What we’ll cover:
It can be unsettling whenever the stock markets go haywire. And that’s totally understandable given that sudden dips in your portfolio can scramble your confidence as an investor.
During times of volatility, some might wonder if there are “safer” alternatives to investing their savings in the stock market. Of course, no investment or savings vehicle is ever 100% safe. But there are certain savings accounts that are more stable or better shielded from the ups and downs of the market. Interest-bearing accounts offered by banks such as a certificate of deposit (CD) is one example that readily comes to mind.
Let’s take a closer look at how CDs might offer some stability in times of market uncertainty and how they are an important component of a well-diversified financial strategy. But first, if you’re not familiar with how CDs work or just need a refresher, check out our Guide to CDs, which breaks down the basics for you.
A CD is a common type of deposit account offered by banks – a savings tool that can typically help you earn, depending on the terms, a higher interest rate than a traditional savings account.
In comparison with stocks, CDs are generally considered low-risk because you get the return of your principal (read: original deposit) along with any interest accrued at the end of the term. On top of this, your money is insured if you open an account at a FDIC member bank (up to $250,000, per depositor, per category of account).
Earnings from a fixed-rate CD are also more predictable: You know exactly how much interest you will receive at the end of your term – no matter what’s going on in the market. The same, however, cannot be said for investments in securities like stocks, where there is no guaranteed rate of return. And with the stock market, while there’s an opportunity to earn a higher rate of return than a CD, bear in mind that you also face the potential risk of losing the money you originally invested.
In this way, fixed-rate CDs are better shielded from market downturns than stocks. Even if the market takes a stomach-dropping tumble, your rates are locked in for a set amount of time. This is why CDs are often a vital component of any savings strategy.
Given that they are relatively low-risk, some might be inclined to think that CDs could be an “alternative” or replacement to stocks when the markets are struggling. But it’s important to understand that a well-thought-out financial strategy isn’t about whether you should put your savings towards CDs or stocks. In other words, it shouldn’t be an either-or strategy.
The goal is to strike a balanced approach with diversification in mind. Stocks and CDs both have their respective roles to play as you work towards your short-term and long-term financial goals.
For example, if you have an aggressive retirement savings strategy where stocks make up a good chunk of your portfolio, then CDs are a good way for you to diversify your assets, helping to provide some cushioning whenever the stock market goes through wild swings in the near term.
Bear in mind that CDs are generally intended to help you reach short- or medium-term savings goals, while investing in stocks or other securities can help you reach your long-term financial goals (think: retirement). And that’s because, historically, stocks tend to provide higher returns than CDs over the long run.
When the stock market goes through a steep downturn, it can be a wake-up call for some people to revisit their savings and investments. But it’s good practice to review your assets and financial strategy on a regular basis — not only when the market is in chaos.
Why? Because you may not want to be shifting your money around when the market is shaky. For instance, selling stocks while the market is spiraling can lock in your losses and hurt your savings in the long run.
Similarly, thinking about CDs only when the market is in turmoil can hurt your ability to lock in a favorable interest rate. Keep in mind that rates tend to fall when there’s an economic downturn, so if you wait to open a CD when market conditions are grim, you might receive a lower interest rate offer from banks (that is, when compared to rates that were available during better market conditions).
Ready to open a CD? Here are some tips to keep in mind:
Remember, CDs can lock up your savings for a certain period of time depending on your terms. And breaking a CD can often invite penalties (unless you have a No-Penalty CD). So make sure to think about how much of your savings you can really afford to commit before opening an account.
The good news is that there are CD strategies that you can use to give yourself a little wiggle room. CD ladders and CD barbells are two common strategies that can give you some flexibility to access a portion of your savings in the near term.
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