Quora Answer: Under What Circumstances Would You Invest in Short-Term, Medium-Term, & Long-Term Certificates of Deposit?

The following is my answer to a Quora question: “Under what circumstances would you invest in short-term, medium-term, and long-term certificates of deposit?”

Certificates of deposit are normally used to balance out a portfolio.  You are sacrificing liquidity for a slightly higher return.  Therefore, you have to be certain that the opportunity cost is not more than the return.  For example, if your portfolio is heavy on equity, and you expect turbulence in the market, and you do not want your AUM to drop significantly, for various reasons, you balance it out with debt instruments, and CDs are an option.  In the short-term, a CD has a lower interest rate than a longer term one, but it lowers the risk profile of your funds.

Long-term CDs have a higher interest rate, but they are also considered higher risk because of the length of time those funds are locked into a specific undiversified instrument.  Also, there is the early withdrawal penalty to consider, since there is no liquidity here, and no attractive secondary market.

It does not make sense to invest solely in CDs.  They are instruments to diversify a portfolio to mitigate short term risk due to currency exposure, political exposure, or even an anticipated downturn since the interest rates are guaranteed.  By themselves, however, they are illiquid, and there are better instruments to put your money into.