The Survey of Consumer Finances released last month by the Federal Reserve shows that the popularity of certificates of deposit (CDs) has dwindled in recent years. That is somewhat understandable given the low-interest-rate environment, but is it a mistake for savers to turn their backs entirely on CDs? Given today's rate environment, the yield advantage CDs offer may still give bank customers a vital edge. Here are six things you should know about today's CD rates, in order to take advantage of every opportunity to earn a little extra interest:
1. Today's CD rates reflect a bleak outlookThe average rate on a five-year CD is below 1 percent now. This means that banks are saying that interest rates are likely to stay low for the next few years. Before you buy into that, consider that employment is improving and the Federal Reserve's policy is in transition. So, only commit to a longer-term CD if that CD offers a combination of a well-above average interest rate and a mild penalty for early withdrawal.
2. Five-year yields still offer a little extraAccording to national averages for CD rates published by the FDIC, you typically get a 0.20 percent rate for committing to a one-year CD. You can get an extra 0.14 percent for committing to a two-year CD, then an additional 13 basis points for each of the next two years in length (three and four years). However, if you stretch your CD term from four to five years, you get an additional 18 basis points on average. In other words, as uninspiring as five-year CD rates may seem, there is a better-than-average reward for stretching out to that extra year. In contrast, you do not get much extra yield in the two- to four-year range.
3. Relative rate gaps remain wideRemember that choosing a CD is not just a case of locking into a rate -- it also means locking into a bank. CD rates may be low today, but the relative rate differences between institutions can still be wide. While the average five-year CD rate is 0.78 percent, rates of 2 percent or more -- in other words, more than two and a half times the average rate -- are still available.
Before you commit to a bank, be sure the rate that bank is offering is among the most competitive, because it may be some years before you get to make that choice again.