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A certificate of deposit lets you lock in a fixed interest rate for a set amount of time. CD rates have been high over the past few years, helping savers earn more money and beat inflation.
The Federal Reserve has recently paused raising interest rates — and indicated that cuts may be on the horizon. Some experts think CD rates may soon start falling.
Does that mean now is the time to lock up your money in a long-term CD? Or is your money better off somewhere else? Here’s what you need to know.
How do CD interest rates work?
CDs are savings accounts that keep your money locked up for a set period of time. Most CD terms range from three months to five years. In exchange for agreeing not to touch your money for the duration of the CD, the bank pays you interest.
CD rates are largely determined by the Federal Reserve’s federal funds rate. This is the interest rate banks charge each other for overnight lending. When the Fed raises its benchmark rate, rates on CDs or high-yield savings accounts tend to rise, too.
That explains why CD rates soared as the Fed started hiking rates in 2022 to combat inflation. In March 2022, the average 5-year CD rate was around 0.40%. By the end of 2023, it was 1.43%.
Typically, the longer the CD term, the higher the interest rate. So a 5-year CD pays often more than a 1-year CD.
But in the past few years, you can often find higher rates on shorter-term CDs. That’s because banks expect rates to fall in the future and are hesitant to let savers lock in high rates for years.
Have CD rates peaked?
With the Fed holding steady, many financial experts think CD yields have peaked — at least for now. Greg McBride, Bankrate’s chief financial analyst, predicts the national average yield for five-year CDs will drop to around 1% in 2024.
That said, no one can predict the future with 100% accuracy. Some analysts think inflation could heat up, forcing the Fed to raise rates again. Other experts believe we could be headed for a recession that would prompt the Fed to cut rates more quickly.
But the consensus seems to be that CD yields are close to topping out. So, does that mean it makes sense to lock your money away in a long-term CD?
Why you should lock in a long-term CD right now
The best argument for investing in a multi-year CD today is that you can lock in a strong fixed interest rate.
Other accounts, like high-yield savings accounts, have variable interest rates that can fluctuate. You’ll earn a guaranteed rate with a CD, no matter what the Federal Reserve does.
If you have extra cash you don’t need for a couple of years, it may be smart to deposit it in a CD.
“Taking advantage of the currently higher interest rates on CD products can be a great idea, provided it matches your timeframe,” says Faron Daugs, a certified financial planner at Harrison Wallace Financial Group. “Locking in a higher rate for a longer period of time can help add stability and higher yields to your portfolio or even just your cash reserves.”
What to consider before you commit
Of course, there’s the chance that CD rates could rise, and you could miss out on bigger returns later. If the Fed raises rates again in the future, your money will be stuck earning the fixed yield you locked in now.
Tying up your savings for years also reduces your flexibility. Maybe you receive an unexpected home repair bill or medical expense. Or the housing market cools, and there’s an opportunity to buy. If your cash is locked in a CD, you can’t access it without paying an early withdrawal fee.
“CDs tend to be poor investments for long-term savings goals, like retirement, because they do not offer the returns of other long-term investments,” says Matt Hylland, a financial planner at Arnold and Mote Wealth Management.
For example, the highest-yielding CDs offered around 5-6% APY in 2023. The S&P 500 gained around 24% that year — and some experts expect stocks to rise even more in 2024.
“Before locking your money into a multi-year CD, you should be fairly certain that you won’t need to touch that cash for the duration of the term,” says Ben McLaughlin, savings expert at Raisin, an online savings platform. “If you have no other financial cushion to protect you in an emergency, locking up those funds could cause more harm than good.”
Who should (and shouldn’t) invest in a long-term CD right now
Deciding whether to lock up your money right now depends on your situation. Long-term CDs appeal most to low-risk investors who want stable returns over growth. Specifically, long-term CDs may make the most sense if:
- You’re a retiree who needs fixed income: Locking in today’s rates via a CD ladder can bring stability alongside other income sources like Social Security.
- You have a short-term savings goal: A long-term CD that aligns with a specific financial goal — like saving for a house, wedding, or other milestone — can help you safely grow your money.
- You already have emergency savings: With liquid cash reserves set aside, you can commit other funds more easily.
Locking money away might not be smart if:
- You’re still establishing your emergency fund: First, build up 3-6 months’ expenses in a savings account that you can access anytime.
- You may need cash unexpectedly: If you face sudden expenses, prioritize flexibility using a high-yield savings account.
- You mainly want to grow savings long-term: Though today’s CD rates look solid, stocks and other investments often deliver higher returns over longer periods.
Alternatives to long-term CDs
Instead of locking up your money for years, you may prefer to stay more flexible and earn more interest another way. Here are some alternatives.
These savings accounts won’t lock up your money or limit withdrawals. Many online banks now offer yields above 4% on their accounts. While rates may fluctuate, these accounts are much more accessible and flexible than CDs.
CD laddering
With a CD ladder, you spread your money across CDs with different terms, such as three months, six months, one year, and so on. When each CD matures, you roll it into a new long-term CD at the new interest rate. This approach allows you to lock in better yields if rates rise over time steadily. It also allows you to have some money available if you need it for other purposes.
The stock market
If you’re seeking growth, investing in the stock market often delivers higher returns over fixed-income assets like CDs.
Historically, the stock market’s average annual return is around 10.3%. By comparison, even today’s above-average 5-year CD yields only offer returns of 4-5%.
However, the tradeoff for those higher stock market returns is higher short-term volatility. The market could plunge 20% or more in any given year. Meanwhile, CD rates stay much more stable.
A balanced approach may serve you best rather than an “either-or” decision. Laddering some CDs can provide stability and diversification for part of your portfolio. But, combining high-yield savings and other investments may boost your overall returns.
Bottom line
Investing in a long-term CD has trade-offs. It’s a good idea if you don’t need the cash immediately and can earn a decent return.
It depends on your timeline, risk tolerance, and the interest rate outlook. If you think interest rates will fall soon, you may want to open a CD right now.
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