There are many great options for investors looking to earn money. One option that’s gained in popularity lately is opening a certificate of deposit (CD). Some CD rates pay annual percentage yields (APYs) of more than 5%, but is a CD the best place to grow your money? Probably not.
Here’s how much a 5% CD would have earned you over the past two years compared to the stock market’s gains.
The stock market trounced CDs
Let’s assume that two years ago, you put $5,000 into CD earning 5% APY, and another $5,000 went into your brokerage account to buy a low-cost index fund that tracked the S&P 500. Here’s what your earnings would like from both of those investments:
- Two-year earnings from CD: $512.50
- Two-year earnings from S&P 500: $1,662.93
In short, investing in the stock market would have earned you three times more money over the past two years. This is based on an index fund that tracked the S&P 500 over the past two years, with a total gain of about 30% since May 2022, including stock dividends.
Of course, this is just one example of the market’s past performance. But in general, it shows the massive earnings potential of investing in stocks versus CDs.
While owning stocks always comes with some uncertainty, the historic annual rate of return for the S&P 500 since its inception in 1957 is about 10.2%. If you’re patient and have time to let your money grow, there are no investments comparable to stocks for earning potential.
The downside to investing in stocks
Stock values tend to be volatile. For example, the same index fund that gained nearly 30% over the past two years was down by more than 18% in 2022. That means that if you had invested your money in May 2022, you would have needed a lot of patience to see your investment begin to grow.
This is one of the key reasons why some people choose a CD. CDs can be a great option if you’re looking for a (mostly) guaranteed return without the risk.
If you leave your money in the CD for the entire term, you’ll earn the advertised APY. However, if you take your money out early, you’ll usually be charged 90 days of simple interest on CDs with terms of two years or less. The penalty fee increases to 180 days of simple interest on CD terms longer than two years.
How to decide between stocks or a CD
One way to decide between these options is to ask yourself two questions:
- What’s my investment timeframe?
- What’s the goal for my money?
If you’re 20 years away from retirement, stocks are probably the best place for your money because you have a long investment timeframe. With that amount of time, you’ll be able to ride out the market’s volatility and likely see your investment make significant (though not guaranteed!) gains.
On the other hand, if you’re currently retired and just want some of your money to outpace the inflation rate, then a CD is probably a better choice. You can earn a guaranteed rate (as long as you keep your money in the CD for the entire term) and get all of your money back at the end of the term.
Everyone’s investing goals and timeframes are different, so weighing all options before deciding is a good idea. And if you’re going to take a while choosing, open a high-yield savings account and throw your money in there first. You’ll have easy access to it when you want it, and many of these accounts will pay you 5% interest right now while you’re mulling over your decision.
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