While the Federal Reserve’s rate hikes made it more expensive to get a mortgage and carry credit card debt, they also made it more lucrative for people to save. By stashing your cash in a high-yield savings account or a certificate of deposit (CD), you can score a rate that tops 5%.
If you’re looking for a place to stash your cash for a fixed period a CD could be a solid option, especially since annual percentage yields (APYs) on CDs of various term lengths are the highest they’ve been in the past two years.
CDs: a rundown
With a CD, you lock up your money for a fixed period in exchange for a fixed interest rate. The catch? If you tap your money before time is up, you’ll be on the hook for an early withdrawal penalty, which typically is worth a few months of interest.
When the Fed started increasing the federal funds rate in 2022, rates on deposit accounts like CDs followed. In June 2022, the national rate on a 12-month CD was 0.25%. Now, it’s 1.86%. That’s a more than sevenfold increase.
There’s also been a similar stratospheric rise in APYs for 5-year CDs: from June 2022 to December 2023, the rate on 60-month CDs increased nearly threefold, from 0.48% to 1.4%.
However, if you’re willing to do some shopping around for CDs, you may be rewarded with higher rates—online banks typically offer better APYs than brick-and-mortar banks. Some of the best 1-year and 5-year CDs have rates that top 5% and 4%, respectively.
Here are a few institutions that regularly offer excellent rates on CDs:
Why are short-term CDs offering higher APYs than long-term CDs?
Typically, investors receive a higher rate for tying up their money for longer periods of time–think of it as a reward for parting with your cash. Currently, however, you can get a higher interest rate for opting for investments with shorter durations over those with longer ones.
This is due to the inverted yield curve. A yield curve is a graph representing the yields of securities (typically bonds) with different maturities but similar credit quality. Note that while we’re referring to bonds in the example below, the same pattern holds true for CDs.
Usually, the curve is upwards-sloping, with bonds with longer maturities offering higher yields. But the curve is currently inverted—as of January 10, 2024, a 2-year treasury is offering a 4.37% yield while a 10-year treasury has a 4.02% yield.
Why has the yield curve inverted? When the yield curve inverts, it means that, in part, investors predict that interest rates will be lower in the future. So, how do you choose between a CD with a shorter duration and higher yield versus a CD with a longer term and lower yield?
Should you opt for a short-term or long-term CD?
It’s important to consider your investment horizon and liquidity needs when you’re choosing between a short or long-term CD, according to Frank Newman, Director of Portfolio Construction & Due Diligence at Ally.
Newman recommends using a savings or money market account for your emergency fund, which can be used to cover unexpected expenses like a home repair. Generally, CDs offer higher rates than savings or money market accounts (MMAs) because they’re less liquid, so you get a better APY because you can’t access your cash as easily.
“At the end of the day, it’s about mapping the timeframe of the financial goal to the CD maturity,” says Newman.
For example, a 5-year CD could be a good place to store your down payment if you’re looking to buy a house a few years down the line—you’ll earn some extra interest on your down payment and if you choose to get a CD or share certificate at a Federal Deposit Insurance Corp. (FDIC) or National Credit Union Administration (NCUA)-insured bank or credit union, your money is safe up to $250,000.
While CDs with longer maturities might not be suitable for everyone, investors who opt for short-term CDs should be aware of reinvestment risk, which occurs when interest rates drop, and you must reinvest your funds at a lower interest rate once your investment matures.
Newman offers this example: If you get a 1-year CD with a 5% APY and the interest rate has dropped to 4% after it matures, you’ll have to reinvest your funds at a less lucrative rate. On the other hand, if you open a 5-year CD with a 4.50% APY, you’ll lock in that rate for the next few years. For some investors, that could be a good move.
Recently, the Fed signaled it’s likely done raising rates and will start reducing them this year. Many investors expect a rate cut in March.
“As the federal funds rate goes down when the Fed starts cutting, you lose that return,” says Preston Caldwell, Chief U.S. Economist for Morningstar.
By tying up your money in a CD, you get a guaranteed rate of return—but only if you don’t access your money before the term expires. Otherwise, you’ll have to pay the dreaded early penalty fee.
CD rates by term
The takeaway
Although it’s unlikely CD rates will soar any higher, don’t open a CD just because the Fed could start cutting rates soon.
James Martielli, head of investment and trading services at Vanguard, encourages people not to make investment decisions primarily based on whether the Fed will increase or reduce rates.
“From an investor standpoint, interest rates go up and down, and if they focus on that too much, they might be missing the forest for the trees,” says Martielli. “If you're focused on short-term investing or saving, it's probably more important to focus on your needs and preferences. Are you looking for yield, safety, or convenience?”
Ultimately, consumers should opt for a CD only if it fits within their financial goals. The choice between a short-term or long-term CD should come down to your risk tolerance, time horizon, and liquidity needs—regardless of what the Fed does with interest rates.
