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- For a long-term CD to be worthwhile, it must fit your financial goals and your risk tolerance.
- A CD ladder allows you to take advantage of interest rates on long-term and short-term CDs.
- People who are willing to take higher risks are unlikely to find the interest rates on long-term CDs attractive enough.
The best CD rates for three- to five-year terms are above 4% APY, but you won’t see those for much longer.
The interest rate environment for CDs is changing. The Fed is expected to cut rates soon, possibly at the next meeting in September.
“As interest rates generally decline, we will see banks become less competitive when it comes to holding cash,” explains Lauren Williams, CFP® professional and co-founder of ProsperPlan Wealth.
Short-term CDs still have a long way to go, with top rates still hovering around 5% APY, but long-term CDs have less room for competitive rates. This begs the question: Is it worth opening a long-term CD now, or are there better options?
Should I lock in interest on longer-term CDs now?
Locking in a long-term CD rate could be a good option if it fits your financial goals and you want to keep your money in a low-risk place.
For example, Williams says a long-term CD might be appropriate for a more conservative investor who cannot bear to participate in the general stock market.
CDs like the 3-year from Lafayette Federal Credit Union (4.52% APY), the 3-year equity CD from Department of Commerce Federal Credit Union (4.50% APY), and the 5-year CD from First Internet Bank of Indiana (4.35% APY) still offer good interest on cash.
However, for people willing to take more risk, the interest rates on long-term CDs may not be as attractive as other options.
“If you don’t need the money for more than three years, you’ll probably want to look for something that has a better long-term growth rate,” Williams adds.
Although interest on CDs is fixed and guaranteed until the account matures, it may not be worth tying up your money for an extended period of time.
“We are still in an environment where short-term interest rates are higher than long-term interest rates. The reason for this is that banks do not want to commit to paying fixed interest rates beyond a certain period of time,” says Marguerita Cheng, CFP® expert and CEO at Blue Ocean Global Wealth.
One solution that allows you to benefit from both short-term and long-term CD rates is to build a CD ladder that includes high-yielding, shorter-term CDs such as USALLIANCE FINANCIAL’s 1-year online CD (5.20% APY), Sterling Federal Bank’s 3-month CD (5.10% APY), or Freedom Bank’s 6-month CD powered by Raisin (5.00% APY).
“The advantage of the CD ladder is that your money matures regularly and you minimize interest rate risk,” says Cheng.
However, CD ladders require maintenance. You need to keep track of the various maturity dates to avoid early withdrawal penalties and reevaluate each CD renewal to see if it’s the best option for you. If you don’t want to commit to maintaining a CD ladder, there are alternatives to long-term CDs.
Alternatives to long-term CDs
If you’re looking for a low-risk account, Treasury bills or T-bills are an alternative to CDs. Williams says she typically prefers T-bills over CDs because they have more favorable income tax rates.
CD earnings are taxed as ordinary income, so your tax rate depends on your tax bracket. In comparison, you pay federal taxes on the interest from a Treasury bill, but no state taxes, which may be more advantageous.
One thing to keep in mind is that Treasury bills are not protected by FDIC insurance like CDs are. With a CD, you know your account balance is federally insured up to $250,000 in individual accounts and up to $500,000 in joint accounts. However, Treasury bills are backed by the full bona fides of the U.S. government, so overall they are still low-risk and safe.
You can also consider other types of fixed income investments, but you will need to evaluate your risk tolerance to decide if another type of investment is worthwhile.
If quick access to your money is more important to you, a high-interest savings account may be another option.
“There’s nothing wrong with playing it safe. If you think you need a little extra cash, it’s true that it may not earn as much in a high-yield savings account, but remember that you can get your money in a high-yield savings account,” Cheng says.
Although they have a variable interest rate, high-yield savings accounts allow you to deposit and withdraw money at any time. Moreover, the best interest rates on high-yield savings accounts are still around 5% per annum
How to choose the best option in a falling interest rate environment
With interest rates falling, it’s important to review your overall financial strategy and consider individual financial goals. Having a concrete idea of when you’ll need money to reach a specific goal will also help you better assess your risk tolerance.
For example, if you plan to buy a home soon, Cheng says it’s important to avoid market or investment risks.
“Maybe the Fed will start cutting rates. They have indicated that they are seeing an improvement in inflation. They are meeting in September. We have no idea whether they will cut rates by 25 or 50 basis points,” Cheng says.
To narrow down the selection of safe investment options, you can compare opening requirements, interest earning potential, fees and account accessibility.
Overall, a changing interest rate environment offers you the opportunity to review your money and decide whether it could be better invested.
Frequently asked questions about long-term CDs
A long-term CD is a bank account that allows you to lock in a fixed interest rate for several years. Many banks offer long-term CDs with terms of two, three, and five years. In some places, you can also find terms of up to 10 years.
A long-term CD might be worth it if it fits your overall financial strategy and you want to earn guaranteed interest for a specific purpose. A long-term CD can also be a good option for anyone who prefers to keep their money in a low-risk account. It might not be worth it if you need an account with more liquidity or want to earn higher returns.
The biggest disadvantage of long-term CDs is that you must leave the money in your account until maturity. You also cannot make additional deposits unless you have opened a supplemental CD.
