When interest rates drop, you have to make difficult decisions about where to put your money. Certificates of deposit (CDs) are traditionally a safe option if you want to avoid risk because they provide a fixed return over a specified period of time. However, in a low-fee environment, it is important to choose the CD terminology that is most beneficial to your individual situation.
Should you lock in a long-term CD to lock in current interest rates, or choose a short-term CD to have your funds readily available?Here’s how falling interest rates affect CDs. Learn how to influence and choose the period that best suits your financial goals.
What does a CD rate drop mean?
Interest rates on CDs often move in conjunction with the Federal Reserve System’s benchmark, the Federal Funds Rate. At the Fed’s September meeting, interest rates were cut by 50 basis points (0.5 percentage point) to a range of 4.75% to 5%. Leading up to this, competitive CD yields had been falling as banks expected the Fed to cut interest rates. When interest rates are high, CDs and other savings accounts offer higher yields, but in an environment of falling interest rates, new CDs tend to have lower yields. This situation creates a dilemma for savers.
While CDs remain a safe way to earn guaranteed interest, locking in your current interest rate for too long could mean missing out on better opportunities in the future if rates rise again. there is. As of this writing, short-term CD rates are higher than long-term rates. You have the opportunity to reinvest in higher-yielding options sooner if interest rates start to improve again.
Which CD term is best in a low rate environment?
In low-rate environments, there is no one-size-fits-all solution when choosing CD terminology. This decision depends on your financial goals and how much flexibility you need.
Short-term CD (1-12 months)
Short-term CDs are typically more attractive because they offer some flexibility when interest rates are low. If interest rates rise quickly after your CD matures, you can reinvest your funds into a CD with a higher interest rate. Currently, short-term terms tend to be more expensive than long-term terms, but this may change. As of this writing, the top short-term CD rates are just over 5% APY.
Prior to September’s Fed rate cut, the Fed raised rates 11 times in two years, and banks increased CD APYs accordingly. However, many companies have chosen to keep long-term CD APYs slightly lower than short-term ones, in case the Fed lowers interest rates over the life of the CD.
“A short- to medium-term CD is ideal in a declining interest rate environment,” he says.
Dr. Orhan Kaychan, CFP, Founder of Orhan the Money Doctor. “If interest rates stabilize or improve, or if you find a better investment, you can lock in a higher interest rate while providing the flexibility to reinvest sooner. You can avoid falling into a long-term CD, which will result in lower returns.
Mid-term CD (12-36 months)
Intermediate-term CDs strike a balance between locking in interest rates and maintaining flexibility. If interest rates are unlikely to rise again next year, an intermediate-term CD may allow you to secure a slightly higher interest rate than a long-term while avoiding frequent reinvestment. Stephen Connors, founder and president of Connors Wealth Management, says it’s best to avoid variable-rate CDs.
“CDs with a fixed rate are best,” says Conners. “In an environment of falling interest rates, variable rate CDs and CDs with low interest rates don’t make sense.”
Long term CD (3-5 years)
If you expect interest rates to fall further or remain low for an extended period of time, locking in a long-term CD now may be a good choice. However, there is a risk that you could miss out on higher returns if interest rates start rising in the next few years.
“If you find a five-year CD that’s offered at around 4.75 percent, hold onto it,” said Joe Camberato, CEO of National Business Capital. “We’re in a rate cutting cycle and these offers won’t last long, so long-term terms make sense at this point.”
How do I choose the CD terminology that is best for me?
Choosing an appropriate CD terminology depends on several factors. Here are some things to consider:
liquidity needs
If you might need access to money quickly, short-term CDs are a better option. CDs typically come with early withdrawal penalties, which can hurt your returns if you need to cash out before maturity. However, one alternative is a penalty-free CD. This allows you to withdraw your money before the maturity date without incurring early withdrawal penalties.
Interest rate prediction
If you think interest rates will continue to fall, locking in a long-term CD now could be a good move. However, if you expect interest rates to rise soon, you may be better off choosing a short-term CD or intermediate-term option that offers a good balance of income potential and flexibility.
CD ladder ring
To hedge against interest rate fluctuations, consider building a CD ladder. This strategy involves purchasing CDs on a variety of terms, allowing you to benefit from both short-term and long-term rates while providing regular access to your funds.
conclusion
In a low interest rate environment, the optimal CD term will depend on your financial goals and liquidity needs. Short-term CDs offer flexibility. Long-term CDs, on the other hand, offer the chance to lock in a higher interest rate, but come with the risk of missing out on potential interest rate increases.
Balanced approaches such as CD ladders and mid-term CDs can help address these challenges. Consider how quickly you will need access to your funds and how you expect interest rates to change in the near future.
