How much has $5,000 increased in the last two years?
There are many great options for investors looking to make money. One option that has been gaining popularity recently is opening a certificate of deposit (CD). Some CD rates pay annual percentage yields (APY) in excess of 5%, but are CDs the best place to raise money? Probably not.
Here’s what you could have earned on a 5% CD over the past two years compared to the gains in the stock market:
The stock market trumped CDs.
Let’s say two years ago you put $5,000 into a CD earning 5% APY and another $5,000 into a brokerage account to buy a low-cost index fund that tracks the S&P 500. Here are the returns you can earn from both investments: :
- 2-year income from CD: $512.50
- 2-year return for S&P 500: $1,662.93
Simply put, you would have made three times more money over the past two years if you had invested in the stock market. This is based on an index fund that has tracked the S&P 500 over the past two years, with a total return of approximately 30% including stock dividends since May 2022.
Of course, this is just one example of the market’s past performance. But in general, this shows the tremendous return potential of investing in stocks versus CDs.
Although owning stocks always comes with some uncertainty, the S&P 500’s historical annual return since its inception in 1957 is approximately 10.2%. If you are patient and have the time to let your money grow, there is no better investment than stocks when it comes to generating returns.
Disadvantages of investing in stocks
Stock values tend to be highly volatile. For example, the same index fund that returned nearly 30% over the past two years Under It will increase by more than 18% in 2022. This means that if you invested your money in May 2022, you would need a lot of patience for your investment to start growing.
This is one of the main reasons some people choose CDs. If you want a (mostly) guaranteed return without the risk, CDs can be a great option.
If you leave money in the CD for the entire term, you’ll earn the advertised APY. However, if you withdraw your money early, you will typically be charged 90 days of simple interest on a CD with a maturity of two years or less. The penalty increases to 180 days of simple interest for CDs of two years or more.
How to Decide Between Stocks and CDs
One way to decide between these options is to ask yourself these two questions:
- What is my investment period?
- What is my money goal?
If you have 20 years left until retirement, stocks are probably the best place for your money because you have a long investment horizon. During that time, you will be able to ride out the volatility of the market and see your investments generate significant (though not guaranteed!) profits.
On the other hand, if you are currently retired and want some of your money to outpace the rate of inflation, CDs may be a better option. You get a guaranteed interest rate (as long as you keep your money in the CD for the entire term) and get all your money back at the end of the term.
Since everyone’s investment goals and time horizon are different, it’s a good idea to consider all options before making a decision. And if you’re going to take the time to choose, open a high-yield savings account first and invest your money there. You can easily access them when you want, and many of these accounts will pay you 5% interest right now while you ponder your decision.
This savings account is FDIC insured and can earn 11 times the bank’s earnings.
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