If you're just getting started making investments, you know you have a huge number of options to choose from. Young investors often put their initial investments in mutual funds or CDs, but knowing which one is right for you can be a challenge. Before you invest, make sure you understand the differences between these types of investments in terms of risk and returns.
CDs, or certificates of deposit, are one of the most low-risk investments available. Like most low-risk investments, CDs typically offer higher returns than savings accounts but lower returns than stocks. CDs are fixed investments, so they are held for a certain amount of time at a fixed investment rate. CDs may reach maturity anywhere from a month to several years, depending on the one you choose. The longer you leave your CD in the bank for, the higher return you can get. CDs make money by accumulating interest; banks pay interest at different periods throughout the investment time or at “maturity” when your investment time expires.
Mutual funds differ from CDs in a multitude of ways. Mutual funds are diversified portfolios of stocks and bonds managed by a financial advisor or broker. They typically offer substantially higher returns than CDs, and while they are riskier than CDs, they are not considered high risk investments. Mutual funds usually aren’t vulnerable to market trends except huge drops in the stock market which can decrease the value of certain funds. Because they are managed by a broker, you don’t have to spend much time tending to them after you invest.
Choosing between a CD and mutual fund is largely based on the amount of risk you are comfortable with. CDs can be good choices for those close to retirement or uncomfortable with risk for other reasons. It’s important to remember, though, that investing in the market by purchasing a mutual fund can lead to higher returns. CDs are ideal for those with long-term savings that do not need to be accessed for the life of the CD. It’s important to shop around for the best interest rates so that you can get the highest return possible. Make sure your bank’s interest rates are competitive before you purchase a CD there.
The biggest downfall to a CD is that there are penalties for early withdrawals. If you withdraw a CD before its maturity date, be prepared to face penalties. Remember that mutual funds are a higher risk investment; if you are new to investing or can’t afford to lose any of the amount that you invested, a mutual fund might not be for you.
Megan Martin has more than 10 years of experience writing for trade publications and corporate newsletters as well as literary journals. She holds a Bachelor of Arts from the University of Iowa and a Master of Fine Arts in writing from The School of the Art Institute of Chicago.