Can You Ever Lose The Money On The Certificate of Deposit (CDs)?

 Can Certificate of Deposit (CDs) Go Down in Value?

Generally, a CD doesn't lose its value. CDs are savings products, widely considered secure and low-risk investments. Opening a CD account is an attractive option for conservative investors and savers, who want to earn a fixed rate of returns on deposit money. 

Most CDs are insured. CDs issued by banks as banking products are federally insured by the Federal Deposit Insurance Corp. (FDIC), and CDs issued by credit unions are insured by the National Credit Union Administration (NCUA) in case of failure of the financial institutions that issue the CDs. [1]

However, like financial products, CDs are not entirely risk-free. While It isn't common, there are certain situations where you could lose money. Several financial products are considered non-deposit investments and aren't insured by the FDIC: investments in Stocks, Bonds, Mutual Funds, Crypto Assets, Life Insurance Policies, Annuities, Municipal Securities, and Safe Deposit Boxes or their contents. [ 2].

Despite the bank's failures, there are certain risks associated with CD investment: your deposits aren't FDIC-insured or within insurance coverage limits, locking in long-term CD and interest rates increase during its maturity dates, and higher inflation rate overtaking your interest rate earnings. All of that would reduce the CD's value and can result in financial dismay. Before committing your funds, learn the risks and how to protect your money.[3].

CDs can lose value

Key Takeaways: Can CDs Fail 

• A standard certificate of deposit (CD) protects deposited money, earns a fixed rate of returns, and is locked up for certain terms depriving access to your deposits. 
• CD investments are suitable for longer terms and offer better rates than savings accounts.
• FDIC provides insurance coverage on the deposits only maintained at FDIC-insured banks in case of financial failure.
• A traditional CD has two inherent risks: losing value in case of early withdrawal penalties (EWPs) and bank failures. However, this is an institutional failure with federal insurance coverage up to $250,000. 
• Losing money in CD investments isn't common, but it may carry the risk of non-FDIC insurance, and a high inflation rate can deteriorate the purchasing value 

Understanding How CDs Work

A certificate of deposit (CD) is a popular savings tool for savers who intend to earn interest-rate returns on their lump sum deposits for a fixed term and can maximize savings returns. Many banks or credit unions require a minimum deposit requirement to open a CD account such as $100, $500, or more, other ones require none. 

You keep funds untouched for a certain period ranging from days to 10 years, follow banking instructions regarding CD terms, and avoid funds withdrawal before completing the maturity period. Banks or credit unions calculate interest rates on CD deposits and compound them daily, monthly, or annually. 

A CD calculator would help you find what you will receive on CD deposits in the form of interest rates. Here you put CD details including the deposited funds, annual percentage yield (APY), and CD terms length in months or years. Then pressing the calculate button will show you the results: the total interest earned and the total balance including the principal and interest amount you might receive after achieving CD maturity dates. [4]

A CD account works for specific terms called maturity period, at the end of it, it has a liquidation option without losing any value. [5]. In addition to a standard CD, you may select different variations of CDs including jumbo, and Add-on CDs. Here are some key risks associated with CDs and every investor should be aware of

Interest Rate Fluctuations

CDs allow you to lock in the entire term. The possibility of interest rate changes during this locked-in period is a significant risk. If interest rates increase, you are bound to fulfill the maturity period at the previous rates and would lose these higher rates returns. 

If you had waited to commit to the CD fund for the interest rate increase or invested in no-penalty or bump-up CDs, you could earned a greater chunk from the market. A no-penalty CD known as a liquid CD allows you to break the term incurring no financial penalties. A bump-up CD gives an option of interest rate increase during the CD term. Sometimes a high-yield savings account, investments in stocks, or index can generate high interest as CDs rate, without locking up funds for certain terms.

Inflation Risk

An inflationary economy faces a rise in the price of goods and services over time. A financial product based on fixed rates despite the market conditions faces inflationary risks. It can erode the real value of your investments if the inflation rate exceeds the rate of interest on your CD investments.[6]. In case of a high rate of inflation, you lose the value of the CD, not money. For instance, you put $500 in CD with 3% APY and the inflation rate has increased up to 3.5% during this period. On CD investment, you would receive $15 as interest and a total savings of $515. As the inflation rate is 3.5% and the general price level costs the products $517.5, meaning losing 0.5% purchasing power, losing CD investment value.

Early Withdrawal Penalties

CDs are designed for long-term investments and encourage eliminating access to your CDs deposits. Withdrawing money before maturity dates incurs financial penalties and most common way of losing money significantly reducing overall returns. You may choose a no-penalty CD which bears no penalty on withdrawing funds before the maturity date but CD liquidity comes with a lower rate of interest.[5].

Bank Failure and FDIC/NCUA Insurance

Bank failure occurs in certain rare circumstances. It is a financial inability or shut the door for good and all to serve its depositors, creditors, and other obligations. You may lose your money if your CD deposit is not insured by the FDIC or the National Credit Union Administration (NCUA). This insurance coverage is up to $250,000 per depositor, per insured bank, for each account ownership category.[7].

If your total deposits in one institution increase your insurance coverage limit of $250,000, any amount above this insured limit could be at risk in case of bank failure.

Brokered CDs and Their Risks

Brokered CDs are CDs issued by banks but sold through brokerage firms. They often offer attractive rates but come with additional risks and benefits. Some brokerage CDs are callable and you can potentially lose returns. It's easy to buy CDs through a brokerage firm but it may be very risky as there is no requirement to be FDIC-insured to sell CDs. [8].

Before purchasing a brokered CD, do some research and should follow your risk-reward ratio.

How to Protect from Losing Money on CDs

Although CDs are protected by FDIC/NCUA. Protecting and maximizing your savings need specific strategies to mitigate these risks. You need to balance the interest rate returns and safety to your risk tolerance. Your financial strategy should take into account the assessment of your financial goals and consideration of interest rate trends.  Short-term CDs perform best in an interest-increasing economy without locking up your funds for a longer period.

Here is how you can protect yourself from losing money on CDs:

• Building a CD Ladder includes spreading your investments among multiple CDs with different maturity dates ensuring you take advantage of liquidity and changing interest rates.
• Shop for the best rates and make a comparison sheet or search for other alternatives to CD such as bonds, stocks, and mutual funds.
• Purchasing CDs from a bank insured by the FDIC and credit union insured by the NCUA, and keeping deposits together in an institution not more than the federal insurance coverage limit of $250,000.
• Make sure you have an emergency fund to meet your unseen expenses and restrict yourself from bearing penalties on withdrawing funds before the maturity date.
• Take careful consideration of the inflation rate and interest rate environment and adjust your financial strategy accordingly.

Frequently Asked Questions (FAQs)

★Do CDs Have a Market Value?

All CDs work to earn interest rates and the interest rate market frequently fluctuates over a short period. This means the market value of CD also fluctuates accordingly. However, the market value of brokered CDs depends upon many factors such as the credit rating of the CD issuer, CDs featured on call, or step-up options. If you sell a CD on the secondary market at a price less than its face value, it would result in losing money on the CD.

★Can You Lose Money on a Brokered CD if You Hold it to Maturity?

One of the most significant factors that affect the brokered CD value is interest rate changes. When interest rates increase, there is less demand for brokered CDs already purchased and paying comparatively lower rates of interest than the brokered CDs issued in an interest rate-increasing environment.

★ Is It Safe to Buy a Certificate of Deposits from Brokerage Firms, instead of Buying Directly from Banks?

You can buy a certificate of deposit from brokerage firms. It is easy to buy CDs from brokerages, but they can't be insured by the FDIC or NCUA. Attractive rates are offered on brokerage CDs but have complex rules and regulations. You should clear at it. 

The Bottom Line

CDs represent the safe investment options and are federally insured up to 250,000. Like financial products, CD investments carry financial risk too. Making well-informed decisions, the fixed interest, safety, and factors affecting the value of CD investment all maximize returns on your savings. 

Article Sources:

1. Federal Deposit Insurance Corp. “Are My Deposit Accounts Insured by the FDIC? https://www.fdic.gov/resources/deposit-insurance/financial-products-insured/”
2. Federal Deposit Insurance Corp. “Financial Products That Are Not Insured by the FDIC, https://www.fdic.gov/resources/deposit-insurance/financial-products-not-insured/”
3. Federal Deposit Insurance Corp. “Understanding Deposit Insurance,https://www.fdic.gov/resources/deposit-insurance/understanding-deposit-insurance/index.html ”
   
4. Nerd Wallet. "CD Calculator, https://www.nerdwallet.com/calculator/cd-calculator"
5. Office of the Comptroller of the Currency. "What Are the Penalties for Withdrawing Money Early From a Certificate of Deposit (CD)? https://www.helpwithmybank.gov/help-topics/bank-accounts/certificates-of-deposit/cd-penalties.html"
6. Investor.gov, U.S. Securities and Exchange Commission. “What Is Risk? https://www.investor.gov/introduction-investing/investing-basics/what-risk”
7. Federal Deposit Insurance Corp. “Your Insured Deposits.https://www.fdic.gov/resources/deposit-insurance/brochures/insured-deposits/”