The fixed interest rates on most CDs offer customers stability
of both principal and interest for a specified period of time. But
ironically, it is this same stability that can make CDs more
vulnerable to changes in the economic environment under certain
conditions -- such as today's low interest rate environment.
With economic change in the air in recent months, three things
are worth noting now if you're shopping for a CD.
1. Interest rates on CDs have become a one-sided
deal
By nature, the fixed rates and terms of CDs usually represent a
trade-off. Locking into an interest rate leaves you vulnerable to
the possibility that inflation and/or interest rates might rise
during the term of your CD, thus making your interest rate less
attractive than you thought it would be when you signed up. On the
other hand, that same lock-in protects you over the term of the CD
from the possibility that interest rates might fall.
However, as
CD rates
approach zero, there is less and less room for interest rates to
fall, leaving CDs with more vulnerability than protection. In an
extreme low-interest-rate environment, that trade-off becomes a
one-sided deal.
2. Inflation is back up
This vulnerability became more worrisome because of the most
recent
Consumer Price Index
(CPI) reports. Earlier this month, the Bureau of Labor Statistics
reported that inflation had jumped by 0.3 percent in March,
following a rise of 0.4 percent in February. The increases in
previous months had been more modest, so the jump was worth
noting.
Most troubling about this was the fact that much of the rise
came from gasoline prices, which can affect many other areas of the
economy and start to make inflation a more widespread problem.
3. Market rates made progress in March
Treasury bond yields were also on the rise in March. After
spending most of early 2012 just below 2.00 percent, 10-year
Treasury yields broke through and held onto territory above 2.20
percent last month. Since they are traded daily, Treasury bonds can
be viewed as a barometer for what changing economic trends mean for
interest rates -- and in March that barometer signaled rising
rates.
While they've since fallen below 2 percent in April, even the
temporary rally was a reminder that rates won't be low forever.
Three ways all this affects how you should shop for
CDs
Given this background, here are three things to keep in mind
when you shop for a CD:
-
Keep CD terms short.
Change could be on its way according to some economic indicators,
and there is almost nowhere for rates to go but up, which makes
flexibility important.
-
A low early-termination penalty can be a good substitute
for a short CD.
A short-term CD gives you flexibility, but you also might find
you can get a similar amount of flexibility -- along with a
higher interest rate -- by choosing a longer-term CD with a low
early termination penalty.
-
Shop for the highest rates every time.
When CD rates change, they tend to change differently from
institution to institution, rather than all banks moving in
lockstep. This means you should always
shop around
rather than simply let a maturing CD roll over at the same
bank.
Change can be challenging, but with CD rates mired at low levels
for the past few years, bank customers might be inclined to embrace
any changes that could mean a reprieve from today's low rates.