Why Long-Term CDs Can Be A Smart Choice In Any Rate Environment

MoMo Productions/Getty Images; Illustration by Austin Courregé/Bankrate

Whether interest rates are rising, falling, or holding steady, long-term certificates of deposit (CDs) can play a valuable role in your financial strategy. While timing the market perfectly is impossible, understanding the benefits of long-term CDs can help you make better decisions about when and how to incorporate them into your savings plan.

Unlike a savings account, opening a CD typically locks in the advertised yield for the duration of the account’s term. Thus, locking in a CD means you can continue earning a high yield far into the future, even if annual percentage yields (APYs) decrease.

6 reasons why now is a good time to consider a longer-term CD

1. You want protection against changes in interest rates 

When you open a CD, you typically lock in the advertised rate for the entire term. This rate guarantee provides stability in your returns regardless of future market changes. 

While variable-rate accounts such as savings accounts may adjust their yields up or down based on market conditions, your CD’s APY remains constant until maturity.

2. You have funds you won’t need for a period of time

If you’ve identified funds that you won’t need in the near term, moving them from a variable-rate savings account to a long-term CD could provide several advantages:

• Potentially higher yields than savings accounts
• Protection against future rate decreases
• Guaranteed returns for planning purposes
• Reduced temptation to spend the funds

Make sure you won’t need these funds during your CD term, otherwise, you could incur an early withdrawal penalty, which typically range from 90 days to 365 days’ worth of interest. 

A no-penalty CD could be a win-win situation for funds that you think you might need during a CD’s term, since you’ll earn a fixed APY and you won’t generally pay a penalty for withdrawing your money early. (No-penalty CDs typically allow you to withdraw your money without paying a fee starting seven days after you fund the CD.)

Even though you can avoid an early withdrawal penalty this way, it’s still smart to compare no-penalty CDs’ APYs with those of high-yield savings accounts before making the decision.

3. CDs typically offer a guaranteed return

There are few guarantees in life. But if your bank fails, your money is protected when it’s in a CD from a bank that’s insured by the Federal Deposit Insurance Corp. (FDIC) and within the FDIC’s limits and rules. It also earns a guaranteed APY, provided you keep the money in the CD for the entire term and the CD isn’t callable. (The National Credit Union Administration, or NCUA, offers similar protections for CDs that are offered at credit unions that are members of the NCUA.)

What’s more, your insured funds are also backed by the full faith and credit of the U.S. government should your bank fail.

4. CDs can protect against inflation 

Long-term CDs can serve as a hedge against inflation, particularly when you can secure rates above the long-term inflation average. While past performance doesn’t guarantee future results, historical data shows that CDs yielding 3 percent or more have often helped preserve purchasing power over time.

5. A CD ladder could be beneficial in this uncertain economic environment

A CD ladder — a savings strategy where you open multiple CDs with different maturity dates — allows you to access portions of your money periodically while potentially earning higher interest rates on some terms. Because CD APYs are fixed, you’re guaranteed those rates should the Federal Reserve lower interest rates in the future. 

To build a CD ladder, you’ll divide your funds across multiple CDs with staggered maturities. For convenience, it might make sense to have all of your CDs in your ladder at the same bank. 

Here’ is a sample CD ladder:

• $1,000 in a one-year CD, 4.10% APY
• $1,000 in a two-year CD, 3.95% APY
• $1,000 in a three-year CD, 3.90% APY
• $1,000 in a four-year CD, 3.75% APY
• $1,000 in a five-year CD, 3.75% APY

6. You’re retired, or about to retire

People who are already retired – or retiring soon – should consider a high-yielding CD and lock in a rate now. That way, they can stay ahead of expected long-term inflation, earn a guaranteed income stream and reduce risk in their overall portfolio. 

Choosing the right CD term

The major decision to make in selecting the best CD for your financial needs is to determine your time horizon for the money you’re putting into the CD. If, for example, you’re planning to buy a home within three years, putting your savings in a five-year CD won’t be the right choice because you’ll likely incur a hefty early withdrawal penalty that could cost you the entire interest accrued. 

Even if the five-year CD has a higher yield, it’s smart to prioritize the term that’s right for you instead of focusing on the APY. Once you’ve determined the proper term, it’ll be easier to find the ideal CD for your needs.

Bottom line

A long-term CD can be a good fit for money that you won’t need during the CD’s term. Locking in a longer-term CD now could help you preserve purchasing power if rates drop more or substantially in the future. But depending on your risk tolerance and time horizon, there are other types of investments that might align better with your financial goals.