For decades, a simple rule has applied when investing in CDs. But that rule has not applied in recent months.
Investors considering buying certificates of deposit need to understand why their choices are very different now, so they can make the right decisions about what to do with their dollars.
This rule isn’t in effect right now and hasn’t been for months
Traditionally, when you invested in CDs, you had to decide between:
- A CD offering a shorter term, with a lower rate
- A CD offering a longer term, with a higher rate
Banks had to offer investors more money to buy CDs with longer investment timelines because that was the tradeoff for locking up their cash for longer. This is called the “term premium,” and it refers to the added compensation banks pay investors to take the risk of committing to a long-term CD they’d be stuck in even if rates went up.
Now, however, this rule does not apply. In fact, as the table below shows, the national average rates on short-term CDs are above the national average rates on long-term CDs.
It’s possible to find CDs paying well above these rates if you shop around (you can see multiple CDs paying above 5.00% on The Ascent’s guide to the best 6-month CDs, for example).
But, these national averages still do a good job of showing that you can earn higher returns if you buy a CD that locks in your rate for a year or less compared with if you buy one that commits to paying you your rate for 36 months or longer.
So, why does the longstanding rule not apply right now? It’s simple. There’s a lot of economic uncertainty, but the general consensus among most experts is that rates will go down soon. And banks don’t want to commit to paying you 5.00% on a 3-, 4-, or 5-year CD. But since rates are very high right now thanks to the Federal Reserve’s efforts to fight inflation, banks are willing to offer upward of 5.00% on CDs with shorter terms.
Take advantage of the chance to earn a great rate for a short-term investment
A rate above 5.00% is a pretty great rate when you only have to commit to leaving your money locked up for a very short period. You don’t have to take a chance of getting stuck in a bad investment for years if the consensus is wrong and rates do go up again in the near future. And if they go down (as most people expect), you’ll have your rate guaranteed for a few months or a year and will have earned a very competitive yield on an extremely low-risk investment.
If you have money you aren’t going to need for a few months, why not take advantage of the current environment where the usual rules don’t apply, and earn that great return on the cash? Check out The Ascent’s guide to the best CD rates today and find a CD with a term of 12 months or less to buy now, before the CD market goes back to normal and this chance disappears for good.
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