There Is Still Time to Lock In Those 5 Percent CDs

The upside of a money market account or money fund compared to a CD is you can withdraw the money whenever you need it. CDs have penalties for early withdrawals. The downside is the rate of return for a money market account or money fund fluctuates.

Going long

Normally, if you want to lock in rates for a long time, you simply buy a CD or Treasury security that has a longer maturity — say, five years. Unfortunately, that tactic doesn’t work well in today’s market, where short-term rates are higher than long ones. (This is called an inverted yield curve, and it’s unusual.) “Yields are peaking now, and from the standpoint of income investors, there’s no incentive to wait,” McBride says.

Banks tend to lower savings rates quickly and raise them slowly. If you want a guaranteed yield for the next five years, you’ll have to find one that’s better than the highest-yielding money market account (or money funds) offer. Currently, the highest-yielding five-year bank CDs yield 4.75 percent.

The Treasury also has options for short-term savings. You can buy Treasury securities, such as the five-year T-note, which yields 4.06 percent. You might also consider Treasury Inflation-Protected Securities, or TIPS, which pay about two percentage points above inflation, currently 1.78 percent. Note that TIPS returns adjust as inflation changes; the rate of return isn’t fixed. Interest from Treasuries is generally free from state income taxes, but it is subject to federal income tax.

Cashing out early from Treasuries or CDs is relatively simple, but it could cost you. Typically, banks want three to six months’ interest for an early withdrawal penalty from a CD, although each bank sets its own early withdrawal penalty. If you invest in a five-year CD with a three-month penalty and withdraw after one month, you could lose some of your principal.

Similarly, if you sell a Treasury note before it matures, you could lose money on the deal if interest rates have risen since you bought it. (Why would someone buy your T-note if they can get a better yield elsewhere?) Conversely, however, you could make money on the deal if you sell after interest rates fall.

Building a ladder

Even Wall Street professionals will tell you that predicting the course of interest rates is about as easy as predicting next month’s weather. It may be that the Fed decides to hold interest rates high till next year, even though most betting is for three rate cuts beginning this summer.

“I think it probably makes sense to hedge your bets,” says Ken Tumin, founder of DepositAccounts.com. One way to do that: Build a CD (or Treasury) ladder.

One approach: Divide your savings into four parts and take out a one-year CD every three months. If rates rise, you’ll lock into higher CD yields every three months. If rates fall, you’ll get higher rates for longer than if you invested in a money market account.

Alternatively, invest your savings into five CDs: A one-year, a two-year, a three-year, a four-year and a five-year. When the one-year CD matures, you can roll it into another CD — a five-year CD if rates have risen, or a shorter-term CD if rates have fallen.

If you’re a CD shopper, you’ve probably taken advantage of special offers from your bank — 5 percent for a six-month CD, for example — and that’s wise. But pay special attention to your CDs when they mature. “Anybody that got into these special CDs should beware when they mature,” Tumin says. Often, they roll over automatically into a CD with the low standard rate, Tumin says.

John Waggoner contributed to the reporting of this story.