CDs vs. Stocks: An Overview
Certificates of deposit (CDs) and stocks are pretty much on opposite sides of the investing spectrum. Their levels of risk, their potential returns, and the length of the commitment involved are very different. In brief:
- CDs are a safe and convenient place to stash some cash that you don't expect to need for a few months. The return on your investment is a little better than on a regular bank savings account. The risk is negligible.
- Stocks are best if purchased for the long term. They are bought with the expectation that they will rise in value over time or pay substantial dividends. Their prices go up and down constantly and sometimes dramatically, making them a risky place to park cash if you need your money unexpectedly.
Many people invest in both, and that's not a bad idea. CDs, because they are low-risk, are a great hedge against the potential for losses in stocks.
Key Takeaways
- CDs are low-risk, low-return financial vehicles that are best suited for short-term savings and risk-averse investors.
- Stocks have higher potential returns and higher potential losses. They are suited to long-term investors who can ride out price fluctuations.
- Individual stocks vary greatly in their level of risk. Generally, the lower the risk, the lower the potential returns.
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Certificates of Deposit (CDs)
CDs are available at most banks and credit unions as well as through brokerages. Investors interested in buying a CD can easily check the current rates available online and pick the best deal. Most change their rates at least every six months, or more often in times of inflation.
It is worth checking around rather than just opening an account at your bank. The rates can vary widely. In late 2023, a time of relatively high inflation, rates ranged from 0.03% to above 5%.
CD buyers are committing their cash for a period of time, ranging from three months to 10 years. The money can be withdrawn early but there are almost always penalties and fees involved.
CDs Are Insured
On the other hand, your principal is insured by the federal government up to a maximum of $250,000 as long as the institution is an FDIC member (if it's a bank) or an NCUA member (for credit unions). The financial institution would have to collapse into bankruptcy for that insurance to kick in.
All of this makes CDs suitable for the conservative investor who wants to avoid risking principal. It also is a good choice for the person who is saving toward a specific financial goal. Someone who is saving for a downpayment on a home or a new car might invest in a CD, or even buy one monthly as they save towards an objective that is a year or two down the road.
On the other hand, investors who are comfortable with a certain amount of risk may find stocks to be considerably more rewarding.
Read the Fine Print
Brokered CDs, sold by brokerage firms and independent salespeople, may not offer the same insurance protection as those sold by banks and credit unions. Before buying one, be sure to check.
Stocks
A person who is saving money towards a big purchase or any person who is risk-averse probably doesn't want to invest in the stock market. It's a risky business, and one of the risks is that your money won't be there when you need it.
However, stocks are much better than CDs for long-term investors who have the time to ride out short-term losses. An investor in blue-chip stocks will probably end up with a far larger balance than an investor in CDs. An investor in aggressive-growth stocks could end up with a big pile of cash but also could face big losses during downtimes.
A CD will, at best, give you a return that is close to the rate of inflation. Stocks can soar, multiplying your wealth. Or, they can plummet in value. For that matter, the companies that issue them can go out of business, making their stocks worthless.
Flexibility
Stocks are in some ways a more flexible investment than CDs. You can buy and sell stocks with a click when the markets are open.
There's no penalty for selling, such as there is for CDs. There is a tax penalty, however, for selling too soon. The profit on the sale of stock shares owned for less than a year is taxed at your regular earned income tax rate. If the shares are owned for a year or more, the profit is taxed at the capital gains tax rate, which is lower for most taxpayers.
This relative flexibility might be attractive if you are concerned about emergency access to your money. You can pull your money out of stocks at any time, but keep in mind that they may not be worth what you paid for them at that moment.
CDs vs. Stocks: Which Is Better?
All investments are a tradeoff between risk and reward.
CDs, like investment-grade bonds, are very low-risk investments. Their returns are modest but you can be reasonably sure you'll get your money back plus the interest you were promised.
The risks in stocks vary widely. There are thousands to choose from, and you can invest in relatively steady, stable companies and feel fairly confident that you'll earn a decent return in time. Or, you can invest in high-flying companies that might crash or might make you rich.
There's no guarantee in stocks. Even a relatively low-risk portfolio might lose much of its value for weeks or months, and a serious economic slump could harm your portfolio for an even longer period of time.
But over the course of decades, the returns provided by well-diversified stock portfolios should exceed those of CDs.
Why Would I Buy CDs Instead of Stocks?
CDs can be useful for people looking to invest some money for a few months or years without the fear of investment losses. The returns are modest but they're guaranteed (as long as the institution that issues them is an FDIC or NUIC member.)
In general, well-diversified stock portfolios will offer substantially higher returns over the long term. But with a CD, you set the term: three months, a year, or longer.
Are CDs Safer Than Stocks?
CDs are much safer than stocks.
When you purchase a CD, the bank or credit union will guarantee your interest rate and the federal government will insure your principal.
There is no guarantee that any individual stock, or even a diversified portfolio of stocks, will increase in value over time. In a worst-case scenario, a stock can become worthless.
Can CDs Decrease in Value?
A CD cannot decrease in value, and its interest rate is fixed up front. There are, however, two scenarios in which you can lose money investing in a CD:
- If you withdraw your money early, you will face penalties and fees. These can be steep, wiping out your interest and even cutting into your principal.
- In times of high inflation, your money can lose purchasing power. That is, the amount you deposited could be worth less than when you deposited it.
The Bottom Line
CDs are low-risk, relatively low-return investments best suited for people looking for a place to put their money for a short period of time or those who want to avoid any possibility of loss. Stocks are higher-risk investments with potentially higher returns, making them better suited for long-term investors who can ride out price fluctuations.
