Are CDs worth it today? For the right investor, yes.
Are CDs worth it today? For the right investor, yes.

Certificates of Deposit (CDs) offer the same principal protection as savings accounts, but usually have a higher interest rate. When you buy a CD, you promise to keep the money in the bank for a fixed period of time. In return, the bank pays a higher interest rate than the savings account rate.

The CD rate tracks the federal funds rate — the rate at which commercial banks lend to each other. When the Fed raises the federal funds rate, banks also raise rates on certificates of deposit to attract more savers. Since certificates of deposit offer fixed rates, you may want to lock in these higher rates if you can, especially with rates at historically high levels.

But keep in mind that term deposit interest is taxable and will affect your overall return.

Are CDs still worth it now?

Thanks to the Federal Reserve’s rate hikes over the past year, CD rates have risen like a tide over the past year. Between June 2022 and June 2023, the 1-year time deposit rate increased by 552%. After a decade of historically low interest rates, you may be feeling the pressure to lock in as much as possible of these higher rates, but does that mean you should?

Indeed, says Steven Connors, founder and president of Connors Wealth Management in Scottsdale, Arizona. “A year from now and beyond, I don’t think those rates will be as high as they are now … unless there is some sort of catalyst that causes inflation to reemerge.”

Another factor affecting CD rates today? The yield curve is inverted. Normally, long-term interest rates are higher than short-term interest rates, but today the opposite is true. For example, 1-year CDs are currently yielding as much as 5.50%, while 5-year CDs are yielding as much as 4.66%. So today, you can make short-term commitments with a certificate of deposit and still earn the highest interest rates, increasing your liquidity and income.

Term deposit rates are so high that medium-term term deposits pay as much, if not more, than treasury bonds, which typically have the highest yields. The new five-year Treasury note yields just 4.36%, 0.3 percentage points lower than the top five-year certificate of deposit.

Beyond High APY

While certificates of deposit now offer higher yields than before, they are still only suitable for some investors. After accounting for taxes and inflation, the real rate of return on CDs held in taxable accounts is quite low.

The IRS taxes CD interest at ordinary income rates. So, to determine if a CD is worth it, you need to calculate your unique after-tax return. To do this, you’ll multiply the CD’s stated interest rate by one minus your tax rate.

For example, if you fall under the federal income tax rate of 24% (0.24), your CD yields 5%, which is effectively 5 times the after-tax return of 0.76, or 3.8%. With inflation of 3.2% in July 2023, that puts your real return at just 0.6%, and that’s before you factor in any state and local taxes.

In reality, “it doesn’t matter if the timing is good or bad when it comes to investing in CDs,” says Peter Casciotta, owner of Lee County Asset Management and Advisory Services, because CD rates correspond to inflation, like Same for all other rates. In Cape Coral, Florida.

Best CD Current APY Range by Semester*

* Rates as of 17 August 2023 but subject to change

Pros and Cons of Investing in CDs

The secret to determining whether CDs are right for you and worthwhile in the current economy is to determine what you want to achieve with a CD, and then determine that the benefits outweigh the risks, and vice versa.

advantage

  • main protection. You can earn modest returns while protecting your principal, and that’s not a bad thing.
  • Inner Peace. Knowing that your principal is safe and that you are getting a guaranteed return can reduce financial stress.
  • Reduce portfolio volatility. Since the value of CDs does not fluctuate like other investments, they can help reduce the overall volatility of a portfolio.

shortcoming

  • Early withdrawal penalty. Mining CDs early can incur a penalty, which can wipe out all your gains, and more.
  • The overall rate of return is low. CDs offer relatively low returns compared to many other investments, once inflation and taxes are accounted for.
  • Reinvestment risk. There is a risk that after your CD matures, you will not be able to reinvest it at an equal or higher interest rate.

when cd is worth it

The best time to invest in certificates of deposit is when inflation is soaring, Connors said. “The silver lining (of the Fed’s) fight against inflation is that the Fed creates an opportunity for conservative investors to eventually pay off.”

Despite higher inflation, CDs are only worth it if they fit your investment goals.

CDs are best for conservative investors or those looking to curb volatility in their portfolios.

As you age, you should shift your investment focus from growth to capital preservation. “It’s critical that you don’t lose your principles the closer you get to retirement,” because you won’t have time to make up for any losses, Connors says. This makes CDs a good choice for people approaching or retiring.

But even younger investors who hold mostly stocks can benefit from certificates of deposit. CDs can help you put the money you need in the future (for a down payment on a house or a wedding) far away and earn some interest in the process. But younger investors should probably avoid investments like CD IRAs because their yields are often too conservative to help retirement savings grow at an appropriate rate.

When CDs Might Not Be Worth It

CDs may not be worth it when interest rates are low. In these environments, conservative investors tend to invest in other fixed-income securities, such as munis or corporate bonds, for better yields, Conners said.

When interest rates are low, you can increase bond yields by choosing reliable bonds with lower investment grades. For example, owning bonds of lower-rated companies with good repayment records can increase your average return without taking undue risk.

When rates are low, you can explore fixed-income investments like bond mutual funds and exchange-traded funds (ETFs). Actively managed fixed income funds can have slightly higher management fees (expense ratios), but can often outperform the larger bond market.

But when deciding whether a CD is worth it, the real question is: How many CDs do you need to generate income to meet your investment goals? If you need to earn 7 percent to avoid running out of money in retirement, you can’t put all your money in CDs with 5 percent interest, Casciotta said.

frequently asked questions

Are CDs a good investment?

The answer depends. For those willing to sacrifice returns for security, certificates of deposit can be attractive, especially in a higher interest rate environment. However, bonds and bond funds may be better suited to a lower interest rate environment.

Are CDs Still Worth Buying in 2023?

For the right investor, the 2023 CD is worth it. With the recent rate hikes, many of the best CDs are yielding well over 5%. Retirees can also benefit from CDs held in a Roth IRA, which protect your principal and generate tax-free income.

Are CDs FDIC insured?

When a CD is deposited with an FDIC-insured bank or financial institution, the CD is insured by the FDIC up to $250,000 per depositor, per bank, in the event of bank failure.

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