The Rising Appeal of CDs 💿 in Today's Economy

🛑*Disclaimer: This post is for educational purposes only. I am not a certified financial planner, please do your due diligence or consult with a professional before making financial decisions.*🛑

When I first started coaching, CDs (Certificate of Deposits) were averaging a mere 1%. The market was booming then, so it really didn't feel like a great investment. Even though CDs are extremely low risk, they are an investment, and you can lose money if you pull out early. But right now, CDs seem more appealing as the market is very different than in 2018, and with interest rates going down, you might be interested to learn more about some longer-term CD options.

The Basics of CDs

Think of a CD as a financial agreement where you commit your money to the bank for a fixed period. In return, the bank pays you interest at a predetermined rate until the end of that term. When the time's up, you get back your initial investment plus the interest earned, provided the funds remain untouched until the end of the term.

Example: Let's say you deposit $10,000 to a 12 month 5.25% CD. A CD insures you will make $525. 

Interest Rate Dynamics

Breaking it down simply: When interest rates drop, it becomes cheaper and more appealing to take out loans for big purchases, like buying a house. However, at the same time, the amount of money you earn from saving—in things like CDs—also goes down. So, while you might celebrate the lower cost to borrow money for a new home, the flip side is that the cash you've saved up isn't growing as much as it could have when interest rates were higher. It's a balance between the excitement of easier-to-afford loans and the less thrilling returns on your savings.

High Yield Savings Accounts (HYSAs) / Money Market Accounts vs. CDs

Comparatively, HYSAs and Money Market Accounts offer greater access to your funds, albeit with fluctuating interest rates. CDs, meanwhile, lock in a rate for the term's duration but penalize early withdrawals. This trade-off between yield and liquidity is crucial in crafting a savings strategy that mirrors your financial goals and timeline.

According to Richard Sebastian, CFP® of CIC, "Purchasing a CD is making a bet that interest rates are going to be lower during the CD period." 

Who Benefits from CDs?

The person who benefits the most is someone who has a significant cash reserve and doesn't need access to a portion of it for the given period of the CD.

Other examples include:

• Individuals with a clear short-to-medium-term financial plan.
• Those with additional savings beyond their emergency fund.
• Anyone looking to diversify their savings strategy with a fixed-rate return.
• Someone who is extremely risk-averse and wants a safe way to manage their finances.

Who isn't a great fit for a CD?

CDs aren't a one-size-fits-all solution. If you're on the brink of major life changes like moving or expanding your family, locking away cash in a CD might not be ideal. For those without a safety net of cash for emergencies, CDs could complicate your financial stability due to early withdrawal penalties. Also, if you plan to use your savings for significant purchases, like a home or car within the next few months, the inflexibility of a CD might not suit your needs.

Understanding Tax and penality Implications

It's worth noting that the interest earned on CDs is taxable income. This tax liability can influence the overall attractiveness of CDs as an investment option, depending on your personal tax situation.

When you cash out a CD before its maturity date, you're hit with an early withdrawal penalty. This cost varies by bank and CD term length but generally equates to several months' worth of interest. For instance, if you dip into a 1-year CD early, you might lose out on 3-6 months of interest you would have earned. It's a safeguard banks use to ensure the funds stay put for the agreed period, making CDs less flexible for immediate or emergency needs.

Embracing CD Laddering

For those seeking both stability and some degree of liquidity, CD laddering is a strategy worth exploring. It involves staggering the maturity dates of multiple CDs to ensure regular access to part of your investment. I happen to have written an entire blog post about CD laddering. 

Final Thoughts

As the financial world evolves, so too do the strategies for preserving and growing our savings. CDs, with their fixed returns and relative safety, are reemerging as a valuable component of a diversified savings plan. Whether CDs are right for you depends on your unique financial landscape and your appetite for risk versus reward.

By considering the broader implications of interest rate changes and tax liabilities and comparing CDs with other savings options, you're better equipped to make informed decisions that align with your financial goals! 

Best CD Rates I've seen

Andrew's Federal Credit Union 6 months 5.75% 

Western Alliant Bank 3 months 5.41% - through Rasin. BTG does have an affiliate relationship with Raisin.