There are six reasons why CD’s are bad investments. Before I go into the 6 reasons let’s look at an example of how a CD works.
Let’s put $10,000 into a 5 year CD that earns 3%.payday loans online Let’s also assume that inflation averages 3% over the same 5 years and you are in the 25% tax bracket.
Net after Taxes: $11,592.74 – $398.18 = $11,194.56
So what could be so bad about CDs when they go up in value? The first drawback is that you tie up your money for several years locking in the return and losing the return if you actually need to withdraw some or all of the money for whatever reason. Second, the return you are receiving is low and typically below inflation. In the example above it looks like you have gained value. But in reality, the purchasing power of your money actually lost value. So if you were able to buy a car for the $10,000 at the beginning of the first year, you would now need $11,592.74 five years later to buy the same car assuming 3% inflation. In this example, you end up with only $11,194.56 after taxes, which means that you actually have lost value or at least purchasing power by investing in a CD. The third drawback is that the interest earned is taxed at the owner’s income tax rate. This is not the case with some other investments which are taxed at the lower capital gains rate or are tax exempt. The fourth drawback of investing in CDs is that the taxes are due every year, but the money in the CD cannot be used to pay the taxes since it cannot be touched until the end of the CD term. This requires the investor to have extra funds to pay the taxes. The fifth drawback of CDs is that they are exposed to more lawsuits more than other investments. The laws vary from state to state, but they are still at risk if you get sued. The sixth and final drawback of investing in CDs is that there is no upside to the investment. Since you have locked in a low interest rate for an extended period of time, you do not have the opportunity to take advantage of changing circumstances that may occur during the CDs term. This lost opportunity cost can be significant if interest rates rise significantly or if you find an opportunity that you would have invested this money in lieu of a CD. This could be a piece of real estate or some business opportunity or may even be something as simple as a vacation at a great price that you don’t have the money for since it is tied up in the CD.
A CD may be a good option to keep short term money, but don’t assume that it is a good investment. The drawbacks are significant and can limit your investment options and wealth creation potential.
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