When you invest in a certificate of deposit or a share certificate, you expect to earn more on it than you would from a savings account. But with interest rates back near the historic lows reached after the Great Recession, it can be tough to find yields that seem high enough.
CDs are offered by banks, while share certificates come from credit unions, but they are similar investments. Both are government-insured for up to $250,000 at participating financial institutions, making them among the safest possible investments. You pay a price for that safety, though: lower returns.
With both, you invest a fixed sum of money for a specified time period, anywhere from a few days to years. Typically, you earn a predetermined yield. But unlike with money in a savings account, you generally have no access to your funds during the term of the investment, or you may incur a penalty for withdrawing any of the money.
In the late 1970s and early 1980s, these investments soared in popularity as the rates they paid reached nearly 18% amid an inflationary spiral. Rates naturally fluctuated with the economy as the years went on, until the Great Recession hit in 2007. Soon afterward, the Federal Reserve cut short-term lending rates to near zero in an attempt to spur a recovery. Since then, rates have changed very little, and CD investors have earned only small returns.
When a push to raise rates seemed to be on the horizon, some investors may have readied themselves for better returns. But lately, Fed policymakers have suggested they would be “patient” in nudging rates back toward more normal levels as the recovery remains relatively weak in some areas. To some economists, that signaled an even longer wait for higher rates. For CD and share certificate investors, it means bigger yields may remain elusive.
For example, the average yield in mid-2014 for a five-year certificate for $10,000 was 1.34% at U.S. credit unions and 1.15% at banks, according to the National Credit Union Administration. Shorter-duration investments carried much lower rates — three-month bank CDs, for example, paid just 0.14%, while one-year instruments delivered a 0.35% return. By contrast, in early 2008, banks were offering comparable CDs with yields of almost 2.5% for one year and about 3.1% for five-years.
Bonds as an alternative
With CD rates so low, Allan Moskowitz, a certified financial planner with Affirmative Wealth Advisors in El Cerrito, California, doesn’t recommend using them.
“If clients insist on CDs, then I recommend using one year or less term, so that they can utilize CDs with higher rates when rates start to rise,” Moskowitz says. “Using short- or limited-term bonds or bond funds helps hedge against rising rates to some degree.”
Nevertheless, some financial institutions did have better yields available. In mid-January, some institutions offered 12-month certificates with annual percentage yields as high as 1.14% with a minimum deposit of $500, or much higher than most savings accounts. Others were paying slightly higher rates on certificates with larger minimums.
Rates typically vary according to the term of the certificate, the amount of money put into it and where you live. The rule of thumb remains that the longer the term and the bigger the sum invested, the higher the return — up to 2.25% for many five-year certificates. Restrictions may apply, and for credit unions, you generally have to be a member to invest in a share certificate.
Johanna Fox Turner, a financial adviser with Milestones Financial Planning in Mayfield, Kentucky, suggests thinking of CDs or share certificates as “vehicles for specific purposes.” As you look at your five-year goals, she says, think about how CD term lengths can fit into your plan.
“Say you’re going to need a car in four years and you’re going to want $30,000. That’s a good use for a CD that matures in three years,” she says.
There are other ways to stay flexible and remain ready for higher rates without sacrificing the safety of certificate investments. One is by “laddering,” or investing in a series of certificates that mature at regular intervals. As each one matures, you can roll over, or reinvest, the funds into a new certificate. If rates are rising, each new certificate has a higher yield. But even without an increase in rates, by rolling over your money into progressively longer-term certificates, you can wind up with only long-term certificates that pay the highest yields yet mature at regular intervals.
If you choose a CD ladder, make sure to use “a shorter-term laddering period than might be normal,” suggests John Buerger, a financial planner with Altus Wealth Solutions in San Luis Obispo, California. He says three years should be the maximum for any certificate in the ladder.
Another way to stay flexible with certificate investments is to invest in those that let you receive a rate increase during the term. These are often called adjustable-rate or bump-up certificates. How frequently you can raise the interest rate depends on its term, with perhaps two adjustments over a four-year term or one over two years. But to get this flexibility, you often have to accept lower yields than may be delivered by fixed-rate certificates of the same duration.
Remember that using bump-up CDs does introduce a certain amount of speculation into the formula, so it can be more risky than other options, Turner says. Above all, keep in mind that liquidity is your top goal, she says.
“I think that’s where people make big mistakes,” Turner says. “Don’t let income and long-term growth get confused with your short-term needs.”
No matter what sort of certificate you pick, you’ll likely tie up your funds for the term of the investment, so choose carefully among the options to get the best chance of reaching your financial goals.
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