The Fed has continually punished savers with rounds of quantitative easing, making it close to impossible to eke out even a modest return on deposits. That’s not news to anyone who has owned a certificate of deposit in the past few years — but with the Fed tapering its bond-buying measures, long-term CD rates have once again become interesting.
Or perhaps more aptly, depressing.
Rising interest rates are good news for everyone: It’s a sign the economy is recovering, and not to mention, savers might actually get some help saving. The problem is that long-term CD rates, specifically, are only really beneficial when interest rates are falling. So does that mean we should just give up on this product completely?
Historical CD Interest Rates Versus Today
Back when I was way too young to even get an allowance, CD rates were paying out double digits. I promise I’m not making it up — the chart below shows CD rates peaking in the ’80s, based on average six-month CD rates:
I don’t know about you, but I’m feeling totally gypped.
Ever since the financial crisis and subsequent moves by the Fed, however, CD rates have been ridiculously low — and are somehow continuing to get lower.
The Allure of Long-Term CDs
Despite the lackluster rates of late, certificates of deposit can fit nicely into just about any financial plan. I’ve written about how younger, first-time homeowners can use a CD to save for a home down payment — but older investors can also use CDs to earn passive income or park cash that’s not currently invested.
However, longer-term CDs (lasting three or more years) generally attract depositors chasing higher interest rates. Especially when rates are dropping, long-term CDs can be used to lock in a competitive rate for an extended period of time, allowing the depositor to sit pretty knowing his money is safe and growing while everyone else is earning smaller returns.
Until fairly recently, it was safe to assume that the longer the CD term, the higher the interest rate. In a world of plummeting rates, however, even 10-year CDs have been about as competitive as a high-yield savings account.
Now that CD rates have likely hit rock bottom and will, albeit very slowly, begin climbing again, anyone who locks himself into a long-term CD account will undoubtedly sabotage himself out of better rates in the future.
Short-Term Plan: Avoid Long-Term CDs
Brian Caird, consumer solutions manager for Northern Credit Union, told me, “While it depends on the individual’s financial goals, a good rule to follow is if the money is long-term money, then it should be placed … where someone is getting an appropriate risk-adjusted return.”
Josh Koehnen, a CFP based in San Diego, agreed that it rarely makes sense to lock up funds in long-term CDs, especially in today’s rate environment.
“Instead, I would look at a savings account or money market account through reputable online banks who are able to offer higher yields than traditional brick and mortar banks,” Koehnen said. “Although there is still the issue of failing to keep up with inflation and taxes right now, at least there is more flexibility to take advantage of rising interest rates in the future.”
Certificates of deposit are still solid accounts for savers and investors who need a safe place to to put their cash, but there’s no reason to tie up money for an extended period of time for a below-average CD rate. For the foreseeable future, sticking with shorter-term CDs is a good idea until rates rise high enough to make long-term CD rates worth it — which will happen again some day.