If you’ve purchased certificates of deposit that range from short-term investment periods to long-term, then you’re probably at least a little familiar with yield curves. However, being just a little bit familiar can only get you so far if you’re interested in being a serious investor.
So instead of continuing your time in the dark, let’s take a closer look at yield curves and how they impact CDs. This way, the next time you choose to invest, you’ll be able to make truly informed decisions.
What are Yield Curves?
Yield curves define the relationship between short-term interest rates and long-term interest rates when making investments in fixed-income securities. For example, if you’re investing in a 6-month CD and a 5-year CD, because certificates of deposit typically offer different annual percentage yields based on the length of time invested, there will be a curve that shows the increase in interest rates from the 6-month investment to the 5-year investment.
The Types of Yield Curves
There are a number of types of yield curves that represent the different turns in interest rates the market can experience. Let’s look at what they are, as well as the impact they can have on your CDs:
- Normal yield curves: This represents the short-term interest rate being lower than the long-term interest rate. This means, when purchasing certificates of deposit for 3-months, the interest rate will be lower than those of 5-year CDs.
- Inverted (negative) yield curves: These types of curves represent the opposite of the normal curve. So instead of the short-term interest rate being lower than the long-term, it is higher.
- Flat yield curves: When the normal and inverted yield curves are switching places (one is switching to the other), it will often flatten, showing very similar interest rates between short- and long-term CDs.
Understanding the type of yield curves you’re dealing with at any given investment period can help you decide how to manage your certificates of deposit. So if you’re thinking of purchasing some CDs, it’s good to first see what type of curve we’re in.