Thinking of switching from a certificate of deposit account to a CD alternative? As people have grown tired of settling for historically low CD rates, switching to alternatives to CDs has become an increasingly popular choice.
There are a number of low-risk alternatives that can generate much higher income than CDs – but it’s dependent on when you'll need access to your invested money.
CD Alternative #1: High-Yield Bank Accounts
CDs can tie up your money for several months or years. Money market accounts (MMAs) and savings accounts, however, allow you to freely withdraw your money at any time while also paying annual percentage yields (APYs) that are often comparable to some of the best 1-year CD rates.
CD Alternative #2: Short-Term Bond Funds
If you’re thinking about CD alternatives, why consider not short-term bond mutual funds? With low expense fees and no withdrawal penalties, you’ll have access to your money whenever you need it.
Example of Short-Term Bond Funds
The T. Rowe Price Short Term Bond Fund (NYSE: PRWBX) 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 a much safer option than long-term bond funds (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).
Other Short-Term Bond Funds to Consider
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 US government, I bonds are designed to keep pace with inflation, so it adjusting interest rates every six months as inflation fluctuates. Every dollar invested in an I-Bond is also tax-deferred (like an IRA contribution), which means you're only taxed on earned interest after you redeem it.
In recent years, I-Bonds have 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. If you redeem an I-Bond within five years, you'll have to forfeit your last three months of interest (causing your actual yield to drop slightly in the year you incur the penalty).
Where to Purchase I-Bonds
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 a short-term period, but many 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) is made up 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) and they've got cash-rich balance sheets that dominate their markets. This makes them a less risky investment than most stocks.
Tip for Buying Dividend Stocks
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. If interest rates went up, an MMA would allow you to move your cash into a higher-yielding investment faster (or without penalties).
