With interest rates at 22-year highs, you may have heard that it’s a good idea to open a high-yield savings account or money market account (MMA). Some of the best high-yield savings and money market accounts offer interest rates above 4%. However, such a high annual percentage yield (APY) may not last very long.
The Fed recently indicated that it may begin lowering the federal funds rate in 2024, citing the decline in prices over the past year and a half. For consumers with savings accounts or MMAs, this means lower interest rates and returns.
But even if the Fed starts cutting rates this year, what if you could lock in your APY at 4% or higher? You can do that with a certificate of deposit (CD).
What about CDs?
A CD is a savings account that requires you to set aside money for a set period of time in exchange for a fixed interest rate. Savings deposits and MMAs are floating rate accounts. This means that your APY will fluctuate as the federal funds rate changes, but with a CD you can fix your APY for a specific period of time.
For example, if you invest $1,000 in a 3-year CD with a 4% APY, you’ll earn 4% on your balance every year, no matter what the interest rate is.
- After 1 year, you’ll earn $40 for a total of $1,040
- After two years, you’ll have earned $81.60, for a total of $1,081.60.
- After 3 years you will have earned $124.86 for a total of $1,124.86
The APY you earn on a CD is tied to the federal funds rate. In other words, his Fed rate hikes starting in June 2022 have increased the average interest rate on all CDs.
If you want to shop around, some of the best CDs come with very high interest rates, regardless of term. There are 1-year CDs with APYs above 5% and 3-year CDs with interest rates above 4.50%.
Here are some institutions that regularly offer great CD rates.
Additionally, CDs and stock certificates are considered savings accounts, just like savings accounts and money market accounts, so long as they are opened at a bank or credit union that is insured by the Federal Deposit Insurance Corporation (FDIC). It’s a risk-free investment. or the National Credit Union Administration (NCUA).
When should I choose a CD over a high-yield savings account or MMA?
You may be tempted to invest your money in CDs instead of savings accounts, but you only want to put your money in CDs that you don’t plan on touching until the end of the term. If you withdraw your funds before then, you will have to pay an early withdrawal penalty, which is usually equivalent to several months’ worth of interest. Because of this, CDs typically offer higher interest rates than savings accounts.
Frank Newman, director of portfolio construction and due diligence at Ally, recommends a high-yield savings account as an emergency fund to use to pay for unexpected expenses, such as car repairs.
MMA is also a great option for an emergency fund. MMAs are more liquid than CDs, and a customer can usually access cash through his ATM or debit card, check, or wire transfer.
“When you start looking at CDs, I think it’s because of all the extra money. You have to start thinking about what you need with those funds,” Newman says. “For consumers who plan to purchase a home within five years, we believe long-term CDs are the best option to obtain competitive interest rates.”
Note that there may still be limits on how often you can access your money using a savings account. Some banks may limit the number of withdrawals you can make each month, but federal regulations that set limits on that number were lifted during the pandemic, so some banks may not have a limit. there is.
However, if you don’t plan on touching your money for a few years, now may be an ideal time to lock in a CD with a high interest rate. With the Fed expecting up to three rate cuts this year, deposit rates are unlikely to continue rising.
Take out
CDs may not be the best investment option for everyone, especially those looking for a highly liquid account. But if you want to take advantage of today’s high interest rates and cash out, but don’t need the money right away, choosing a long-term CD with a slightly lower APY may be a better option than choosing a short-term CD. there is. higher rate.
“If you buy a one-year CD, you get a 4.75% APY. After a year, even if that money comes out of the CD, you might only get a significant amount. [lower rate], 3.75%,” says David Rosenstrock, CFP and director of Wharton Wealth Planning. “That’s a big reinvestment risk.”
Choosing a long-term CD will ensure you have high returns for years to come, as long as you don’t touch your money.