If there’s a silver lining to the current economic situation that features soaring inflation and falling stocks, it’s that savers can get more for their money.
Even after just a few months of rising interest rates, you can find online savings accounts yielding more than 3%. But that might not be good enough anymore.
“Rather than being grateful for yield, that’s going to change quickly into turning your nose up at yield,” says Matt McKay, a certified financial planner and partner at Briaud Financial Advisors in College Station, Texas.
The Federal Reserve continued to raise rates through the end of 2022, and yields on savings products are now high enough that they look like a safe haven compared with a stock market that’s in the red this year.
And that means certificates of deposits, or CDs, are back in the conversation — even if that comes with caveats.
Advisers still favor Treasury bills and notes and Series I savings bonds for getting the best combination of low risk and high yield, but some are looking more seriously at CDs now. And for the everyday investor doing it on their own, CDs offer an additional boost beyond a savings account without much effort.
“It’s good for anyone if they have cash sitting around, if you can pick up something — CDs, T-bills, whatever — it’s good to get something,” says McKay.
If you’re under 50, you might never have invested in a CD and have no memory of how investors used to build ladders of different maturities as a cornerstone of their portfolio.
“With younger clients, nobody ever talks about CDs — never, never, never,” says Dennis Nolte, a certified financial planner and financial consultant at Seacoast Investment Services in Orlando, Fla.
For some, however, CDs never went out of style. These promissory notes from banks, which have been around in the U.S. since the 1800s, come in maturities generally from three months to five years, in exchange for interest at maturity.
You’re locked into the time period or face surrender charges that vary, unless you choose a more flexible, lower-interest option. The laddering strategy consists of buying CDs at different maturities and then reinvesting as they each come due.
Over the past few years, CDs haven’t been worth it for most savers, who could get as much from a high-yield savings account without restrictions. The average five-year CD would have nabbed you nearly 12% in 1984, but now the average five-year rate is just 0.74%, according to Bankrate.com. Back in 1984, CDs were nearly 50% of deposits at FDIC-insured banks, with $1.24 trillion held in the first quarter of that year. In 2022, there’s nearly the same dollar amount, which amounts to just 6.3% of deposits.
With rates rising, you can find better-than-average deals, closing in on 4% at some banks or brokerages. Many have a $1,000 minimum purchase, but you can find fractional offers for as little as $100.
CDs versus Treasurys and I-bonds
Treasury bills and notes come in roughly the same maturities as CDs, and are yielding slightly more currently. They also have no state tax burden on gains.
You can buy directly at TreasuryDirect.gov, with a $100 minimum, but to sell, you have to transfer holdings to a brokerage. Or you can buy and sell through a brokerage, but your minimums may be $1,000.
For I-bonds, you can only buy directly at TreasuryDirect.gov, with a minimum of $25 and a maximum of $10,000 per person a year, with gifts allowed to others up to $10,000 per recipient. I-bonds are indexed for inflation, with rates that reset every six months, and today are yielding 6.89% through April 2023. The biggest caveat is that you are locked into one year, and then face a surrender penalty of three months of interest if you cash out before five years.
A strategy for today’s rising rates
If you are chasing yield and have money you don’t need for a year, then I-bonds are the place for the first $10,000.
“It makes sense to max out I-bonds before investing in CDs,” says Ken Tumin, founder of DepositAcccounts.com.
Just make sure you’re motivated enough to navigate a still-wonky website and keep track of the investment on your own, because it won’t align with any of your other accounts. McKay had a client who was eager to jump into I-bonds, and he was mad at first that McKay hadn’t recommended it. “But then he called to complain, saying this is terrible, it’s so difficult,” he says.
If you have funds beyond that for savings, consider Treasury bills or notes because the rates are higher, says Tumin. Then consider CDs. That’s what Nolte is doing with some clients, particularly older ones who have past experience with them.
“Why not get something guaranteed? It’s maybe not keeping pace with inflation, but you’re not losing principal,” says Nolte.
CD rates move more slowly than other products, so even after the next rate hike, this strategy would still apply. But already Tumin sees investors ready to lock into long-term CDs, anticipating a recession and a drop in interest rates. If rates subsequently fall, and CDs lag, they would eventually end up with a price advantage over Treasury investments. Then people like McKay will be advising clients to buy in earnest.
“That’s when CDs become most attractive — as soon as rates peak or there are cuts [in rates],” says McKay.
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