If you’re considering a fixed-rate CD, you could lose out by locking your money into any term longer than 18 to 24 months, according to certified financial planner Cory Moore, founder of Moore Financial Planning.
That’s because choosing a long CD term today — as interest rates are on the rise — could hinder your future spending power due to inflation.
“There wasn’t as much of an inflation risk with longer [CD] terms back when rates were lower,” says Moore. But with inflation around 8.5%, according to the latest data from July, even the highest CD yields available today can’t compete. “Given where inflation is [now], CDs haven’t caught up that much.”
Here’s more about how to choose a CD term as rates climb, and other savings options with competitive rates worth considering:
Why to Avoid Long-Term CDs For Now
The Federal Reserve has raised its target federal funds rate four times this year and experts we’ve spoken to predict that more rate hikes will come. CD rates and other bank account APYs are closely tied to the federal funds rate, and have similarly risen over the past several months.
As a result, today’s top 3- and 5-year CD rates are above 3% APY, up from pandemic-era lows below even 1% APY.
But because inflation is so high right now, Moore says you should factor for inflation, too, when comparing CD rates and terms right now.
What’s more, any future rate hikes are designed to offset that runaway inflation rate, meaning inflation should go down as interest rates go up. So the difference may be much more favorable in coming months.
For instance, some banks were offering five-year CDs with a 2.55% in June. If you locked in this rate with $1,000 for a five-year CD and interest compounds daily, your CD would be worth $1,135.98 when it matures. But now, banks are offering upwards of 3.65% for the same term. If you waited and opened a CD today instead with the same deposit, you’d have $1,194.22 upon maturity — a difference of $58.
With rates expected to keep rising, the same may be true a few months from now, too.
Alternatives to Long-Term CDs
Instead of locking money into a CD for multiple years, Moore recommends shorter-term CDs, which can offer more flexibility to take advantage of rising rates.
If you already have a CD or CD ladder, it may be worthwhile to continue incorporating CDs — especially those under the 18- to 24-month threshold — into your savings strategy, says Moore. As those existing CDs mature, you can roll them over one-by-one into continually higher-earning CDs as rates rise. Then, when rates start to level off or lower, you may consider other savings options that will yield a higher return.
Another alternative is an account with a variable APY, like a high yield savings account or money market account. They offer more flexibility compared to CDs since there aren’t as many restrictions on withdrawals or transfers. Plus, the variable APY means your interest rate will keep going up even after opening. However, at around 2% APY, they do have slightly lower interest rates — CD rates start to overcome savings and money market accounts when you look at terms higher than about six months, according to Moore.
Before locking in a CD term and interest rate in today’s rising rate environment, think about the goal you have for the money in your CD or CD ladder. Also don’t forget to compare the different types of savings options available, to get the best combination of rate, liquidity, and term that works for you.
If you already have a CD, be sure to take time to reassess your goals and the most competitive rate options when it reaches maturity, depending on how interest rates have moved by the end of the term.
CDs can be useful savings tools, even as rates rise, but you’ll get the best value by doing some due diligence before opening any new account to ensure it’ll best help you meet your financial goals.