Choosing between a certificate of deposit and shares of stocks in Standard & Poor's 500 Composite Stock Price Index companies should be simple, since the two investments are extremely different. CDs are long-term bank deposits that pay relatively low returns but are very safe. The S&P 500, on the other hand, is an index that tracks the performance of stocks that can offer high returns but also be very risky.
Certificates of deposit, sometimes also referred to as time deposits, are special types of bank accounts. With a CD account, you agree to leave your money in the bank for a set period of time. In exchange for your promise not to withdraw your money, the bank pays you a higher interest rate than it offers for a savings account or an interesting-earning checking account.
The S&P 500
The S&P 500 is a stock index that tracks the performance of the stocks of 500 U.S.-based companies. To qualify for inclusion on the S&P 500, a company must be traded on the New York Stock Exchange or the Nasdaq and have a market capitalization of at least $4 billion. S&P adjusts the index periodically in an attempt to ensure it remains an accurate representation of the market as a whole. While the S&P 500 is an index used for market tracking purposes, you can also buy shares of a fund that invests in stocks on the index. These funds are designed to hold similar stocks in proportions similar to those in the index.
An investment in a S&P 500 stock usually has a much higher return than an investment in a CD. For example, the unweighted average annual return of the S&P 500 over the 40-year period of 1973 through 2012 is 11.43 percent. A six-month CD returns an average of 6.16 percent. Looking over shorter time horizons, the S&P achieved 8.82 percent to a CD's 2.24 percent between 2003 and 2012. In a time of low interest rates, like the period from 2010 to 2012, the S&P 500 does significantly better. During that period index-listed funds earned 10.94 percent, as opposed to 0.43 percent for CDs.
If you invested $1,000 in a S&P 500 index fund on Jan. 1, 2008, you would have finished the year with less than $628. The same $1,000 in a six-month CD would have turned into slightly over $1,031. CDs usually are very safe, since deposits in most banks are insured up to $250,000 by the Federal Deposit Insurance Corporation. When you invest in the S&P, on the other hand, the value of your money will fluctuate with the value of the S&P, and you could end up losing some of it.
Stock investments, like shares in funds that track the S&P 500, can be sold relatively quickly for whatever price the market will bear, although you may have to pay a commission. CDs, on the other hand, usually carry heavy penalties for early withdrawal. While you can usually get your money very quickly, it could cost you a significant portion of your return.
- The Federal Reserve Board: H.15 Historical Data - CDs (Secondary Market) - 6 Months
- MoneyChimp: Compound Annual Growth Rate (Annualized Return)
- Wall Street Journal: What Is a Certificate of Deposit (CD)?
- Standard & Poor's Financial Services LLC: S&P 500 Equity Indices
- Dreyfus: Dreyfus S&P 500 Index Fund - Risks
- Hemera Technologies/AbleStock.com/Getty Images