The case for long-term CDs

As inflation cools and the Federal Reserve hints that interest rate cuts could be around the corner, it may be time to snag some CDs with their current attractive yields before it’s too late. 

Across the board, CD rates are now more appealing than they have for much of the last 15 years, making them a go-to option for people looking for a place to park their mid-term savings. But after hiking rates to their highest level in more than two decades, the Fed recently signaled the era of high rates may be coming to an end. 

The move means it might make sense “to lock in those longer-term CDs and get those higher rates while they last,” said Christopher Cybulski, a financial advisor at Chisholm Trail Financial Group. 

The state of long-term and short-term CD yields

CDs are a type of savings account that banks and credit unions typically offer with fixed term lengths. When you put your money into a CD, you’re committing to keeping it there for the length of that term. Withdrawing your money early means paying a penalty (unless you opt for a lower-yielding no-penalty CD). The benefit of a CD is that you’ll get a guaranteed rate of return during the term of the CD. 

The interest rate that banks and credit unions pay on CDs is influenced by the federal funds rate, which is set by the Federal Reserve. When the central bank raises rates, financial institutions often follow suit, and vice versa. Since March 2022, the Fed has raised the benchmark rate nearly a dozen times, bringing it to its highest level in more than two decades. 

Short-term CDs tend to yield less than long-term CDs, since banks usually reward savers for keeping their money tied up for longer. But the state of the economy and the Fed’s interest rate hikes have upended that dynamic. The yields on the best 1-year CDs are between 4.00% and 5.50% while the yields on the best 10-year CDs are between 2.00% and 4.00%.  

“The fact that short-term rates are higher than long-term rates is far from normal,” said Chuck Failla, a financial advisor and principal at wealth management firm Sovereign Financial.

So why is it happening? 

Shorter-term yields typically represent how investors feel about where inflation, growth and the economy is headed in the short term, while longer-term yields show what they expect over the medium or long term. As the Fed has raised interest rates to cool down inflation, banks have increased the yields on short-term CDs to entice depositors. At the same time, market participants expect the Fed to eventually cut rates over the long-term as the economy slows. 

Why you should consider long-term CDs

It may seem counterintuitive to buy long-term CDs when short-term CDs are offering better rates. But the attractive rates on both CDs may be coming down soon — and a longer-term CD ensures you get today’s yields for longer. 

The Fed has recently been slowing down its interest rate hikes. At its December meeting, the central bank held rates steady and indicated they may cut rates by three-quarters of a percentage point in 2024. 

Because the rates on CDs are so tied to the rates set by the Fed, CD rates will likely come down after the Fed lowers the benchmark rate. That means you may want to lock the attractive rates we’re seeing now — and doing so for longer, like two to five years, guarantees you today’s rate for much longer.

“The more that rates come down, the more those long-term CDs will be affected,” Cybulski said. 

But while you may be tempted to rush to get those attractive rates while they last, you need to consider your personal goals, risk tolerance and timeline. 

How to use long-term CDs 

Like with most financial decisions, CDs come with risk. Here’s what financial advisors say to do when buying long-term CDs to ensure you’re maximizing their benefits and minimizing their risks. 

Consider your time horizon. Over the long term, the S&P 500 tends to have returns around 10% annually. But investing in the stock market should typically be reserved for money you won’t need for the next five years, says Catherine Valega, advisor and founder of Green Bee Advisory. 

Enter long-term CDs. If you have money that you know you’ll need in several years — such as if you’re buying a house in three to five years — locking in today’s rates on a 3-year or 5-year CD could be the way to go. 

“We’re not going to risk that downpayment in the stock market,” Valega said. 

Shop around. While long-term CD rates overall are yielding more than they have in years, the rates vary from bank to bank. Online banks can often offer higher rates than large, traditional banks since they avoid the cost of running physical branches. The same goes for small, local branches, which can be more agile than the industry giants. 

Visit your local bank and check online rates before committing to a CD, Cybulski says. But make sure you’re not doing a ton of extra work — like driving a far distance or opening several online accounts — just to get a slightly better rate. 

“Ask yourself what the ‘return on hassle’ is,” Cybulski said. 

Don’t forget about FDIC insurance. In 2023, the banking industry experienced turmoil following the collapse of a few major institutions. This bruhaha underscored the need for deposit insurance. The Federal Deposit Insurance Corporation and the National Credit Union Administration insures money in accounts like CDs up to $250,000 per depositor, per insured institution for each account ownership category.

That’s plenty of protection for most people. But if you are planning to have more than $250,000 in a CD at a bank, Cybulski says to consider opening an additional account elsewhere so you can ensure all your money is protected. 

“It’s perfectly fine to buy multiple CDs,” he said. “You can buy them at different banks.”