Read on to find out if now is a good time to invest in a CD.
CDs are similar to savings accounts in that they are insured by the Federal Deposit Insurance Corporation (FDIC). The annual percentage yield, or APY, will get a slightly higher rate of interest than a savings account. For this reason, many investors prefer to put their money into a CD, and some even speculate with a CD.
The average CD rate has been falling since the recession began in 2007-08. This is primarily because banks are offering lower interest rates to attract depositors and keep their business. In addition, the Federal Reserve has kept interest rates at a historic low since the economy hit a rough patch. While the CD rates haven’t been increasing since the recession, the average rates have been rising slightly over the past couple of years.
If you’re looking to make a large deposit into a CD without moving it from the bank for a number of years, you can prevent yourself from losing interest by looking for CDs that come with flexible rates. These CDs are pegged to CDs with minimum rates over a set time period. The money can be moved easily by a decision from the customer after a set amount of time.
Why Are CD Rates Falling?
The simple answer is that CDs are not for everyone anymore. Banks are trying to entice consumers away from CDs to make more money. In order to do that, they have to offer interest rates that are better than the competition.
CD rates have declined 33% from the last decade. Unlike bonds, which have similar risk profiles but pay better interest rates, no one really has an incentive to drive the rates up. With that in mind, CD rates are probably here to stay, but don’t expect much improvement in the next decade.
The average CD term is a little over six months. This is why people who have held CDs don’t seem to realize you can get higher rates elsewhere. A five-year CD might pay 2% and if you pull it out after six months, you are only getting 0.5%.
Are the rates falling because people aren’t investing in CDs, or because most people are purchasing CDs with a short term goal in mind? Many older investors purchase CDs as a way to provide a source of income for retirement. As a result, most CD investors have already made the switch to bonds.
What Should Investors Do?
In general, it makes sense to avoid tying up your money for long periods of time because rates of return generally come down over the years. However, you might object that there are solid reasons to put some money into CDs. After all, how risky are they? They are backed by the federal government. They are issued by financial institutions that are required to make a certain amount of money available at the same interest rates that they promise us. And they can be quite a bit better than money market accounts.
Unfortunately, in a situation where interest rates are very low, they can be very long-term investments, putting you in a vulnerable position. You see, at very low rates of return, you have to tie your money up for longer periods in order to make up what you are losing. At a 2 percent return for five years, for example, you must invest double the amount of money at a comparable return of 3 percent. But if rates go lower, your money loses even more.
If you are not comfortable with the risk of losing principal as the economy grows and interest rates rise in coming years, you can try to come up with lower-risk alternatives.
One alternative is to hang on to the CDs and hope for higher interest rates.
How to Make the Right Move When It Comes to CDs
When Will CD Rates Go Up Again?
The U.S. Federal Reserve has increased interest rates five times over the past two years. It raised rates from an all-time low of 0.25% in December 2015 to 1.5% in December 2017. A sixth rate hike is expected in December 2018. The Fed said they would stick with its target for three more rate hikes in 2019.
As the Fed continues to raise rates, CD rates will eventually follow suit. So when will CD rates go up? It depends on two things. First, we have to see if the economy improves. Rising rates often signal a healthier economy. If the economy continues to improve, then rates will rise. The second factor to consider is that the Fed will have to slow down with its rate hikes. If they raise rates too quickly, they’ll trigger an economic downturn. So the Fed has to fine tune its rate hikes and CD rates will rise accordingly.