When it comes to investing, many people are unsure of where to begin. Two popular investment options for beginners are certificates of deposit (CDs) and mutual funds. People often don’t know the difference between the two and which one might be a better choice for their needs. Let’s take a look at how CDs and mutual funds compare when it comes to risk, liquidity, return on investment, and fees.
What are CDs?
Certificates of deposit, or CDs, are a type of savings account that you can purchase from a bank or credit union. When you invest in a CD, you agree to leave your money in that account for a specific amount of time – usually anywhere from three months to five years – in exchange for an interest rate that’s higher than what you would get with a traditional savings account. The longer the term length, typically, the higher the interest rate. Your money is also insured up to $250,000 by the FDIC (or NCUA if it is a credit union).
What are Mutual Funds?
Mutual funds are investment vehicles made up of a pool of funds collected from many investors that buy stocks, bonds, and other investments. They provide access to professionally managed portfolios, providing more diversification than investing in just one stock or bond at a time.
This diversification helps reduce risk associated with investing since it spreads out your exposure across several different types of investments rather than solely relying on one company or sector. With this reduced risk comes lower returns though; mutual fund returns tend to be lower than those associated with individual stocks or bonds.
Risk: CDs are regarded as low-risk investments since they generally guarantee your principal investment. Mutual funds, however, carry a higher level of risk because the value is subject to market fluctuation.
Liquidity: With a CD you must wait until the maturity date in order to access the money you invested; however, with mutual funds you can withdraw your money anytime without penalty—although there may be some taxes associated with withdrawing early.
Return on Investment (ROI): It’s important to understand that while CDs tend to offer lower returns than mutual funds, they also guarantee your principal amount unlike mutual funds where there is no such guarantee. On average, CDs have an ROI ranging from 1% – 3%. Mutual fund ROI will vary based on what type of fund you invest in—stock or bond—as well as market conditions; however, stock mutual funds typically have a higher ROI than bonds depending on market conditions.
Fees: Generally speaking, CDs require some sort of fee for opening them but do not require any additional fees after that point—at least until maturity when you may face an early withdrawal penalty if applicable. Mutual funds usually require both a setup fee and annual maintenance fees regardless of whether or not you make withdrawals before maturity.
Conclusion: When deciding whether or not to invest in either a CD or a mutual fund it’s important to consider factors like risk tolerance, liquidity needs, expected return on investment, and fees associated with each option. Do your research beforehand so that you can make an informed decision that best meets your individual needs as an investor!