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Are CDs a Good Investment for the Average Joe?

I don’t think I’ve ever met a person who wouldn’t say “Yes” to the question, “Would you like to make/have more money?” Aside from our job, the best way to get more money is by investing what you have in various financial products like savings accounts, the stock market, real estate or business ventures. Some would even use CDs as a valid investment. But are CDs a good investment for the average person?

Let’s find out.

What Is a CD?

CD stands for Certificate of Deposit. These products can be purchased at local, national or online banks. They serve a function similar to a savings account except they offer a higher return on your money. How can they do that? It’s because of one big difference between CDs and savings accounts.

With a traditional savings account you can freely move money in and out as you have need. Not so with CDs. When you open a CD, you agree to keep your money in the CD for a set length of time.

The time period (or term) of the CD varies. Typical ones usually last anywhere from 3 months to five years. If the money is withdrawn before the CD matures, the account holder faces penalties. Most likely they will lose some or all of the interest that has accrued.

In exchange for parking your money with the bank for a set length of time, they offer you a higher interest rate for the CD than what can be found with a savings account. That is the attraction to CDs. If you know you are going to have money in a savings account long-term, why not get a little bit more interest, right?

So are CDs a good investment for the average Joe? Should the typical American have one? To answer that question, we need more information about this person.

Who Is the Average Joe in America?

are cds a good investmentTo understand who the average American is, we need to look at a few data points. There are many financial statistics floating around out there that don’t bode well for the financial health of Americans. Take these four data points as examples:

  1. We have little free cash flow. The Bureau of Labor Statistics stated in 2016 that the average household earned (before taxes) was $74,664. The average we spend each year (on housing, food, transportation, healthcare, etc.) was $57,311. That’s a difference of only $17,353 to account for taxes and whatever else we need/want to use our money for. So we don’t have that much left over, especially after taxes.
  2. We fail to save for everyday things. This 2017 report from Marketwatch states that half of Americans live paycheck to paycheck. 19% have zero saved for emergencies. 31% have less than $500 in emergency savings.
  3. We are up to our ears in debt. The most recent NerdWallet study from 2017 found that the average household with credit card debt owes $16,883. The average household with any kind of debt, including mortgages, owes $137,063.
  4. We are unprepared for retirement. In 2016, 56% of Americans have less than $10,000 saved for retirement. That statistics does include young adults what have just started saving. But it’s still a stunning headline.

You may or may not fall into any of these categories. It’s clear though from these and other statistics I’ve seen that the average American a) doesn’t have the best financial habits and b) needs to maximize their potential for investment growth with what little they have left over. Only then can they get out of the mess they are in.

So that brings us back to the question…

Are CDs a Good Investment Then?

The answer to this question depends on your definition of “good.” Are CDs a good investment to safeguard your money? Yes. There is basically no risk in losing any money with CDs. If that is your goal – to not lose your initial investment – then a CD might be an option for you.

However, if your definition of “good” means getting a great return on your investment, then CDs make little sense. CD rates are higher than traditional or high yield savings accounts but they are not that high. You might be able to find CD rates between 2-2.5%.

Let’s just take the high number and plug it into a CD calculator. An initial deposit of $5,000 on a 5-year CD with a 2.5% interest rate compounded annually would only increase to $5,657 by the end of the term. You have gained $657 in interest over five years.

So say this phrase out loud (to yourself or a friend), “I made $657 in five years on my investment.” Does that sound like a lot? $657 might be enough to feed my family of six a dozen times at Chick-Fil-A. There is no way it’s going to help pay for college, or a new car or a down payment on a house.

For the Average Joe in America who exhibits the characteristics listed above, a CD is going to have little value. For starters, they need to save for emergencies, get out of debt and then begin investing for retirement. A CD is going to do little to help someone reach those goals.

Related Content: How to Get Out of Debt in Five Simple Steps

Who Should Invest With CDs?

So are CDs a good investment then? Not really if you are looking for high investment returns. If that is your goal, look to the stock market where historical returns average 7% or higher. Or maybe consider investing in real estate if your financial situation allows.

If you are concerned about the safety of your money a CD may make sense. That is their biggest advantage. There is little risk to the principal you invest. You may lose some or all of the interest that has accrued but only if you withdraw the money early. And if the penalties are large enough they may eat into your principal. So make sure you understand the product before you invest.

People who are overly concerned about risk and want to hold money in savings long-term might look into a CD. Think parent or grandparent who has all their other financial issues covered and wants to save money for a child for the next 20 years.

Or someone who just likes to save. They have a 3 to 6-month emergency fund in place but want to save more. A CD might make sense in this situation.

Related Content: Emergency Fund Basics: The Step on Which All Other Financial Success Is Built

In conclusion, are CDs a good investment? It all boils down to your risk tolerance and your goals. If you are looking for extreme safety, they may be an option. If you need to get out of a financial mess or are hoping for high returns, look somewhere else.

Questions for Discussion: Have you ever invested in CDs? Did they help meet your goals? What other investment options are really good for people concerned about the safety of their money?

Image at FreeDigitalPhotos.net

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Comments

  1. Ron Cameron says:

    CDs are great short term investments. Your money is safe from disappearing, and you know exactly when you’ll get it back for that short term goal. They are, however, horrible long term investments! They don’t keep up with inflation, you won’t know the reinvestment rate after maturity, and it’s generally a poor return compared to long term investments like bonds or stocks.

    Also, I think every discussion on CDs should include Chik-fil-A.

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