Are CDs Really Risk Free? The Answer Is More Complicated Than You'd Think

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With CD rates being as high as they are today, a lot of people are rushing to open them. And you may be eager to put money into a CD because in doing so, you're supposedly not taking on any risk.

There's a reason CDs are often hailed as a risk-free investment. As long as you limit your deposit to $250,000 and stick to an FDIC-insured bank, you don't risk losing your money in the event of a bank failure. With a stock portfolio, you could put $10,000 into a brokerage account only to see your balance fall to $9,000 (or lower) a month later.

But while CDs may be risk free in theory, they're not actually risk free in practice. Here's why.

1. You might still lose money to early withdrawal penalties

When you open a CD, you commit to leaving your money in the bank for a preset period. Because of this, banks don't take kindly to early withdrawals. If you end up having to take out your money before your CD matures, you'll usually be penalized.

Banks set early withdrawal penalties individually. There's no universal penalty like there is with an IRA, which is 10% for taking your money out before turning age 59 1/2. But a common penalty is losing three months of interest for cashing out a 12-month CD or shorter before it matures.

You may want to stick to a regular savings account over a CD since there are no penalties to worry about. You might earn a bit less interest, but you'll get more peace of mind.

2. You risk losing out on a better deal when CD rates are in flux

Opening a CD isn't particularly risky right now from an interest rate standpoint. CD rates are high and unlikely to come down significantly anytime soon. But during periods when CD rates have the potential to rise, opening a CD could mean losing out on the chance to earn more interest on your money.

Let's say you commit to a 12-month CD at an annual percentage yield (APY) of 3.00%, only then a few months later, interest rates rise across the board. Suddenly, your plain old savings account is paying 3.50% APY. So now, you've committed to a CD and are earning less as a result. For this reason, pay attention to how interest rates are trending before opening a CD.

3. You risk losing out on higher returns over a long period

When you open a CD, there's a chance, as just mentioned, that you'll miss out on a better rate a few months down the line. Also, if you put money into CDs over a longer period, you risk losing out on the much better returns a stock portfolio might give you. And that risk could also translate into not having enough retirement savings.

Say you're able to save $300 a month for retirement over 30 years, and you put that money into CDs that entire time. Let's also assume you get a 3% return from your CDs. That would leave you with a little over $171,000.

But if you were to invest that $300 a month in stocks, you might score a 10% return instead. That's in line with the market's average annual return over the past 50 years. In that case, a $300 monthly investment over 30 years could leave you with around $592,000. That's a difference of $421,000 in retirement savings you might end up missing out on.

CDs are indeed risk free, but only to a point. There are some less obvious risks of opening CDs, so consider these carefully before moving forward.

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