Is a 5-Year CD Too Risky Right Now?

It may be -- but not for the reason you think.

The Federal Reserve has been on a mission to slow the pace of inflation. To do so, it's been steadily raising interest rates over the past year. That's driven the cost of borrowing up for people looking to take out loans or rack up credit card balances. But it's also led to an uptick in interest rates for savings accounts and CDs.

In fact, these days, you're looking at getting a much higher interest rate from your bank than you would've a year ago. But we don't know how long today's higher interest rates will last.

As such, you may be interested in opening a longer-term CD. Many banks offer a 5-year CD, and putting money into one guarantees you the same interest rate for half a decade's time. By contrast, the interest rate on your savings account isn't guaranteed, and in a year or two from now, it could be much lower.

But is a 5-year CD a good idea right now? Or is it a risky proposition?

Why a longer-term CD may not be ideal

It's easy to see why you might be tempted to open a 5-year CD. And as long as you limit your deposit to $250,000 and open that CD at an FDIC-insured bank, your principal is nice and protected.

But that doesn't make a 5-year CD a risk-free prospect. First of all, we don't know what interest rates are going to look like later this year. If the Fed keeps implementing rate hikes, banks might start paying even more on CDs. So if you tie up your money now, you might lose out on a better rate down the line.

But perhaps an even bigger risk in opening a 5-year CD is that a lot can change during that time. You might switch careers and take a pay cut. You may decide to buy a home. Or you might have kids, and money might get tight as a result.

When you put money into a CD, you're committed to keeping it there until that CD matures. And if you cash out your CD before it comes due, you'll be penalized to the tune of multiple months of interest (the exact penalty will depend on your bank's policy).

What's more, CDs tend to work on an "all or nothing" basis so that if you have $5,000 in a CD and need $1,000 in a pinch, you can't just withdraw that $1,000. Rather, you're generally forced to cash out your entire investment and face whatever the associated penalty is.

A shorter-term CD might be better

Opening a CD right now isn't necessarily a poor choice. But you may want to stick with a shorter-term CD due to the risks just mentioned.

Another thing to consider is that you might manage to snag a higher interest rate on a shorter-term CD than a longer one. Often, that's not the case. But when interest rates are up, you can often find a better rate for a shorter term.

As an example, right now, Capital One is paying 4.15% interest on a 1-year CD and 4.3% on a 2-year CD. But it's only paying 4.1% on a 5-year CD. Since tying your money up for a longer period of time carries a lot of risk, and you're not even being rewarded in the form of a higher interest rate (at least in this case), a shorter-term CD starts to look very appealing, doesn't it?