CDs vs. Mutual Funds: What's the Better Investment Now?

There are many excellent options for investors right now, including high-yield certificates of deposit (CDs) and mutual funds.

CD rates are unusually high right now, with many paying an annual percentage yield (APY) of 5.00% or higher. Meanwhile, mutual funds give you access to a large portfolio of different investments, like stocks and bonds, with the potential to grow your money over the long term.

But which is the better investment choice right now? It depends on your financial goals. Here are some benefits of mutual funds and CDs, and when each is the right choice.

The case for CDs

One of the main benefits of a CD is that you'll earn a (mostly) guaranteed return. If you put $5,000 in a 2-year CD that pays 5.00%, you can basically bet on the fact that you'll earn $512.50 in interest over the CD term.

Another benefit is that you won't lose any money as long as you don't withdraw funds early. Few investment options guarantee your rate of return and ensure that you'll get the full amount you initially deposited (plus interest).

The only caveat is if you take some of your money out early. Most banks will charge you three months of simple interest on the amount you withdraw for CD terms of two years or less. For CDs with longer terms, the fee usually increases to six months of simple interest.

Generally speaking, CDs are a great option if you want a safe place to put your money and let it earn interest to outpace inflation.

The case for mutual funds

One of the best reasons to buy a mutual fund is that they're simple. You don't have to know anything about investing to own a mutual fund. You can choose a fund that tracks the S&P 500 or a target date fund that automatically adjusts your investments based on when you expect to retire.

Another benefit of mutual funds is that they can help you diversify your investments. Mutual funds may have a large mix of stocks and bonds in different sectors and companies, giving you a well-balanced portfolio.

Finally, mutual funds offer great earning potential. For example, if you bought a mutual fund that tracks the S&P 500, your investment would have earned about 30% over the past two years.

The downside to this is, of course, you can lose money, too. If you put $5,000 into a mutual fund and its value drops 8% over a year, your investment is now worth $4,800. It's also worth mentioning that mutual funds usually charge an expense ratio to cover administrative costs and to pay managers. These can range from 0.12% for passively managed funds to 1.5% for some actively managed funds.

Verdict: Pick mutual funds for growth, CDs for preservation

Knowing where to put your money right now depends on your financial goals. CDs can be a good option if you're retired or near retirement and want to preserve your money.

With many CD rates above 5%, putting some of your money into a CD will help your cash outpace the negative effects of inflation without putting you at financial risk of losing the money.

But if retirement is a long way off, you're probably better off putting your money in a mutual fund. Buying a low-cost index fund in your brokerage account is a great option. The S&P 500 has a historical rate of return of 10.2%, giving you a lot of potential to earn significant returns in the coming years.

Of course, it's not a guaranteed return, but if you have many years left before you retire, you'll have plenty of time to ride out the market's ups and downs and likely come out ahead in the end.