Rising inflation impacts the stock market and more
Rising prices scare investors. Here you'll learn how inflation works, how it affects investments like stocks and funds, and how to protect your money.
For the kitchen table investor with some cash to spare, now might be the ideal time to consider investing in a certificate of deposit.
CD prices are higher than they have been in years. According to a January survey by personal finance website WalletHub, the best one-year CDs offer 5.66% annual interest rates. The best six-month CDs are 5.75%.
“There's no doubt that CDs are getting more attention these days,” said Chris Starr, head of personal and commercial deposits at Wells Fargo Bank.
CDs spooked some investors. In a 2023 survey by Forbes Advisor, 41% of Americans said they had never opened one. Some respondents said applying for a CD was “too complicated and time-consuming,” but others didn't want to lose access to their money.
Certificates of deposit may be unfamiliar to many, but bank officials say the application process is actually not particularly complicated or time-consuming.
“Opening a CD is easy and can be done in minutes from your phone or computer,” Starr said.
This is how a deposit certificate works
When you open a CD, you agree to hand over your money to the bank for a specific period of time. In return, the bank usually offers you a higher interest rate than on a normal checking or savings account.
Typically, the longer the term of the CD, the higher the interest rate. But in recent years the rules have been repealed. A campaign of aggressive rate hikes by the Federal Reserve caused interest rates to skyrocket in 2022 and 2023.
Market researchers expect interest rates to fall in 2024 and beyond. As a result, interest rates on short-term CDs are now, somewhat counterintuitively, generally higher than on long-term CDs.
In the WalletHub survey, the top five-year CD offers 4.75% interest. Investors can get higher interest rates on CDs with terms ranging from three months to one year.
“We are currently in an unusual situation where yields on shorter-term CDs are higher than yields on longer-term CDs,” said Greg McBride, chief financial analyst at Bankrate. “Interest rates are expected to fall in the coming years.”
Experts say the best CDs with interest rates of 5% or more are competitive with the best high-yield savings accounts and bonds.
To open a CD, you must be willing to spend money
But CDs aren't for everyone.
To open a CD, you must be able and willing to spend your money for the entire term of the investment. You can withdraw the money early, but you will then face penalties that can reduce the interest and even some of the principal.
“You have to be able to live without the money for the life of the CD,” McBride said.
A CD wouldn't be a good idea for someone who doesn't have a fully funded emergency savings account, McBride said. According to a recent Bankrate report, less than half of American adults have enough savings to cover three months of living expenses.
For investors who can afford to put some of their savings in a CD, the benefits are obvious: “guaranteed returns,” said James Morgan, vice president of savings and deposits at Capital One.
The certificate bears interest at a fixed interest rate over the entire term. The same cannot be said for the typical high-yield savings or money market account, whose interest rate generally fluctuates with the market.
CDs come in many lengths: three months, six, nine or ten, or a year or longer.
“People thinking about a CD should really shop around and consider a number of options,” Morgan said.
Let's say you want to save some money for gift shopping during the 2024 holiday season. A one-year CD won't work because you won't get your money back until 2025. However, a nine- or 10-month CD could be perfectly timed.
“It comes down to knowing your savings and cash needs,” said Frank Newman, director of portfolio construction and due diligence at Ally Financial.
As of early January, Ally offered interest rates ranging from 5% to 5.25% on CDs with terms of six to 12 months.
Not every bank offers such high interest rates. According to Bankrate, the average interest rate on a one-year CD was about 2% at the end of 2023.
Do not miss that: Many Americans fail to open high-interest savings accounts.
Short-term CDs pay better interest rates, but investors should also consider longer terms
Today's interest rates make short-term CDs seem attractive, but experts say investors should also consider longer terms.
Banks set CD interest rates based on their best estimates of how interest rates will evolve in the coming months and years. Interest rates are now lower for longer maturities as forecasters believe interest rates overall will eventually fall.
“Some people might look at a two- and three-year CD and be put off: 'This has a lower rate than a one-year CD or a six-month CD.'” What a scam.” said Odysseas Papadimitriou, Founder and CEO of WalletHub. “Well, there’s no cheating here. The market expects interest rates to fall.”
The banks “know better than we do if and when interest rates will fall,” Papadimitriou said.
So if a bank offers you a slightly lower interest rate on a five-year CD than on a one-year CD, “that doesn't mean you're getting a worse deal,” he said. “You will receive a fair offer based on market forecasts.”
Daniel de Visé covers personal finance for USA TODAY.