5 things to know about CDs now
November 23, 2011
There are some rules that always apply to choosing a CD, such as matching its maturity date with your cash flow needs and applying laddering principles to reduce interest rate risk. These are as valid now as ever, but they need to be balanced against some guidelines that are specific to the current environment.
Here are five things you should consider when evaluating your CDs now:
1. The Fed's commitment to low interest rates
Following the meeting of the Federal Open Market Committee (FOMC) this past August, the Federal Reserve issued a statement saying it expects to continue its low interest rate polices through at least mid-2013. The length of this commitment seemed extraordinary, if not unprecedented, simply because it's virtually impossible to anticipate what economic conditions will occur over a two-year period. Still, this commitment is one argument for extending CD maturities to at least mid-2013, because if the Fed has anything to do with it, interest rates won't be rising before then.
2. Operation Twist
On September 21, the Fed announced Operation Twist, which is basically an exchange of short-term Treasuries for longer-term ones. This will take place in stages lasting through the middle of 2012, and the goal is to narrow the spread between short and long-term interest rates. As a result, long-term CD rates may become increasingly less attractive during this time.
3. Inflation
In its recent announcements, the Fed has consistently expressed confidence that inflation pressures are easing. Meanwhile, over the past year, the annual inflation rate has risen from 1.1 percent to 3.9 percent. In general, a period of rising inflation is a good time to keep CD commitments short. So decisions on long-term CDs may come down to whether you believe the Fed, or the inflation numbers the Bureau of Labor Statistics reports.
If, like the Fed, you think inflation is not a problem, then you should feel more comfortable with a longer-term CD commitment. On the other hand, if the accelerating rise in prices over the past year makes you nervous, you might want to keep your commitments short.
4. Deposit size
There are times when making a larger deposit will help you get better CD rates, but this isn't one of them. CD rate premiums for jumbo deposits (those over $100,000) range from one to three basis points on average. So this is no time to go out of your way to maximize your CD deposits.
5. Opportunity
When conditions are generally unfavorable, the importance of being opportunistic is magnified. Shopping for the best interest rates on CDs can really make a difference, so watch for banks that are trying to attract attention with limited-time-only rate specials. When it comes to savings accounts and money market accounts, on which rates can change at any time, these specials can be more trouble than they are worth, but if you can lock in a special rate with a CD, you can gain an ongoing advantage.
With CD rates trailing the rate of inflation, any choice you make can feel like a losing decision in this environment. However, successful investors know that minimizing your losses can sometimes be just as important as maximizing your gains.
