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How To Invest In CDs In A Rising Rate Environment

By newadmin / Published on Wednesday, 31 Jan 2018 23:24 PM / No Comments / 18 views


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Photographer: Andrew Harrer/Bloomberg

Today, the Federal Reserve&nbsp;left its benchmark rate unchanged. Despite today’s lack of action, investors are expecting at least two further rate increases this year. With higher rates expected,&nbsp;should you really lock in a CD rate today? Or should you wait until after the expected rate increases to decide?&nbsp;Before putting your money to work, here are three important considerations:

  1. If your money is in a traditional (not an internet-only) bank, you are almost certainly getting a horrible return on your money. Whether it is a savings account, money market account or CD, traditional banks are paying ridiculously low interest rates that seem immune to the rising rate environment.&nbsp;If you search online for the best savings account at sites likes&nbsp;MagnifyMoney (where I work) or NerdWallet, you will easily find rates as high as 1.50% APY. If you go to your local branch, you will likely find rates as low as 0.01% – 0.03% APY.
  2. Short term rates (1-year CDs and online savings accounts) are rising faster than long term rates. If you do invest in a CD, you are probably not getting paid enough to lock up your money for a longer&nbsp;term.
  3. If you don’t want to time the market or spend too much time thinking about a strategy, a CD ladder is always a good option to diversify by CD term.

I will explain each point in more detail below.

1. Internet-Only Banks Pay Higher Interest Rates

Because internet-only banks do not have branches, they are able to pay significantly higher interest rates.&nbsp;Some of the biggest players include Ally Bank (which uses the deposits to fund its auto lending business), Synchrony (which uses the deposits to fund its store card portfolio) and Goldman Sachs (which is using its deposits to fund its rapidly growing online consumer lender). As of publication date, it is easy to get a 1.50% APY with an online savings account.

A 58-month CD at Wells Fargo (and other big banks offer similar rates) pays 1.15% APY. You would need to lock up your money for 58 months (in a rising rate environment) to get a rate that is still 35 bps lower than an online savings account (where you can take out your money at any time). A CD at a traditional bank does not make financial sense.

2. Short-Term Rates Are Rising Faster Than Long-Term Rates

Online, you can find a 2.5% APY with a 5-year CD. However, you can also find a 12-month CD for 2.00% at Synchrony. The intense price competition for immediate access savings accounts and 12-month CDs has narrowed the difference between long and short term money. Given that the federal reserve is expected to raise rates 50 bps over the next 12 months, it might not make sense to lock your money up for five years, given the current rates. You can get a lot of yield with a short duration while you wait for rates to rise.

3. CD Ladders: An Easy Way To Diversify By Tenor

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Photographer: Andrew Harrer/Bloomberg

Today, the Federal Reserve left its benchmark rate unchanged. Despite today’s lack of action, investors are expecting at least two further rate increases this year. With higher rates expected, should you really lock in a CD rate today? Or should you wait until after the expected rate increases to decide? Before putting your money to work, here are three important considerations:

  1. If your money is in a traditional (not an internet-only) bank, you are almost certainly getting a horrible return on your money. Whether it is a savings account, money market account or CD, traditional banks are paying ridiculously low interest rates that seem immune to the rising rate environment. If you search online for the best savings account at sites likes MagnifyMoney (where I work) or NerdWallet, you will easily find rates as high as 1.50% APY. If you go to your local branch, you will likely find rates as low as 0.01% – 0.03% APY.
  2. Short term rates (1-year CDs and online savings accounts) are rising faster than long term rates. If you do invest in a CD, you are probably not getting paid enough to lock up your money for a longer term.
  3. If you don’t want to time the market or spend too much time thinking about a strategy, a CD ladder is always a good option to diversify by CD term.

I will explain each point in more detail below.

1. Internet-Only Banks Pay Higher Interest Rates

Because internet-only banks do not have branches, they are able to pay significantly higher interest rates. Some of the biggest players include Ally Bank (which uses the deposits to fund its auto lending business), Synchrony (which uses the deposits to fund its store card portfolio) and Goldman Sachs (which is using its deposits to fund its rapidly growing online consumer lender). As of publication date, it is easy to get a 1.50% APY with an online savings account.

A 58-month CD at Wells Fargo (and other big banks offer similar rates) pays 1.15% APY. You would need to lock up your money for 58 months (in a rising rate environment) to get a rate that is still 35 bps lower than an online savings account (where you can take out your money at any time). A CD at a traditional bank does not make financial sense.

2. Short-Term Rates Are Rising Faster Than Long-Term Rates

Online, you can find a 2.5% APY with a 5-year CD. However, you can also find a 12-month CD for 2.00% at Synchrony. The intense price competition for immediate access savings accounts and 12-month CDs has narrowed the difference between long and short term money. Given that the federal reserve is expected to raise rates 50 bps over the next 12 months, it might not make sense to lock your money up for five years, given the current rates. You can get a lot of yield with a short duration while you wait for rates to rise.

3. CD Ladders: An Easy Way To Diversify By Tenor

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