The best options for CDs when interest rates are low
July 07, 2011
You may not be seriously considering investing in a certificate of deposit this year. Even the best CD rates are at a historic low these days, and some aren't any better than the interest rates being paid for an online savings account.
To make matters worse for those searching for the best CD rates, the pace of inflation in some cases is higher than the rate for CDs. According to Forbes, for instance, as recently as April the best CD rates were five-year certificates of deposit paying 2.40 percent. At the time, the inflation rate was 3.16 percent, which means your money would lose value sitting in investments like that.
When even the best CD rates get better
But interest rates won't always be this low. According to the Wall Street Journal, many economists feel the Federal Reserve will start raising interest rates as soon as early next year, and once the Fed turns that corner, it often continues on that course for a while. For two years starting in June 2004, the Fed raised its target interest rate 17 consecutive times.
That means investments like money market funds--mutual funds that specialize in relatively safe, short-term investments--will start to look much more appealing. So will money market accounts and savings accounts; although interest rates for those products are averaging 0.17 percent, the Journal said, rising interest rates could put banks into a competition that prompts them to offer higher money market rates and better savings accounts.
The best rates for CDs are not as responsive. Although the interest rate for CDs will undoubtedly go up if the Fed raises its target interest rates, those rates could start to climb while you're stuck in a low-interest CD.
Other options for CDs
There are ways to profit from CDs when the interest rates are going up. Here are some products that might appeal to you:
- Unpenalized withdrawal CDs. Although most CDs will charge you for withdrawing your money before the term is up, some don't - and these are perfect for when there is an interest rate jump and you want to make some money off of it.
- Step-up CDs. These come with built-in interest rate increases that come up at specific intervals.
- Bump-up CDs. These allow investors the opportunity to request one interest rate increase to prevailing rates. The key is knowing when that interest rate has peaked.
There are some other options, too. One is to "ladder" your CDs, which means you invest in a number of different CDs and stagger the terms at which they will mature. That way you will always have some money come free--and available to re-invest at a higher interest rate.
Before buying any certificate of deposit, make sure you understand how long your money will be tied up and what that ramifications are if you need to withdraw early.