The Survey of Consumer Finances released last month by the Federal Reserve shows that the popularity of certificates of deposit (CDs) has dwindled in recent years. That is somewhat understandable given the low-interest-rate environment, but is it a mistake for savers to turn their backs entirely on CDs?
Given today's rate environment, the yield advantage CDs offer may still give bank customers a vital edge. Here are six things you should know about today's CD rates, in order to take advantage of every opportunity to earn a little extra interest:
1. Today's CD rates reflect a bleak outlook
The average rate on a five-year CD is below 1 percent now. This means that banks are saying that interest rates are likely to stay low for the next few years. Before you buy into that, consider that employment is improving and the Federal Reserve's policy is in transition. So, only commit to a longer-term CD if that CD offers a combination of a well-above average interest rate and a mild penalty for early withdrawal.
2. Five-year yields still offer a little extra
According to national averages for CD rates published by the FDIC, you typically get a 0.20 percent rate for committing to a one-year CD. You can get an extra 0.14 percent for committing to a two-year CD, then an additional 13 basis points for each of the next two years in length (three and four years).
However, if you stretch your CD term from four to five years, you get an additional 18 basis points on average. In other words, as uninspiring as five-year CD rates may seem, there is a better-than-average reward for stretching out to that extra year. In contrast, you do not get much extra yield in the two- to four-year range.
3. Relative rate gaps remain wide
Remember that choosing a CD is not just a case of locking into a rate -- it also means locking into a bank. CD rates may be low today, but the relative rate differences between institutions can still be wide. While the average five-year CD rate is 0.78 percent, rates of 2 percent or more -- in other words, more than two and a half times the average rate -- are still available.
Before you commit to a bank, be sure the rate that bank is offering is among the most competitive, because it may be some years before you get to make that choice again.
4. Low yields take some of the sting out of penalties
Perhaps the only silver lining about low CD rates is that penalties for early withdrawals usually consist of a few months' worth of interest. So low yields also mean low penalties, which takes some of the risk out of committing to a longer CD in this environment.
5. Automatic renewals can be a costly convenience
Banks very kindly offer to have CDs roll over automatically at the prevailing interest rate when they expire. That's a kindness that can cost you -- particularly if your bank is offering rates at the lower end of today's spectrum when your CD rolls over.
Never roll a CD over without shopping around to make sure the rate you are locking into is competitive.
6. Size is not being rewarded
Banks today are offering very little extra yield for jumbo deposits (those in excess of $100,000). So, since there is no real reward for consolidating your deposits, you can instead spread them out more to take advantage of strategies such as CD laddering.
Banks are having no trouble attracting deposits, but it seems fewer customers are choosing to put those deposits in CDs. However, if more customers used CDs to their advantage, there might be a little less suffering in today's low rate environment.