CD Earnings

Inflation is yet another ingredient that can silently reduce returns. When inflation increases at a rate higher than the CD's interest rate, purchasing power drops in real terms, as per the Yahoo Finance report. That indicates that even if you do make interest, your dollars might be worth less when the CD expires.

How to Keep Your CD Investments Safe

Even with these dangers, CDs are one of the safest savings options on the market. There are some precautions experts recommend to safeguard your money. Ensure your organization is federally insured, limit your aggregate deposits to $250,000 per bank, and consider dividing large amounts among several institutions. For those with larger balances, the Certificate of Deposit Account Registry Service (CDARS) provides protection for sums in excess of federal thresholds by spreading money between a number of banks, as per the Yahoo Finance report.

Selecting the appropriate CD term is also important. Short terms minimize the possibility of having to withdraw prematurely, while extended terms can secure better rates. Others construct CD ladders, a method that spreads money into several CDs with staggered expiration dates, to balance liquidity and return, as per the Yahoo Finance report.

FAQs

What’s the safest way to open a CD?
Always choose a federally insured bank or credit union and stay within coverage limits.

Are CDs completely risk-free?
No. While CDs are low-risk, factors like early withdrawals, inflation, or bank failures can still affect your returns.