Friday, 19 April 2024

CD Rates Are Doing Something They Haven’t Done Since the 1980s — and It’s Good News for Savers

by BD Banks

<div>CD Rates Are Doing Something They Haven't Done Since the 1980s -- and It's Good News for Savers</div>

Image source: The Motley Fool/Upsplash

Certificates of deposit (CDs) have become a popular investment in recent years. As the Federal Reserve has raised interest rates, CD rates have skyrocketed in response.

But some investors may notice something weird about the CD market right now. There’s something going on that hasn’t happened since the 1980s, and it’s a phenomenon that could really benefit savers.

Here’s what’s happening.

The CD market is experiencing something it hasn’t for more than 30 years

For a very long time, there’s been a simple rule of thumb when it comes to investing in CDs. CDs with longer terms paid higher rates. That’s because banks reward people with better returns if they’re willing to lock up their money for longer periods of time. These higher yields were necessary to convince people to agree to leave their money invested for years, since they were taking on more risk by doing so.

In January of 2022, for example, the average rate on a 5-year CD was 0.26%, while the average rate on a 6-month CD was 0.09%. And in January of 2000, more than 20 years prior, the 5-year CD offered an average yield of 5.41% compared to 4.54% for a 6-month CD. (It’s worth noting that average rates are much lower than the rates high-yield CDs offer, but they still offer insight into how rates are trending).

While the exact numbers varied, short-term CDs have paid lower rates than long-term CDs for decades.

Things changed recently, though. In May of 2023, the average yield on a 5-year CD was 1.20% while the average yield on a 6-month CD was 1.29%. And average yields on 6-month CDs have been higher than those on 5-year CDs ever since. This is the first time that has happened since 1989! That was more than 35 years ago.

Why are short-term CDs paying higher rates right now?

The phenomenon going on in the CD market right now is known as an inverted yield curve. While this sounds technical, it’s actually pretty simple. A yield curve is just a visual representation of the cost to borrow money over time. It slopes up in most cases because of the “term premium.” That’s the extra amount of compensation given to people willing to commit money for years and accept the uncertainty that goes along with doing that.

Right now, though, banks don’t want to promise to pay people high yields for the long term because there’s strong reason to believe interest rates are going to fall soon. The Federal Reserve (the U.S. central bank) has made clear it wants to lower rates as soon as inflation comes under control. Banks don’t want to be caught holding the bag and paying upward of 5.00% to investors with long-term CDs if interest rates go down.

As a result, the yield curve has flipped, or inverted. Historically, that’s been a worrisome indicator of a recession, but many experts believe that’s not necessarily the case this time for a variety of reasons including strong job growth, solid economic activity, and the basic fact that the post-COVID-19 economic environment is pretty unique in a bunch of ways.

Why is this unprecedented switch good for savers right now?

Putting aside all of these technicalities, what this means for savers right now is that they can lock up their money for just a few months and get paid a really high rate — upward of 5.00% with many CDs.

Savers don’t have to take on really any risk since most CDs are FDIC insured and they aren’t making a long-term promise that would mean taking a chance of getting stuck in a bad investment for years if market conditions don’t go their way. They can earn an extremely competitive ROI that was unheard of just a few short years ago and still get their money out in just a few months’ time.

Take advantage of this unusual opportunity

A few years ago, a “great” rate on a CD was one paying around 2.00% or 3.00%. Now, you can easily earn 5.00% on your money without taking on any risk of loss and without agreeing to give it to the bank for years to come.

If you have any cash you won’t need in the coming months, there’s no reason not to take advantage of this opportunity while you can. Just check out The Ascent’s guide to the best 6-month CD rates to find tons of options and buy a CD today. Many have no minimum balance requirements, so you don’t even need much money to jump in.

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

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