When the Federal Reserve adjusts its federal funds rate, it can have significant impacts across the financial sector. Rate decreases, in particular, tend to affect various aspects of consumer banking and lending.
The Fed’s rate decisions influence the cost of borrowing money, which affects interest rates on mortgages and credit cards. Similarly, yields on deposit accounts including certificates of deposit (CDs) and savings accounts tend to move in correlation with the Fed’s rate changes, as banks adjust their annual percentage yields (APYs) accordingly.
In a declining rate environment, you may be asking yourself: Is it still worth opening a CD? For the right CD, the short answer is yes, but it depends on your particular financial needs, not just a high APY.
While yields on deposit accounts such as CDs typically decline in a falling rate environment, there are often still opportunities to open CDs with competitive rates that can outpace inflation. Here’s what to look for if you’re interested in opening a CD now.
What are the benefits of opening a CD right now?
When inflation moves closer to the Federal Reserve’s target and the central bank begins decreasing interest rates, banks typically respond by decreasing APYs on various deposit products.
As such, we’re likely to see further decreases on many top-yielding deposit accounts, including high-yield savings accounts, in the coming months — and that’s where the benefit of locking in a high-yield CD right now lies.
Outpacing future rate cuts
Interest rates on checking, savings and money market accounts are variable, meaning they can change at any time. Thus, while your savings account may have earned a competitive yield when you opened the account, it may earn substantially less at a later date.
In contrast, when opening a CD, you lock in the advertised yield for the duration of the CD’s term. Thus, opening a CD right now while interest rates on deposit accounts are still relatively high will guarantee that you continue to earn a solid yield, no matter if banks keep cutting rates.
Outpacing inflation
And, of course, there’s also inflation to think about. Ideally, you want a deposit account that outpaces inflation, which bars against the eroding effect of inflation on your dollar. But you can’t guarantee your savings or money market account will continue to earn a yield that beats inflation, as banks can change their APYs at any time.
With a CD, however, you know exactly how much you’ll earn over a specific period of time. CD terms typically range from as short as three months to as long as five years, giving you the opportunity to choose an account that outpaces both inflation and future rate cuts.
What should you consider when opening a CD right now?
Sure, a high APY is a prime factor when opening a CD, but there are others to consider.
In general, these are the main components of a CD: the yield, the minimum deposit requirement, the term length and the penalty for early withdrawal. You’ll need to balance each of these factors to meet your specific needs.
The typical minimum deposit requirement for a CD is $1,000, though there are CDs that require less and others that require more. You’ll want to balance the amount you deposit and the CDs term, as you’ll need to consider how long you can park your cash in the account without needing to withdraw from it. Unless you’re opening a no-penalty CD, you’ll likely get hit with a penalty for withdrawing your money before the CD’s maturity rate.
Moreover, if your main goal is choosing a CD that will outpace inflation and future rate cuts, you’ll want to consider CDs with very high yields and terms of one year or greater. CDs with shorter terms won’t give you as much bang for your buck right now, unless you’re interested in setting up a CD ladder, which means you’ll be opening several CDs with different maturity dates.
“The ability to lock in a multi-year CD at a yield that should handily outpace inflation is particularly attractive to retirees looking to generate income, for specific cash needs in the future, or as a way to diversify an overall portfolio,” said Greg McBride, CFA, Bankrate’s Chief Financial Analyst. “But you have to be able to live without that money for the term of the CD.”
The bottom line
Annual percentage yields for deposit accounts, including CDs, typically decline following Federal Reserve rate decreases. In a declining rate environment, locking in a high-yield CD can help insulate you from falling rates.
Choosing a CD with a term of one year or greater will be particularly helpful in achieving this goal. And if you’ve got enough cash to set up a CD ladder, now may be your best bet.
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