It has been a while since certificates of deposit or CDs were a good investment, but that is changing in the current market. Today’s high interest rate environment has made CDs not only viable, but also a potentially strong near-term investment for the first time in years. While the average interest rates on 5-year CDs have dropped to just 1.41% (as of 9/7/23, according to the FDIC), investors who buy could do far better. In fact, you can currently find CDs that earn more than 5%.
current cd rate market
For most of the 2010s, the Federal Reserve kept interest rates at or near 0% in an effort to stimulate growth after the Great Recession. This ushered in an era of low yields on banking products such as CDs, as interest rates averaged below 1% for both long- and short-term options.
In an effort to combat the inflation of the past few years, the Federal Reserve has raised its benchmark interest rate again. A series of interest rate hikes took rates from near zero in March 2022 to 5.25-5.50% by July 2023. This has made all types of interest-bearing products more valuable. Although high interest rates have not been good for borrowers, they have proved to be a boon for people looking for safe investments.
CD has gained significant strength from the above mentioned minimum. Average interest rates for 5-year CDs have climbed to 1.41%, which is a sustainable, wealth-creating level. On the other hand, a 3-month CD has an average rate of 1.31%, which is still well above the rate you get on a savings account at a major bank these days.
Of course, these are just simple market averages from the FDIC. Top CD rates beat these numbers by a lot. For example, Bread Financial offers a 1-year CD that yields 5.4% as of 9/7/23. Additionally, PenFed has a 2-year CD with a 4.6% APY, while Barclays offers a 5-year product that yields 4.5% per year, both as of 9/7/23.
What can these strong interest rates offer?
Average interest rates on CDs are competitive with month-to-month inflation, but they still haven’t kept pace. However, the best rates not only beat inflation, they can also beat some stock market returns.
CD rates over 4% are competitive with most investment-grade corporate bonds, arguably the next closest benchmark security investment. This yield comes close to current bond yields, which have also been boosted by Federal Reserve rate hikes, and comes with the security of an FDIC-insured banking product.
For example, take a 5-year CD paying 4.5%, like the one from Barclays mentioned above. An investor who puts $10,000 into this account will receive $12,523. In contrast, a 4% bond would make you about $300 less over the same period. It’s been more than a decade since this has been reliably true that CDs will be a better investment.
Pay attention to the shortcomings of the CD
One significant drawback to certificates of deposit compared to their bond counterparts is the length of the asset. For long-term investors, especially income investors, even a 5-year CD may not provide enough duration. In that case, a 10- or 20-year bond may be a better way to lock in long-term rates.
For investors with shorter time horizons, the current CD market is competitive again. Someone looking to make a safe, multi-year investment may consider these assets for a mix of safety and growth. This is especially valuable, for example, for someone saving to buy a home or go on a big trip. Other investors who want to store their cash for a period of time may look for CDs that last only a few months, which keeps their money on hand while collecting rates beyond a simple savings account.
This also presents an opportunity for CD laddering.
Ladder investing is the practice of sequencing your CD investments into timed intervals. You open a series of short, medium and long-term accounts, creating a portfolio that is “laddered” over time. This allows you to combine some of the higher returns of long-term investments with some of the liquidity of shorter-term options.
In an era of high interest rates, CDs have finally begun to regain their value relative to inflation and other asset classes. This makes them a potentially good choice for short- and medium-term investors looking for a mix of safety and growth.
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