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Understanding CD Rates and Their Impact on Your Investments

Certificates of deposit (CDs) are low-risk investments that allow you to earn interest on your savings. However, CD rates can fluctuate due to various economic conditions and the Federal Reserve’s financial goals. Understanding these changes can help you decide if a CD is a suitable savings vehicle for you.

Why Do Banks Change CD Rates?

The Federal Reserve, the central bank of the United States, sets the federal funds rate, which influences the rates financial institutions offer on various products, including CDs. When the federal funds rate increases or decreases, CD yields typically follow suit. For instance, the Federal Reserve may raise its target rate to combat high inflation, increasing borrowing costs and reducing consumer spending. Conversely, during a recession, the federal funds rate is more likely to decrease.

How Often Do CD Rates Change?

CD rates do not change on a fixed schedule. Instead, they fluctuate based on the Federal Reserve’s goals. For example, during the pandemic, the federal funds rate decreased twice, reaching an all-time low. Since March 2022, it has increased 11 times. As of January 2024, the Federal Reserve’s target range was 5.25% to 5.50%, with some CD rates as high as 5.51%. However, yields are expected to decline in 2024.

How Do Changing Interest Rates Affect Investments?

Changing interest rates can impact your returns if you have money in a CD, savings account, or money market account. For example, if you invest $10,000 in a five-year CD with a 1.5% yield, you’ll earn a total return of $150. CDs typically have fixed rates, and early withdrawal penalties can apply. However, if yields are expected to drop, locking in a good rate with a CD can be beneficial. For instance, a five-year CD with a 5.6% APY would yield $560 in interest.

Should I Keep My Money in a CD?

Deciding whether to keep your money in a CD depends on your financial position and goals. Here are some considerations:

When a CD Could Be a Good Place to Keep Your Money

• Low-risk investment: CDs offered by banks are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000 per depositor, per insured bank for each account category.
• Long-term savings: CDs can be a great place to park money you don’t plan on using in the near future.
• Alternative to savings accounts: APYs on high-yield savings accounts and money market accounts typically lag behind CDs.

Signs a CD Might Not Be for You

• Looking for competitive returns: The stock market has historically produced higher returns, though it involves more risk.
• Lack of emergency savings: If you need to pull money from a CD unexpectedly, you could face penalties.
• Other financial goals: You might prioritize other financial goals, such as buying a house or starting a business.

Can I Get a Rate Increase During the CD’s Term?

CDs generally have fixed interest rates, but there are some options to consider:

• Bump-up CDs: These allow you to increase your rate if yields rise during the term, usually one time.
• Step-up CDs: Your rate will increase on a predetermined schedule, though they often start with lower yields than fixed-rate CDs.
• CD laddering: This involves opening several CDs that mature at different times, providing ongoing liquidity.
• Money market or high-yield savings accounts: These options offer easy access to your money and the ability to make frequent deposits, though APYs are usually lower than CDs.

The Bottom Line

CD rates are closely linked to the federal funds rate. If the Federal Reserve changes this rate, CD yields will likely move in the same direction. Your personal financial situation and goals will determine if a CD is the right investment for you.

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