CDs Haven’t Done This Since the 1980s, and Investors Can Benefit Right Now

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Investors have an unprecedented opportunity to buy short-term CDs at yields that are higher than long-term CDs. Find out why this helps you. [[{“value”:”

There are some long-standing rules of thumb for investing in certificates of deposit (CDs). One of those rules was in effect between 1989 and May of 2023. However, in May of last year, the “rule” was broken and the norms haven’t been restored since.

So, what is this rule of thumb that no longer applies despite the fact it has been the standard for decades? Here’s what you need to know.

CDs are breaking the term premium rule

The basic rule of investing in CDs is that you typically need to buy a certificate of deposit with a longer term to get the best rates. Between 1989 and 2023, 6-month CDs always offered a lower yield than 5-year CDs did.

This makes good sense. After all, if you agree to lock up your money for five years — and take the chance of losing out on a better yield if rates go up during that time — you should be rewarded for your long-term commitment.

The higher yields offered by the longer-term CDs were compensation for losing your liquidity. That compensation was called the “term premium.”

However, in May of 2023, things changed. Shorter-term CDs now offer higher rates than longer ones do.

If you look at the best 6-month CD rates, you’ll see numerous offerings with rates topping 5.00%.By comparison, 5-year CD rates are still competitive, but they’re typically in the range of 4.00% or below.

These are for high-yield CDs, but overall averages across the CD industry all show the same thing: Right now, you’ll do better investing for a shorter time than a longer one.

Why are short-term CDs offering better rates now?

When short-term CDs offer better rates than long-term CDs, it’s called an “inverted yield curve.” Normally, an inverted yield curve is a harbinger of bad news, as it can suggest a recession may be on the horizon.

Right now, that may not be the case, as we’re currently facing an unprecedented situation where inflation surged due to pandemic relief measures but the economy as a whole is generally doing pretty well.

Regardless of the broader implications of the inverted yield curve, the basic fact is CD rates are very high because the Federal Reserve repeatedly raised the federal funds rate in response to an unprecedented rise in prices that occurred post-COVID-19. The Fed has signaled it’s going to be lowering rates as soon as it can, though, and there could be one rate cut in 2024 followed by several more in 2025.

Since banks know that rates are probably going to go down soon, they don’t want to offer long-term CDs at today’s very high rates. Short-term CDs are available at these rates, though, as rates above 5.00% are the prevailing rate, so banks have to offer that to get people to buy their CDs.

This means you have a great opportunity to buy a CD with a very short time commitment, so you’re taking very little interest rate risk, and earn a great return. You do need to be OK with not touching your cash for the duration of the CD term, but you won’t have long to wait if the CD you’re buying matures in a few months.

If you have spare money that you don’t want to put into the stock market but that you don’t need right away, the opportunity that CDs present right now may simply be too great to pass up.

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