Pros and Cons of CD Investing

Investing into any investment vehicle will present both advantages and disadvantages to an investor. Both should be considered when evaluating options for an investment portfolio so that the products and services selected are the best possible match for the investor’s financial goals, time frame and risk tolerance.

Advantages

• Fixed Investments – One of the most attractive things about a CD investment is that they offer a fixed rate of return, attractive to many different kinds of investors. Conservative investors as well as those who are seeking income are often the most suitable investors for CDs.

• FDIC Insurance – For many investors, having the backing of insurance for their investments is attractive. Most CDs are backed with FDIC insurance, protecting investors in the event that the financial institution issuing them was to go bankrupt.

• Maturity Date Choices – CDs are offered with a variety of maturity dates, ranging from one month to 5 years. The maturity dates offer differing CD rates to investors, with the longer maturity dates typically offering the investor the higher rate.

• Income Possibility – In addition to conservative investors, those who are interested in a fixed income stream are often attracted to CDs. A common strategy that is utilized by investors to create ongoing income is called a CD ladder. A CD ladder involves purchasing a Certificate of Deposit at varying maturities on an ongoing basis, so that after a year, CDs are maturing regularly. The investor will receive their original principal investment plus the stated interest upon maturity.

• Simplicity – CDs are attractive investments to those who want simplicity as they are easy to invest into and require little to no maintenance until their maturity date.

Disadvantages

• Zero Coupon CD Taxation – While there are many advantages to a zero coupon CD, one of the disadvantages is that the phantom interest income, not received until maturity, is taxed annually. Investors need to be aware of these annual taxes so that they can set aside the income to pay them when they are due.

• Callable CDs – Investors are often attracted to these CDs for their higher CD rates, however they carry the risk of being called before their scheduled maturity dates.

• Withdrawal Penalties – Due to the nature of penalties, often associated with the forfeiture of interest, CDs are often not good investment choices for investors who have the possibility of needing the capital prior to the CD maturity dates.

• Low Interest Rates – While CDs offer higher rates than many other forms of cash investments, their interest rates are often substantially lower than other fixed investment options and equity investment options. It is important to take these rates of return into consideration when designing an ideal investment portfolio.

• Inflation Rate Risk – One of the largest external risk factors to investing into CDs is inflation risk. Inflation risk refers to the risk of eroding purchasing power over time. While interest rate payments are fixed with CDs, it is important that they will out pace inflation so that an investor does not lose purchasing power during the investment period.