Should You Buy a CD or Invest in the Stock Market? Here's How to Decide

If you have some money to spare and want to use it wisely to improve your financial future, you have a few choices for where to put it. One option is to put funds into a brokerage account and use them to invest in the stock market. Opening a certificate of deposit, or CD account is another option.

There are both pros and cons for either option, so to help you decide which is right for you, ask yourself these key questions.

1. Can I afford to risk losing the money?

Investing in the stock market carries some risk. The specifics of the investments you make and your investing timeline determine the level of risk you're taking on -- but even with relatively safe investments, there's always a chance you could lose money.

If you invest in a certificate of deposit, you don't have to worry about that. CDs are FDIC insured, which means you are guaranteed not to lose money on them, up to FDIC insurance limits. Now, you can face penalties if you choose to voluntarily withdraw your money from a CD before the term expires, but you're in direct control over whether you do that so you can choose to avoid even this potential financial risk.

If you absolutely cannot afford to risk losing the money you are investing -- say, because you need it for a home down payment in a few months for a house you're under contract on -- then you should not put the money into the market. A CD is a better bet.

2. When am I hoping to cash in on the investment?

The next key question to ask yourself is when you're hoping to start accessing the invested funds and the returns that you earned.

See, if you invest in the stock market, your risk of loss is greater if you do so for the short term. That's because even really great investments can perform poorly over a period of a few months or even a few years if there are poor economic conditions or if you timed your investment wrong. Investing for a secure retirement is a better bet, as you'll have a longer timeline.

The S&P 500, for example, is a financial index of 500 of the largest U.S. companies. Over many years, it has consistently produced 10% average annual returns. But in some individual years, there have been big losses, as the table below shows.

If you are hoping to cash in your investment within five years or less, putting your money into the market is too risky because you could get caught in a downturn, not be able to afford to wait for recovery, and end up buying high and selling low.

CDs, on the other hand, have a wide range of different terms. It's common to find CDs that require you to commit for as little as three months, as long as five years, or for a variety of different time periods within that range. So, if you'll need your money soon but not immediately, you should be able to find a CD that works with your timeline.

3. What are my goals for the funds?

Finally, you should think about your goals for the money. Are you hoping to maximize returns at the price of taking on more risk? If so, then investing in the stock market is the right call. On the other hand, if keeping the money safe is a priority, a CD could be the better solution.

By asking yourself these three questions, you can decide where your money should go. It's always best to carefully consider any investment decision, because you work hard for your money and it should work hard for you.