The Federal Reserve's decision this week to raise short-term interest rates should mean higher interest rates for retirees and others who invest in certificates of deposit, or CDs. Some CD yields are already closing in on 3% following the Fed's latest rate hike.
Does this mean you should buy CDs for your retirement? Experts say the answer is something of a draw:
CDs typically earn higher annual percentage yields than traditional savings accounts, plus they often don't charge monthly fees and are usually insured by the Federal Deposit Insurance Corp. (assuming you get a CD from an FDIC-insured bank). All of that means that your deposit can grow quickly when compared to some basic savings accounts -- and rates are on the rise. "They've been increasing slowly over the past year," TheStreet's Bob Powell said.
The longer the term length, the higher the interest rate you typically earn. For example, the Synchrony Financial (SYF) three-month CD pays just a 0.75% annual percentage yield, but the bank's five-year CD pays 2.5% (more than three times as much).
According to consumer-rate site NerdWallet, the highest-yielding CDs are currently from the following:
- Barclays Plc (BCS) and Capital One Financial Corp. (COF) . Both have no minimum required deposit and pay a 2.05% APY for a one-year CD and a 2.65% rate for a five-year CD.
- Action Alerts Plus holding Goldman Sachs Group Inc. (GS) comes in a close second with a 2.6% APY on a five-year CD and 2.05% APY for the one-year version.
But because rate increases in CDs often lag rate increases from the Fed by a considerable amount of time, it's best to invest in short-term CDs when rates are rising and long-term CDs when rates are falling, Powell said. If the Fed just raised interest rates, it wouldn't be particularly wise to invest in a long-term CD, as you would miss out on the rate increase that would likely follow the Fed hike.
With a CD, you can't touch your money without paying a fee until the previously agreed upon maturity, typically between three months and five years. That means it's not the kind of rainy-day fund that your savings account might be.
And even at their highest historic interest rates, CDs typically don't outpace inflation by all that much. If you invest in a one-year CD with a 2.1% interest rate when inflation is running at 2.1% that year, your real return will be zero. Powell said that even when CD interest rates were sky-high -- rising to as much as 12% during President Jimmy Carter's 1977-81 administration -- they still didn't outpace U.S. inflation.
It's also worth considering the pace at which CD interest rates rise. While the rates have been rising over the past year, they remain well behind the pace of the Fed's actions. Fed Chairman Jerome Powell admitted as much in congressional testimony last month, saying: "Retail deposits, as you know, are sticky on the way up. They generally come up with a lag."
That lag has done more to cushion bank profits than it has to benefit those saving for retirement. According to the FDIC, net interest margins, or the difference between investment returns and interest expenses relative to the average amount of interest-earnings assets, reached a five-year high during 2017's fourth quarter. More than 70% of banks also reported higher net interest margins for the quarter than they did for a year earlier.
TheStreet's Bob Powell said that CDs can be a good place for investors to "keep their powder dry," but recommends Series I U.S. savings bonds for those hoping to keep a better lead on inflation. Series I bonds are U.S. government savings bonds that earn interest based on a combination of both a fixed rate and the inflation rate.
"They're a great way to earn current income but keep pace with inflation," Powell said.