Certificates of deposit (CDs) are a popular type of deposit account for savers looking to protect their money from market risk and inflation. CDs allow you to deposit money at a fixed interest rate for a specific period and often come with higher rates than many savings accounts.

CDs are considered low-risk because the interest rate is fixed for the entire term, and the principal balance can’t lose money — in most cases. That said, CDs can lose money in certain rare situations. So before you put your money in a CD, learn the risks and how to protect your funds.

Read more: The best CD rates on the market for April 2024

How CDs work

CDs differ from traditional savings accounts due to their time component. When you open a CD, you deposit a lump sum into your account and keep it on deposit for the full term. CD terms can range anywhere from 30 days to 10 years; longer terms tend to come with higher interest rates, but this isn’t always the case.

The biggest drawback of a CD is that you’re expected to keep your hands off your money until it reaches maturity. Making a withdrawal before then will likely result in an early withdrawal penalty, which may not be ideal for savers who need regular access to their money.

On the plus side, CDs can offer stability and security, especially in an environment where interest rates are fluctuating. It’s important to weigh the pros and cons of CDs to determine if they align with your financial goals.

Factors that can impact CD returns

While CDs are considered low-risk investments, there are certain factors that can negatively impact your returns.

Fluctuating interest rates

CDs allow you to achieve higher interest rates and lock in those rates for the entire term, regardless of market fluctuations. The downside is that you could miss out on better returns if rates increase while your money is tied up. This means you have to weigh the benefits of locking in a certain rate now versus the risk of losing out on potentially higher rates during the CD’s term.

Read more: What the Fed rate decision means for bank accounts, CDs, loans, and credit cards

Inflation

Inflation is the rate at which the cost of goods and services rises over time. Inflation impacts not only how much you spend but also the value of your dollars. When the inflation rate surpasses the interest rate on your CD, the real value of your return decreases. In other words, when the CD matures, the money you get back will have less purchasing power than when you first invested it.

Early withdrawal penalties

CDs typically come with early withdrawal penalties to keep account holders from dipping into their funds before maturity. These penalties can significantly reduce your overall return. In fact, if you haven’t earned enough interest to cover the early withdrawal penalty, you could lose a portion of your principal balance.

If this is a concern, consider opening a no-penalty CD, which is offered by some financial institutions. The tradeoff is that you may have to accept a lower interest rate.

Bank failures

A bank failure happens when a bank is closed by a federal or state regulatory agency because it’s unable to meet its financial obligations to depositors, creditors, and others. That’s why it’s important to open a CD with a bank that’s insured by the Federal Deposit Insurance Corporation (FDIC) — or in the case of a credit union, the National Credit Union Administration (NCUA).

These government entities back up to $250,000 per institution, per account holder, per ownership category. If your CD is not held at a federally insured institution, you may not be able to retrieve your CD funds in the event of a bank collapse.

How to protect your CD returns

While CDs are one of the safest places to put your savings, no investment is totally foolproof. Consider these steps you can take to protect your CD funds:

• Make sure your money is insured: Federal insurance provides an added layer of protection in the event that your bank fails. You can easily verify whether your financial institution is protected by using the BankFind or Find a Credit Union tools.

• Keep your deposits within federal coverage limits: If you have deposits over $250,000, it’s a good idea to spread that money across multiple financial institutions so you remain under federal coverage limits. Another option is to take advantage of the Certificate of Deposit Account Registry Service (CDARS). By participating in the CDARS program, you can have more than the FDIC insurance limit insured by distributing your funds into CDs across a network of banks without having to manage multiple bank accounts yourself.

• Choose a CD term that aligns with your goals: Early withdrawals from CDs can impact your overall returns because of the fees involved. So before you open a CD, think carefully about your short-and long-term savings goals, and choose a CD term that matches your needs to avoid dipping into funds too soon.

• Try a CD ladder: Creating a CD ladder is a strategy where you split your funds into several CD accounts with varying terms and rates. This allows you to maintain some liquidity as shorter-term CDs mature while still taking advantage of the higher rates that come with longer-term CDs.