CD Rates and the Art of Appreciating Small Numbers
February 12, 2010
| MoneyRates.com Senior Financial Analyst, CFA
In some of the harsher climates of the earth, there are plants that can draw all the moisture they need out of the air because it rarely rains and animals that can live for months without food, because opportunities to feed are scarce. Life adapts. Compared to those feats, it should be relatively simple to start adapting to low bank rates.
That doesn't mean you have to like it, but with the economy suddenly appearing very shaky again, everyone had better get used to low interest rates on CDs, savings accounts, and other deposit vehicles. Adapting means taking advantage of what might normally seem like insignificant differences in rates, because it's now necessary to make the most of anything the market will give.
Where CD Rates Offer the Best Value
CD rates offer an example of how to look for small advantages. Like all bank rates, CD rates are low across the board, ranging from a national average of 0.24% for a 1-month CD to 2.13% for a 5-year CD, according to the Federal Deposit Insurance Corporation (FDIC). With that being the case, is it wise to take the risk of locking in your money for 5 years to get a higher rate?
Not necessarily. Comparing CD rates with the bond market, it seems that 5-year CDs are not offering enough interest to compensate you for locking up your money that long. You see, for most terms (1 month, 1 year, and so on) CDs offer a slightly higher rate than bond yields for Treasuries of the same terms. This is understandable, as Treasury bonds are more liquid and are also considered the world's safest securities. However, 5-year CD rates don't hold up as well in comparison with Treasury bonds.
To illustrate, let's compare investments of 5-year terms and 1-month terms. One-month CD rates are 22 basis points (0.22%) higher than the interest rate on 1-month Treasury bills, according to the Federal Deposit Insurance Corporation (FDIC). The advantage of CD rates over Treasuries starts to grow as you move into longer maturities--33 basis points at 3 months, 44 basis points at 6 months, and 56 basis points at 1 year. But that's the peak. With longer maturity horizons, the advantage of CD rates over Treasury yields starts to fall off, with 45 basis points at 2 years and 22 basis points at 3 years.
While interest rates on CDs are not a mirror image of Treasury bond rates, they should generally reflect the same interest rate trends. For the most part they do: both sets of rates are low overall, and both feature higher rates as you move out to longer maturities. The difference is that while CD rates are generally higher than the corresponding Treasury rates, 5-year CD rates are 25 basis points lower, suggesting that 5-year CD rates are disproportionately low. This would make them a bad deal for depositors. The sweet spot would seem to be at 1-year CDs, where the spread over the corresponding Treasury bond is highest.
Other Tips for Dealing with Low CD Rates
Additional ways of adapting to a low CD rate environment include shopping for rates on Money-Rates.com, where the average rates exceed the national averages reported by the FDIC and some clearly better deals can be found. Also, if you have the resources, consider a jumbo CD--most banks will pay more for larger deposits.
Again, nothing says you have to like this low bank rate environment. But like plants and animals who want to survive in any climate, it's important to start to appreciate even small differences in rates, because right now that's the only way to gain an advantage.
