Is it better to invest in stocks or a CD?
As you build your emergency fund, you may want to focus on generating a meaningful return while you store your money in a safe, highly liquid environment — like a high-yield savings account. But your savings goals shouldn't stop when you have a flush emergency fund. Instead, it makes sense to save money in different ways.
And, once your high-yield savings account has enough money to cover your expenses for three to six months, it can also make sense to branch into other investment opportunities as well. Considering that you have numerous choices, though, you may wonder whether it's better to invest in stocks or focus on safer vehicles like certificates of deposit (CDs). Well, chances are that both of these options have a place in your portfolio.
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Is it better to invest in stocks or a CD?
"The first thing to consider is the investor's timeline and risk tolerance," says Brian Spinelli, CFP, AIF, co-chief investment officer at Halbert Hargrove. "When do they need the funds, and what is their ability to stick with price volatility?"
"Historically, stocks outperform cash and CDs over longer periods of time. However, there are periods when stocks can decrease significantly while CDs stay steady," Spinelli says.
So, when is it best to invest in one over the other?
When it's better to invest in a CD
"If an investor will need that money in the short term, they may not have the time to ride out a stock market pullback," says Spinelli.
According to Hartford Funds, bear markets happen about every 3.5 years on average and last for more than nine months. If you're saving for a near-term goal and get caught in one of these bear markets with a stock portfolio, you may be forced to accept losses. So, in these cases, CDs may be the better option.
The fact that bear markets happen regularly also makes the stock market relatively risky. That means if you are a risk-averse investor, you may be better served with a higher allocation of your excess funds in CDs than in stocks.
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When it's better to invest in stocks
CDs aren't always going to be your best option. In many cases, stock investments are a better bet.
"Looking back on the last six instances where we hit peak CD rates, the following 12 months have seen stocks and bonds outperform CDs," says Spinelli.
Sure, stocks come with significantly more risk than CDs, but the biggest financial rewards often come with the highest risks. Moreover, by practicing sound investment habits — like diversifying your investments — you may be able to reduce the risk in your portfolio.
So, stocks are typically a better option when you have a long-term time horizon and are comfortable with the ebbs and flows the stock market will take from time to time.
A well-balanced portfolio typically has CDs and stocks
The truth is that neither stocks nor CDs are the better option 100% of the time. These are both effective financial instruments that can help you meet your goals. As such, it's likely wise to take advantage of them both. Here are a few reasons why:
- Diversification in your asset allocation can reduce risk: Stock investments come with more risk than CDs. However, when you add CDs to the mix, you may be able to reduce risk, increasing your risk-adjusted returns.
- CDs make compelling savings vehicles for short-term goals: Most people have some short-term financial goals. As Spinelli mentioned, the stock market may not be a good place to store your money for these goals. Instead, it may be wise to use CDs to save for the short-term.
- Stocks can offer impressive long-run gains: Considering the historic performance of stocks, they're likely a strong investment vehicle for your long-term goals. For example, stock investments are often an effective way to save for retirement.
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The bottom line
"The bottom line is if the investor has a longer-term horizon for the money and can bear the volatility, stocks generally provide a much better growth potential than CDs," says Spinelli. So, whether stocks or CDs will be the better option for you depends on your goals and how comfortable you are with the risk of market volatility.
