Exchange-traded funds (ETFs) and certificates of deposit (CDs) are entirely different products. They are purchased through different markets, have different risk and reward profiles, and are even regulated through different sections of the law. In most cases, an ETF is good for growth. These are generally equity-heavy funds based on diversified, often returns-oriented, assets. A certificate of deposit, on the other hand, is good for security. These are depository products that pay a moderately higher interest rate in exchange for keeping your money in place for an extended period of time. Here’s what you should know.
If you need help picking investments for your portfolio, a financial advisor can work with you to create an investment plan for your specific needs and goals.
What Is an ETF?
An ETF, or “exchange traded fund,” is a portfolio-based investment product. Like other portfolio products (most notably REITs and mutual funds), an ETF operates as a derivative asset. Any given fund will hold a collection of investments. The performance of the fund overall is then based on the average performance of those underlying assets.
Investors can purchase ETFs by the share. Returns are based on the fund’s performance and proportional share of ownership. Investors also pay a fee set by the fund known as an “expense ratio.” These fees are typically below 1%.
An exchange-traded fund can hold publicly traded assets. In practice, however, most ETFs hold a collection of equities and bonds, with some market-wide preference toward equities. This makes them structurally similar to mutual funds. Unlike mutual funds, however, ETF shares are highly liquid. Due to their underlying redemption structure, you can buy and sell shares of an ETF freely on a public stock exchange.
An exchange-traded fund is a regulated security.
What Is a CD?
A CD, or “certificate of deposit,” is a depository asset offered by regulated banking institutions. They are also sometimes known as a form of high-interest savings account.
When you buy a certificate of deposit, you put an amount of money on deposit with the bank. You must keep that money in place until the CD matures, typically a period of several years, or pay a significant early withdrawal penalty. During the certificate of deposit’s term the bank will make regular, fixed interest payments into this account. When the CD matures, you receive back both the value of your initial deposit and the collected interest.
For example, say that you buy a five-year certificate of deposit for $1,000 at a 3% interest rate. This means that you would put $1,000 on deposit with the bank. You must keep it in place for the next five years. Over this time, the bank will pay 3% annual compounding interest into your account, and when the asset matures you will receive both the principal and interest.
As a depository product, CDs are FDIC insured and rarely have any fees. Longer-term certificates of deposit will typically offer higher interest rates.
When Should Invest in Each?
Exchange-traded funds and certificates of deposit are highly asymmetrical assets. A few of the most important differences include:
- Liquidity. An ETF is highly liquid, a CD is highly illiquid.
- Growth. An ETF can be high-growth, a CD is always low-growth.
- Security. An ETF is exposed to the market, a CD is FDIC insured.
- Asset class. An ETF is a regulated security, a CD is a regulated depository product.
- Investment. An ETF has no minimum investment, a CD may require several thousand dollars.
A certificate of deposit is generally a good investment for long-term security investors. If you know that you will not need this money, and if you want to prioritize security over growth, a CD might be a good option. This is particularly true during high-interest rate periods. For example, at time of writing CD rates were relatively high. Although average rates for a 12-month certificate were 1.8%, investors can find rates as high as 4% or 5%. This is comparable to the rates offered by some corporate bonds.
An ETF, on the other hand, has an extremely diverse profile. Despite their typical makeup, many exchange-traded funds are built for income and security. For example, investors can find entire ETFs built around Treasury debt, generally considered the safest asset class in the world. Others are built around corporate bonds and other forms of relatively low-risk assets. This can make exchange-traded funds an attractive option for investors who want security without the lock-in of a CD.
However, ETFs are historically known for their growth investments and equity investing. In particular, this is a popular asset class for equity index funds. Investors looking for diversified, portfolio-based growth often seek out ETFs for their high liquidity and low fees relative to similar asset classes. In this way, ETFs are particularly asymmetrical to certificates of deposit, as they are often a strong investment for growth-oriented investors.
Bottom Line
Exchange-traded funds are a portfolio based asset typically associated with diversified, growth-oriented investing. Certificates of deposit are depository banking products typically purchased by investors looking for long-term, low-growth security.
Depository Investing Tips
- Depository products, like certificates of deposit and high-yield savings accounts, make regular interest payments. If you’re an income investor, here are three main forms of investment income to keep in mind.
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Photo credit: © iStock/PeopleImages, © iStock/Zinkevych, © iStock/nortonrsx