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One positive coming from the Federal Reserve’s recent interest rate hikes is that most banks also raised the rates that they offer to savers. In particular, certificates of deposit (CDs) have been relatively attractive for many savers over the past couple of years, following a prolonged period of ultra-low interest rates. However, the CD interest rate yield curve has recently become inverted. Currently, short-term CDs typically pay more than long-term CDs.
Normally, the opposite is true, in part because banks want to entice consumers to lock up their deposits for longer. But because interest rates are projected to fall this year, short-term CDs — typically those with a duration of 12 months or less — often pay more than long-term CDs.
Still, it’s not always clear what the best move to make is. Should you go for the highest CD interest rate, regardless of the CD term? Or is it better to gain the certainty of long-term CD expiration dates, even if rates are lower? We asked some experts for their advice to help you decide what to do.
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4 expert tips for choosing the right CD in today’s rate environment
Here are four ways to pick the best CD for your needs now, according to the experts we spoke to.
Focus on when you need your money back
Because CDs typically have limited liquidity, in the sense that you usually have to pay a penalty for early withdrawals, you want to be sure you choose a CD duration that matches your liquidity needs, rather than solely getting enamored with CD interest rates.
“You need to align the maturity of the CD with your upcoming cash need. For example, if you’ll be funding a kitchen renovation in March of 2025, you would consider buying a one-year CD now,” says Chris Nemes, CPA, partner, Nemes Rush Family Wealth Management.
“If you buy a six-month CD today, it’ll mature in August of 2024. At that point, you’ll have to reinvest the proceeds into another six-month CD that matures before March of 2025. However, the interest rates in August might be lower than they are today. As a result, you could earn a reduced rate of interest from August on,” he explains.
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Consider inflation risk
Another factor in choosing the right CD for your needs could be your willingness to tolerate inflation risk.
“A disadvantage of a longer-term CD is the rate is locked in and the return could potentially be impacted by inflation,” says Courtney Mitchell, head of consumer deposit and payment products at TD Bank.
While you might want the certainty that comes with, say, a 5-year CD with a 4% annual percentage yield (APY), it’s possible that inflation will tick back up and eat away at those returns. Yet if you invest in, say, a 1-year CD and inflation falls, then your CD renewal rate might be lower than what you could have gotten with a longer-term CD. So, you have to weigh these tradeoffs.
Weigh withdrawal fees
If you underestimate your liquidity needs or get caught off-guard by inflation, you might decide to withdraw your funds before the CD maturity date.
Thus, you might consider CDs from banks that charge relatively early withdrawal fees, and that might also influence the CD duration you choose. In general, long-term CDs have higher penalties than short-term CDs.
Fees probably aren’t the only factor you’ll consider, but it’s important to weigh how everything fits together.
“The biggest points to consider are the term or how long your money will be tied up, the rate it pays, any fees that might be charged, and what happens if you want to get your money back sooner. Balancing these can help you find the best CD for you,” says Mike Hunsberger, CFP, owner of Next Mission Financial Planning.
With this in mind, it’s worth considering accounts with minimal or no fees, even if the interest rate isn’t as high as accounts that will charge you for withdrawing your money early.
Diversify your investments
If you’re having trouble choosing the right CD in today’s interest rate environment, one solution could be to build a CD ladder.
“A CD ladder entails buying multiple CDs of different terms — maybe 1, 3, 5 years,” says Hunsberger. “When the 1-year CD matures they can decide to reinvest the money in another longer-term CD if rates are attractive or keep it liquid in a high-yield savings account or money market” account.
And keep in mind that CDs aren’t your only option.
Whether you’re “considering CDs, municipal bonds, corporate bonds, or Treasuries, it’s prudent to space out the maturities of your investments to reduce reinvestment risk and introduce more predictable investment income,” says Nemes.
The bottom line
It’s hard to say exactly what the best CD moves to make are, considering everyone has different risk tolerance, investment goals, etc. Instead, focus on what matters to you, such as your liquidity needs and willingness to tolerate inflation risk, along with factors like CD fees and the interest rates of different CD terms. And remember, you don’t have to choose just one type of CD. You can spread your money across different CD terms, as well as other assets, based on your situation.
