CD Vs. Mutual Fund: How To Choose

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by Forbes

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CD Vs. Mutual Fund: How To Choose

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If you've got extra cash you won't need for a while, you may be wondering where to put it. Both certificates of deposit (CDs) and mutual funds are useful investment vehicles that can put your money to work. But these accounts serve different purposes.

When deciding between CDs vs. mutual funds, the best place for your money depends on your goals and circumstances. It helps to understand the ins and outs of both types of investments, so you can choose one that fits your needs.

CDs and mutual funds are both investment vehicles with the potential to grow your money but in different ways.

CDs are insured deposit accounts that offer a fixed interest rate over a specified period of time. You generally can't lose money in a CD, making it a safe place for savings you don't want to put at risk. But once your money is in a CD, you can't access it for a set period of time without incurring a penalty.

Mutual funds, on the other hand, invest your money in a diverse pool of securities. Though mutual funds can offer much bigger returns -- and sometimes greater liquidity -- they're riskier than CDs because you can lose some or all of your money.

CDs are deposit accounts that offer guaranteed interest over a specific period of time -- anywhere from a few months to five years or more. When you open and fund a CD, you lock up your deposit until the CD matures. At maturity -- that's when the CD term is up -- you can either withdraw your money or reinvest it. If you withdraw your money before the CD matures, you'll have to pay an early withdrawal penalty.

Because most CDs are insured by a bank or credit union, they're a low-risk investment. The biggest risk with CD investing is that inflation could rise while your money is locked up. If this happens, you may miss out on higher interest rates.

CDs appeal to people who are saving for short- or medium-term goals. When you invest with a CD, you risk lower growth potential in favor of guaranteed growth over a specific time frame.

You can open a CD at a bank, credit union or other financial institution. You'll find a wide range of CDs with different interest rates, minimum deposits and terms. Look for the best CD rates and terms that align with your financial needs.

Before opening a CD account, make sure you review the fine print, including any withdrawal fees and minimum deposit requirements.

Next, apply for a CD in person or online. You may need to decide how you want to receive your interest payments -- either throughout the term or at maturity. Last, you need to fund the account. Keep in mind, most CDs only allow for one initial deposit.

Mutual funds let you invest in a diverse portfolio of securities, including stocks, bonds and other assets. These funds are passively or actively managed to meet specific goals or track a particular index. Unlike CDs, mutual funds don't have a guaranteed return, nor are they insured for any amount.

Because mutual funds include a diverse pool of investments, they aren't as risky as individual stocks. But without insurance or a guaranteed return, they're riskier than CDs. You could lose some or all of your initial investment.

That said, mutual funds have the potential to earn higher returns than CDs, which sometimes don't even outpace inflation. For these reasons, mutual funds are better suited for longer-term goals like retirement.

Mutual funds typically have minimum investment requirements. You may need several thousand dollars to invest. Unlike CDs, you can buy or sell mutual fund shares at any time.

Mutual funds also come with annual fees, known as expense ratios. Actively managed funds usually have higher expense ratios than passively managed funds.

You can invest in a mutual fund through an online broker or directly through a fund manager. But you'll need some sort of investment account to hold your mutual fund shares. For example, you can invest in mutual funds through a taxable brokerage account, tax-advantaged retirement account or 529 college savings account.

Before investing in a mutual fund, consider your time horizon and investment goals. What is the money for, and when will you need it? Each mutual fund has its own asset allocation and management strategy based on the goals of the fund. Knowing your goals and time horizon can help you decide how much risk to take on.

You'll then want to research different funds and evaluate them based on performance, fees and management. Finally, you can open an investment account (or log into an existing account), fund it and start purchasing mutual fund shares.

While both CDs and mutual funds let you earn money on your savings, they work in very different ways. Below are some of the biggest similarities and differences between mutual funds and CDs.

Neither a mutual fund nor a CD is better in every circumstance. But one may be better for your unique situation.

If you're looking for a place to keep your money safe for the short- or medium-term while earning guaranteed interest, a CD may be best. But if you have a longer time horizon or are willing to take on a little more risk for the possibility of earning higher returns, a mutual fund would be a better choice. Of course, you can always integrate both CDs and mutual funds into your overall financial strategy.

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