4 CD Alternatives That Can Pay Off
If you’re thinking of switching from a certificate of deposit account to other CD alternatives, there are plenty of options that carry relatively low risk. In fact, as people have grown tired of settling for historically-low CD interest rates, this switch has become increasingly popular over the past few decades.
There are a number of low-risk alternatives that can generate much higher income than a CD – it just depends on when you'll need access to your invested money.
CD Alternative #1: High-Yield Bank Accounts
Unlike CDs (which can tie up your money for several months or years), money market accounts (MMAs) and savings accounts allow you to freely withdraw your money at any time while also paying annual percentage yields (APYs) that are comparable to a one- or two-year CD.
CD Alternative #2: Short-Term Bond Funds
Short-term bond mutual funds are another great CD alternative. With low expense fees and no withdrawal penalty, you’ll have access to your money as soon as you need it.
The T. Rowe Price Short Term Bond Fund (NYSE: PRWBX), for example, invests in a mix of low-risk corporate bonds, government bonds, mortgage bonds, and asset-backed securities, among other sectors. Bonds held within this fund have an average maturity of fewer than two years. This makes PRWBX much safer than a long-term bond fund, which would face a significant price decline if long-term interest rates went up.
PRWBX has a minimum investment requirement of $2,500 but offers an attractive yield of around 2% (minus the expense fee of 0.46%, which is well below the category average).
Similar funds worth checking out include the Vanguard Short-Term Bond Index Fund (NYSE: VBIRX), the Lord Abbett Short Duration Income Fund (NYSE: LALDX), and the Vanguard Short-Term Bond ETF (NYSE: BSV).
CD Alternative #3: I-Bonds
Issued and backed by the U.S. government, I bonds are designed to keep pace with inflation, so it adjusts its interest rate every six months as inflation fluctuates. Every dollar you invest in an I-Bond is also tax-deferred (like an IRA contribution), meaning you're only taxed on earned interest after you redeem it.
In recent years, the I-Bond has paid an APY between 2.5% and 3.5%, but there’s a catch: You must hold the I-Bond for at least one year, without exception. If you redeem an I-Bond within five years, you must forfeit your last three months of interest (causing your actual yield to drop slightly in the year you incur the penalty).
I-Bonds can be purchased (without commission) in $25 increments at TreasuryDirect.gov for up to $10,000 per person. The bonds are then sent electronically into your designated account.
CD Alternative #4: Reliable Dividend Stocks
Many risk-averse investors fear putting their money in stocks for the short term, but there are many that pay steady and reliable dividends. These could land you income yields of 2% to 5% per year on your original investment – easily twice that of a typical CD.
Dividend Aristocrats (a special class of dividend-paying stocks) are comprised of 53 large US companies. Not only have these companies paid dividends to their investors, but they’ve also increased them for 25 consecutive years or more.
Unsurprisingly, most of these stocks are household names (e.g. 3M, AT&T, Chevron, Clorox Company, Coca-Cola) with cash-rich balance sheets that dominate their markets. This makes them a less risky investment than most stocks.
Pro tip: If interest rates look like they're heading higher, it might be smart to strike a balance between liquidity and interest yield. For example, tying up your cash in a 5-year CD for 2% APY may not be worth it if a far more liquid money market account has an interest rate of 1.75% APY. The MMA would allow you to move your cash into a higher-yielding investment faster (or without penalties) if interest rates went up.
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