For the kitchen table investor with a little money, now may be the perfect time to consider investing in a certificate of deposit.
CD rates are as high as they have been in years. The best one-year CDs offer 5.66% annual interest, according to a January survey by personal finance website WalletHub. The best six-month CDs yield up to 5.75%.
“CDs are definitely getting more attention these days,” said Chris Starr, head of consumer and corporate deposits at Wells Fargo Bank.
CDs scare some investors. In a 2023 Forbes Advisor poll, 41% of Americans said they had never opened an office. Some participants said applying for a CD was “too complicated and time-consuming,” while others did not want to lose access to their money.
Certificates of Deposit may be unfamiliar to many, but bank officials say the application process is actually not particularly complicated or time-consuming.
Learn more: Best current CD prices
“Opening a CD is simple and can be done from your phone or computer in a matter of minutes,” Starr said.
How to make a certificate of deposit
When you open a CD, you agree to hand over your money to the bank for a specific period of time. In return, the bank generally offers you a higher interest rate than you would get in a regular checking or savings account.
The longer the term of the CD, as a general rule, the higher the interest rate. However, over the past two years, the rules have gone out the window. A campaign of aggressive interest rate increases by the Federal Reserve has resulted in interest rates rising significantly in 2022 and 2023.
Market forecasters expect interest rates to fall in 2024 and beyond. As a result, and somewhat counterintuitively, interest rates are now generally higher on short-term CDs than on long-term CDs.
In the WalletHub survey, the best five-year CD offers 4.75% interest. Investors can get higher prices on CDs with terms ranging from three months to a year.
“We’re in unusual circumstances right now where shorter-term CD returns are higher than longer-term returns,” said Greg McBride, chief financial analyst at Bankrate. “The expectation is that interest rates will fall over the coming years.”
With interest rates at 5% or higher, the best CDs are able to compete with the best high-yield savings accounts and with bonds, experts say.
To open a CD, you must be willing to part with your money
But CDs aren’t for everyone.
To open a CD, you must be able and willing to part with your money for the life of the investment. You can withdraw money early, but then face penalties that can drain the interest and even some of the principal.
“You should be able to live without money for the duration of the CD,” McBride said.
A CD wouldn’t be a good idea for anyone who lacks a fully funded emergency savings account, McBride said. Half of American adults don’t have enough savings to cover three months of living expenses, according to a recent report from Bankrate.
For investors who can afford to keep some of their savings in a CD, the rewards are clear: “Guaranteed profits,” said James Morgan, vice president of savings and deposits at Capital One.
The certificate pays interest at a fixed rate for its full term. The same cannot be said for a typical high-yield savings account or money market account, whose interest rate generally fluctuates with the market.
CDs come in several lengths: three months, six, nine, 10, one year or longer.
“People who are considering getting a CD should shop around and consider a range of options,” Morgan said.
Let’s say you want to set aside some money to buy gifts for the 2024 holiday season. A one-year CD won’t work, because you won’t get your money back until 2025. But a nine- or 10-month CD might be perfectly timed.
“It comes down to knowing your savings and cash needs,” said Frank Newman, director of portfolio construction and due diligence at Ally Financial.
As of early January, Ally offered rates between 5% and 5.25% for CDs with terms ranging from six to 12 months.
Not every bank offers rates that high. The average one-year CD rate was about 2% in late 2023, according to Bankrate.
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Shorter-term CDs pay better interest, but investors should also consider longer terms
Today’s prices make short-term CDs look attractive, but experts say investors should also consider longer terms.
Banks set interest rates on loans based on their best estimates of what will happen to interest rates in the coming months and years. Interest rates are now lower for longer periods because forecasters expect that overall interest rates will eventually decline.
“Some people might look at a two-year and three-year CD and pause: ‘That’s a lower rate than a one-year CD or a six-month CD.’” “What a scam,” said Odysseas Papadimitriou, founder and CEO of WalletHub. “Well, there’s no scam here. “The market expects interest rates to fall.”
Banks “know better than us if and when interest rates will fall,” Papadimitriou said.
So, if a bank offers you a slightly lower rate on a five-year CD than on a one-year CD, “that doesn’t mean you’re getting a worse deal,” he said. “You’re getting a fair deal, based on what the market expects.”
Daniel DeVacy covers personal finance for USA TODAY.