When it became clear that COVID-19 would lead to a massive economic event, the Federal Reserve quickly reacted by slashing interest rates to near zero. When the Federal Reserve changes its key interest rate target, that change flows into other financial interest rates, and those rates affect certificates of deposit (CDs) at banks, credit unions, and brokerages around the country.
If you hold a CD or are considering adding CDs to your portfolio, it's essential to understand how falling interest rates impact your bottom line. Read on to find out more about falling CD rates and how you might want to react.
Why Are CD Rates Falling?
The Federal Reserve uses a wide range of tools to manage the economy and keep unemployment low. One of the most important ways is by setting the target interest rate for overnight interbank lending. Many consumer products — including credit cards, mortgages, savings accounts, and CD accounts — follow changes to the Fed's interest rate target.
Lowering interest rates encourages people and businesses to spend and borrow more, which is considered good for the economy. The big downside, however, is that studious savers are rewarded with lower income generated by their savings.
Many of the companies that issue CDs are going through a period of financial strain. And the new low interest-rate environment hurts them even more. So, they lower their CD rates as a way to reduce expenses when margins are threatened.
If you have a good chunk of your assets in CDs, now could be an excellent time to make some changes.
What Should Investors Do?
No one likes to see their interest rates drop for savings accounts or CDs. Both are extremely safe, government-insured savings vehicles, but the fallout of lower interest rates is different on each of them.
- With CDs, lower rates don't hurt you right away. In fact, if you locked in a high rate for a long-term CD before rates dramatically fell in March 2020, you could be in good shape for a while. But if you're about to renew your CD, you would be locking in a historically low-interest rate. That probably isn't the right move.
- With savings accounts, the effects of interest rate changes are seen much sooner. However, that goes for both positive and negative rate changes. When CD rates fall, switch to a high-yield savings account to take advantage of possible upcoming rate increases. You can also switch to a cash account like Wealthfront, which allows you to both grow your money and fund your investment account within minutes.
Just be careful where you put your money if you are looking for other investments. The markets recovered very quickly from the terrible rout when the virus began. But with tens of millions still unemployed, the timing still may not be right for the stock market. It's impossible to know how the markets will fare in the coming months.
How to Make the Right Move When It Comes to CDs
It's impossible to know what the markets will do next, but interest rates are likely to stay low for a long while. That leaves CD holders with few options for what to do next.
- Stick with your CD strategy: While rates have fallen, the change in rates may not be big enough to shift your long-term plan. Many people with long-term CDs may be unaffected. Those with shorter-term CDs may want to ride out the low rates and stick with their plan until rates recover in the future.
- Move to high-yield savings: Instead of locking yourself into low CD rates for months or years, you could move to a high-yield savings account. Some online high-yield savings accounts offer better rates than many CDs. These accounts keep your funds FDIC or NCUA insured. Also, you can withdraw at any time with no consequences, unlike most CDs that incur an interest penalty if you withdraw early.
- Shift to riskier assets: Your last major option is to shift funds into riskier assets, like stocks and bonds. Bonds sometimes provide higher yields than CDs. But they also carry additional risks. Stocks may give you even better returns but have much more risk. This option depends on your long-term strategy, risk tolerance, and investment goals.
When Will CD Rates Go Up Again?
Will CD rates ever go up again? Yes, they will. But it may take months or years for that to happen. If the coronavirus pandemic comes to a swift end and the economy switches to growth mode, an increase in rates shouldn't be too far behind.
You don't have any control over market interest rates, but you do have the power to make smart choices around saving and investing your hard-earned money. With CD rates going down, it's up to you to decide if they still deserve a spot in your portfolio.