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I know a lot of people who are opening CDs this summer. And I get it -- who'd want to pass up today's amazing CD rates ? I mean, it's not every day that you can score a risk-free 5% return on a pile of cash you're not using for the next year.
But while a 5% CD might seem like the best place for your money, I'm here to tell you that's not true if you're saving for a goal that's far into the future. In fact, if that's the case, then opening a 5% CD today is a move you may end up kicking yourself over.
The problem with CDs
CDs are great for saving for near-term goals -- for example, the new car you want to buy in a couple of years or the vacation you're hoping to take next summer. But CDs are a pretty terrible choice for long-term financial goals. The reason? Over time, they're highly unlikely to deliver the returns you need to significantly grow your money.
CDs are currently paying 5%, but today's rates aren't typical. Over a 30-year period, you're far more likely to earn an average annual 3% return on CDs than 5% -- or less.
On the other hand, over the past 50 years, the stock market's average annual return has been 10%, accounting for strong years and weak years when investors lost money. That difference in returns could have a huge impact on your long-term savings.
Say you put $10,000 into CDs that pay 3% a year over the next 30 years. You're looking at growing your $10,000 into about $24,300.
But watch what happens when you put that $10,000 into a stock portfolio that gives you a 10% return. In 30 years, your $10,000 will be worth about $174,500. That's a difference of roughly $150,000.
Don't wait to start investing
If the money you're thinking of putting into a CD today is for a long-term goal, you might just say, "Well, why don't I lock this cash up in a CD for a year to get my risk-free 5% interest and then start investing it a year later?"
You could go that route. But you probably won't be doing yourself any favors.
Let's say you earn $500 in interest on a 12-month CD at 5% over the next year. That's a nice sum of extra cash. But if you keep that $10,000 out of the stock market for one year, shrinking your total investment window from 30 to 29, you'll only be looking at about $158,600 at the end of that period.
So in this case, yes, you're gaining $500. But you're losing out on almost $16,000 by waiting a year to put your money to work in the stock market. So which makes more sense?
It's easy to get lured in by today's CD rates. But know that unless you're saving for a short-term goal, investing your money is ultimately a smarter move.
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