Over the last year, we’ve repeatedly heard one specific comment about CDs: that the low interest rates do not warrant tying up your cash. For example, a resident in the San Francisco Bay area would find that the highest CD rate available for a 3 year term is 1.35% at Alliant Credit Union, however the average 3 year CD rate, as reported in our weekly index, is just 0.85%. Meanwhile, the highest savings account yield, found at Ally Bank, is 0.95%. This begs the question, if a high yield savings account can provide a comparable rate to a long-term CD, then why would anyone choose the less liquid CD?
CDs vs. Savings
Given such similar yields between savings and CDs, the logical conclusion would be to choose the highest yielding savings account, which you can access a few times a month, over a CD. However, the savings account yield advantage hasn’t always held true, and it may change again in the near future when interest rates eventually rise. With a savings account, you give up certainty in the rate you will earn on deposits. A bank may raise or lower its savings rates as often as it deems necessary.
To investigate further, we analyzed historical rates to determine how a saver might have benefited, in dollar terms, with each option over the past 3 years.
- For savings accounts, we analyzed ING Direct’s Orange Savings Account, a high-yield account at an online bank and its interest rate changes since January 2010.
- For CDs, we used data published quarterly by Datatrac, Inc. detailing the national average rate for a 3 year, $10,000 CD.
- Both yields declined steadily, as the national 3 year CD average converged with ING’s savings account rate offering
- ING’s savings rate declined from 1.25% APY in January 2010 to 0.75% at present (9 rate cuts, average of 3 per year)
- The 3 year CD rate declined from 1.86% at the end of 2009 to 0.85% in March, 2012 (most recently available report)
This analysis shows that a 3 year CD and a high-yield savings account are nearly equivalent in yield at present. Considering the downside of stashing away savings for an entire 3 years in a CD, consumers are likely to prefer an account like ING’s, where they can withdraw regularly if needed. However, for savers entering the deposits market approximately 3 years ago, the benefits of a CD over a savings account would have been significant, as most certificates of deposit maintain the same rate over the entire term:
Over this time span, the depositor would have earned an effective APY of 0.96% on the savings account, compared with the 1.86% of the 3 year CD. Someone with $10,000 in savings would have seen the following growth (assuming no additional deposits or withdrawals).
Does this mean a long-term CD will always be preferential in terms of yield?
No. Following the 2008 financial crisis, interest rates have declined significantly and look to remain low through 2014, according to the Fed’s stated goals. So CD investors earlier in the recession were rewarded with a rate higher than they could have received in following months, while those with a high-yield savings account saw their rate drop every-so-often. The opposite will theoretically hold true as America emerges from the recession. Consider a hypothetical situation in which the savings account APY increases at more or less the same rate. A depositor could choose either a 3 year CD or a high-yield savings account:
This may be an exaggerated example, however the point remains the same. An illiquid 3 year CD could easily have earned less in interest than a much more accessible online savings account.
As with many decisions, there’s no one right answer for every individual. However, the critical matter is one’s outlook on the economy. Those who believe interest rates will rise in the next few months should not risk tying up their savings in a long-term CD. However, those who expect rates to remain stagnant or decline would be best suited to lock in the highest CD rate available. Banks can cut their savings rate at any time, which for some consumers makes them less appealing than the rate stability of a CD.
Clock & money image via shutterstock