Are Short Term CD Rates Beneficial to Investors?
There was a period in the United States when investors could purchase long term certificates of deposits (CDs) from banks at annual interest rates of 10% or even more. This might be surprising news for the younger generation but in the mid1980s, the CD rates for five year deposits were around 12%, according to a CD rate chart of Bankrate that analyzed national averages of interest rates over long periods. Unfortunately, long term CD interest rates have fallen so precipitously after that peak and the present five year CDs fetch interest rates that range between 0.5% and 2.35%, with this maximum rate available at select credit unions. The average rate for a five year CD of$100,000 or more, termed as jumbo CD, is only between 1.6% and 1.8%. This is nearly 1% premium compared to the CD rates for short term deposits, according to data available from Bankrate.
Any investor would wonder why the rates for even such jumbo long term CDs are so low and also about the reason for the small premium between short term CDs and long term CDs. The following trends invariably affect CD rates, especially short term CD rates.
- The Federal Reserve, the central bank of the United States, has reduced its short term interest rates to record low levels, creating a heavy squeeze on long term interest rates also.
- High demand for risk-free, safe investments like CDs pushes down interest rates due to the standard supply and demand scenarios.
- Even now, many global investors perceive United States as ‘safe haven’ for their investments when compared to many other countries.
- Reserves with the banks in the United States are at all-time highs and they do not have any inclination to attract investors and receive deposits.
- The financial market cycle is considered to be a 30-year cycle and the interest rates are at their lowest since the 30-year cycle is near its lowest end. However, this trend is likely to reverse within the next few years when the financial market cycle starts to rise again.
Even the benchmark Treasury rates have come down to less than 2% and this has never happened after 1940. Hence, the interest rates could not come down anymore and the only way is upwards. At the maximum, the rates could remain flat for some more time but eventually they have to go up. The only positive issue of CDS is that banks add on an interest rate kicker so that they could compete with the attraction of completely risk-free Treasury investments, since the Treasury rates are marginally lower than the short term CD rates.
Still, the two major long term financial goals for any individual are avoiding risks of financial loss and building up savings for emergencies and unforeseen exigencies. Safety of the funds is more important even if the yield is only 1% or 1.5% with short term CDs. Investments in other financial markets like stock markets and corporate bonds carry a fair amount of risk and getting 1% is a much better proposition than losing 5% or 10% in these markets. Hence, for small investors, short term CD rates are definitely beneficial and big investors with large funds need not bother about risks and short term CDs are irrelevant to them.