Certificates of deposit have been in the doghouse for years, with rock-bottom yields leaving investors cold.
But now things are changing. Government insurance for CDs looks more appealing as stock and bond markets get shakier and yields on the most generous CDs are competing with those of U.S. Treasurys. Many experts say CDs can be a good choice for investors aiming to avoid risk, earn some interest and have ready access to principal.
"CDs are becoming very popular among investors because of high-interest yields in comparison with Treasury notes of the same maturity," says Edith Muthoni, chief editor at LearnBonds, a bond-information website.
The chief benefit of a CD is protection of principal and interest earnings through federal deposit insurance, which protects holdings of up to $250,000 per category, such as CDs, per depositor at each bank.
"CDs have a reputation for being boring and predictable -- that's why some investors are so interested in them," says Michael Gerstman, CEO of the Dallas-based retirement planning firm Gerstman Financial Group. "If you are someone who is looking for safety, with better interest than a savings account ... then you might consider a CD. Also, the returns are fixed so you know what to expect each year."
For many investors, low yields on bank savings have been worth living with for protection against loss. But now the trade-off isn't so bad. Top-paying one-year CDs yield 2.7% to 2.8%, compared to about 2.3% for a one-year Treasury. But a Treasury can lose value if interest rates rise and make older, stingier bonds less attractive, while a CD holds its value through maturity no matter what interest rates do.
If interest rates are likely to fall, prices of older, higher-paying bonds will rise, giving the bond investor a capital gain on top of interest earnings, while a CD rate, or value, stays constant. But bond gains don't seem very likely today, as rates have more room to move up than down, and experts note it's very hard to predict interest rate moves, anyway.
Aaron H. Parrish, president of Level Wealth Management in Greensboro, North Carolina, suggests investors not count on bond price gains from falling rates but instead assume the yield they get when they buy a bond will be the total return they enjoy.
"Trying to predict the future movement of interest rates is a fruitless exercise," Parrish says. "For example, a little over 6 months ago the 10-year Treasury rate was over 3% with expectations that it would continue climbing in 2019. Fast forward to today and it has done the exact opposite."
Investors can therefore simply compare CD rates with bond yields, knowing that while bond prices will fall if rates rise, CDs will hold their value.
The ideal CD investor is someone expecting to need cash in the not-too-distant future, says Erik Skjodt, CEO of Medean, a personal finance service. "If you have $5,000 to $10,000 sitting in savings and are looking to buy a home in a year, it would be a great idea to buy a 1-year CD as you won't be tempted to touch the money due to the costs associated with withdrawing early."
Experts say investors should keep these things in mind:
-- Check choices online.
-- Read the fine print.
-- Build a ladder.
Check Choices Online
It used to make sense to do business with a local bank offering personal service. For routine matters like checking, it can still pay to choose a bank that offers conveniences like lots of ATMs. But since CDs do not involve day-to-day transactions, experts recommend looking for the best deal, which may be from an online bank that passes on savings from not having brick-and-mortar branches. Purchases can be by electronic transfer from your regular bank and funds from maturing CDs can be returned the same way. Search for "best CD rates."
"In my opinion, there is no benefit in favoring a local bank over an internet bank," says Mark Andraos, associate portfolio manager at Regency Wealth Management in Ramsey, New Jersey, noting the higher yield often found with internet banks. Services like maxmyinterest.com can help investors spread CD holdings among various banks, he says.
Read the Fine Print
As with any financial transaction, it pays to know how things work. How often is interest credited to the account, and what is the early withdrawal penalty? For a typical CD, it is the loss of three to 12 months of interest earnings, often with a minimum such as $25.
Treasury bonds can be sold at any time with no penalty, but that edge may be more than offset by the higher yield on a CD, even after a penalty is paid.
Also be aware that some products that look like CDs do not have FDIC insurance. They may in fact be mutual funds, annuities or life insurance products.
"You should also be aware of any call provisions where you might receive your (principal back) quicker than expected and potentially not receive the assumed rate of return," Parrish says.
Build a CD Ladder
A CD ladder means spreading your cash among bonds or CDs of varying maturities. Short-term ones will pay less but give you access to cash sooner, while longer maturities will keep your money tied up but pay more. Of course, if the early withdrawal penalty is small, it might make sense to favor the more generous longer-term CDs.
A CD ladder protects the CD owner if interest rates go up, because principal from the maturing short-term CDs can be reinvested in longer-term CDs with higher yields.
"As each CD matures, you reinvest the proceeds with a new later maturity from your prior, longest-maturity CD," Gerstman says. "This gives you the benefit of being able to stagger the availability of cash, and if interest rates are on the upswing, you are going 'up the ladder.'"