Be Careful Not to Rush Too Heavily Into Long-Term CDs Here

Interest rates have collapsed over the last several weeks and that may be good news for those interested in remortgaging or buying a new property. It is also good news for anyone considering taking out a new home equity loan or line of credit or an auto loan.

It may not be good news for your savings. Many banks dropped their online savings rates going into the July rate cut and still others are dropping their rates now based on the assumption that the Fed is not done cutting.

We are getting a lot of notes from savers who remember well a lengthy period from 2009 to 2016 when savings rates were below 1%, and are terribly fearful that we may be heading back there. Indeed, anyone looking at Japanese or German rates and watching the talking heads on CNBC or Bloomberg can get the feeling that there is a real paradigm shift and that interest rates are never going up.

There are still banks and credit unions that are offering online 5-year CDs over 3%. In your local market, you may even find brick and mortar opportunities at banks and credit unions to get these kinds of rates.

Here are two reasons why you should be cautious.

First, we’ve seen a panicked move in Treasuries. Rates may not stay this low for very long. We could be in a completely different environment in a year or 18 months with the 10-year back over 3% and perhaps even with the Fed Funds rate back over 3%. If that happens, you will regret having limited your liquidity by locking into a long-term CD.

Second, even if rates go back to zero, you are still going to see attractive 5-year CD offers as banks will still need to lock up long-term deposits from depositors to fill their capital needs. From 2011 until 2015, while the Fed Funds rate was at zero and the best savings rates were below 1%, it was still always possible to find 5-year CDs at or just under 2.50%. So, even if we see a continued complete collapse in interest rates, you will always be able to get a premium for locking in for a long period. And, yes, there is a difference between 2.50% and 3.50%, but the difference is not a matter of life or death (especially after you calculate the net income from the CD after tax).

If you see 5-year CDs as a sort of insurance against collapsing rates, then you can go ahead and devote a small amount of your savings to provide some level of protection against falling rates (be sure to check the best rates here). But, we’d be much more inclined to direct that energy towards one-year CDs where the rates may be slightly lower, but so is the risk of getting this wrong.