Interest rates are paused. Here's why you should open a CD quickly.
At its final meeting of the year, held on December 13, 2023, the Federal Reserve announced that it was leaving the federal funds rate paused for the third consecutive time. While the Fed does not directly set the rates for saving and lending products, the decision to pause its benchmark rate will have ripple effects that impact many Americans.
One of those ripples could be a drop in the interest rates available for certificates of deposit (CDs). With CD rates high right now, anyone who wants to save using a CD should consider opening an account right away to get the best possible return.
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Interest rates are paused. Here's why you should open a CD quickly.
While the pause in interest rates will likely impact many products, including mortgages and high-yield savings accounts, CDs are the area where investing quickly could be important. Here's why.
CD rates could begin to decrease
Right now, CD rates are very high. For a 1-year CD, you can get an interest rate of more than 5.5%, while a 5-year CD could come with a rate of more than 4.5%. Those types of rates offer the opportunity for significant earnings with little risk.
One reason why CD rates are so high right now is that the Fed has made a series of hikes to the federal funds rate over the past 18 months in an attempt to fight inflation. The Fed generally raises the federal funds rate when inflation is high to encourage saving and discourage spending. This cuts down on the amount of money circulating in the economy and lowers inflation.
The plan has largely worked, with year-over-year inflation for November coming in at 3.1%, down from a rate of more than 9% year-over-year in June 2022.
The rates given to customers tend to track alongside the federal funds rate. While the Fed has not yet cut rates, the fact that it is pausing yet again could lead banks to lower interest rates for both lending and savings products.
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CD rates are locked in when you open the account
Once you open the CD, your rate is locked in. Even if the Fed cuts the federal funds rate next year and interest rates for CDs drop dramatically, you'll still earn interest at the rate you got when you opened the account. So, opening a CD now versus six months from now could help you avoid a lower interest rate.
Let's say you put $10,000 into a 1-year CD today at a rate of 5.5%. In one year, you'd have earned $550 in interest. If you wait six months to open one and rates drop to 4.75%, you'll earn just $475 over the course of a year.
The differences are even more stark for a 5-year CD. If you put $10,000 into a 5-year CD right now at a rate of 4.65%, you'd earn $2,551.52 in interest by the time the CD matures. If you wait and rates drop to 4.00%, you would only earn $2,166.53 throughout the CD term.
"When interest rates were rising, we were recommending shorter-term CDs to avoid getting locked in at a lower rate for too long," says Kim Hall, a financial advisor at Clarity Wealth Development. With rates now paused, Hall says it could be a good time to consider longer-term CDs instead.
The bottom line
CD rates are high right now, but the latest announcement from the Fed means that savers may want to lock in a rate now. If you want to maximize your interest, it may benefit you to open a CD before rates can drop lower than they currently are.
