CDs vs. Mutual Funds: What’s the Difference?

If you have money to save or invest, you may be deciding which asset is right for you. CDs and mutual funds are two common ways to earn money toward long-term financial goals, and each has its own benefits and downsides.

A CD is a type of savings account that locks up your money for a period of time and pays a guaranteed interest rate in return. A mutual fund—riskier but generally with a higher rate of return—is a way to put the money in stocks, bonds, or other investments.

Let’s compare and contrast the different approaches, and how you can invest in both.

What’s the Difference Between CDs and Mutual Funds?

Type

CDs are types of savings accounts that provide fixed income. It pays interest at an established rate on a schedule or at a predetermined time. This money is best used for emergencies or short-term savings goals. You invest in a CD for a certain period of time, generally six months to five years. If you withdraw your funds early, you’ll usually face a penalty, typically a percentage. It’s unlikely you will lose your principal or initial investment amount.

Mutual funds are a mix of stocks, bonds, or other investments. You buy shares of a mutual fund along with other investors. With mutual funds, you could lose some or all of your principal. But there’s also a potential for higher returns. Mutual fund investments do not have set time frames.

Insurance 

CDs are insured by the FDIC (for banks) or the National Credit Union Insurance Share Fund (NCUISF) (for credit unions) for up to $250,000 per account holder. If you have up to $250,000 in a CD at a bank and the bank fails, you will get your funds back.

Mutual funds are not insured, with no guarantee of success or failure. You may lose money with a mutual fund.

Return

CDs offer a predictable return, with a fixed interest rate in exchange for holding your money for an amount of time. If a 12-month CD provides a 1% return on your $1,000, you’ll receive $10.05 in interest for an ending balance of $1,010.05 when the CD matures. CD returns are generally higher than you’d find in a regular savings account or other bank or credit union account.

Mutual funds generally offer the potential for more returns than CDs. Over decades, the stock market has offered an average of 6% to 7% in annual real returns. However, markets have downturns, which could take years or decades to recover. A mutual fund’s prospectus will outline past performance, but past performance does not always predict future returns.

Risk

CDs are considered a low-risk savings type, due to FDIC insurance and predictable returns. However, CDs may present another risk if the earned interest rate doesn’t keep up with inflation. Inflation can erode the value of your dollars so that you lose buying power. There’s also a timing risk around when to put your money in a CD—if rates rise, you could miss out on a higher interest rate.

Mutual funds have varying degrees of risk and return. Lower-risk mutual funds include money market mutual funds. Risks further increase with bond mutual funds, stock mutual funds, and international stock mutual funds. Higher risk usually relates to higher potential returns—or losses.

Fees and Expenses

CDs carry low to no  fees or expenses if you purchase directly from a bank or other financial institution. More-complicated brokered CDs may require fees.

Mutual funds typically carry an annual expense ratio of about 0.01% to 2% or more, although some carry no expenses. Expense ratios are charged annually by the fund company, and actively managed mutual funds may have higher expenses than passive index mutual funds. Mutual funds may also incur additional fees and charges, including account service fees. Weigh any potential mutual fund returns against these costs.

Limits

CD accounts can be opened for as little as $0, but you’ll more commonly see minimum deposit requirements for some of the best CD rates.

Mutual funds typically have higher minimums, ranging from $1,000 to $100,000 or more to buy mutual fund shares, although $1,000 to $3,000 is more common among some of the best mutual funds. You may even find mutual funds with a $0 minimum deposit.

Which Is Right for You?

CDs may be suitable for you if your priority is to protect your wealth. You may, for example, want to avoid losses to save for a short-term goal or emergency savings fund. More experienced investors might use CDs for diversification or to generate income.

You can compare prospectus for various mutual funds, reviewing their investment goals, historical returns, risks, and associated fees.

A Best-of-Both Worlds Option

With investing, you want to maximize returns and minimize risk. When you have a longer investing horizon, you can take on more risk because you have time to recover from downturns in the market. Your overall investing strategy can include both CDs and mutual funds for different reasons.

So you might want to hold some short-term CDs or no-penalty CDs if you need that cash within five years or less. Then consider mutual funds as part of a diversified long-term investing portfolio as a way to potentially earn greater returns than you would with CDs.

The Bottom Line

CDs are fixed-income investments that provide guaranteed preservation of your principal up to $250,000, along with interest earned on the principal. Mutual funds are diversified investments that could gain or lose money, but are invested in growing your money more than a CD or other savings account and helping to mitigate inflation’s impact on your savings.

You might want to spread your cash among various assets, including CDs for short-term savings goals and cash preservation, mutual funds for longer-term potential growth, and other investments such as individual stocks, bonds, or U.S. Treasury securities. If one investment takes a hit from a market drop, inflation, or another factor, the other investments may help you offset any losses.

Frequently Asked Questions (FAQs)

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The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.