CD shopping? Buy short now, go long later
By Greg McBride • Bankrate.com

As many investors reliant on interest earnings know all too well, yields on certificates of deposit have moved in one direction this year -- down. So much so, that yields on all CD maturities are currently 1 percentage point below their long-term averages.

Yet this past two-week period has been the least volatile two-week stretch on CD yields since early December. Is this decreasing volatility a sign of a long-awaited turnaround?

Alan Greenspan's intimations of further rate cuts do not come as a surprise given the lingering risks to economic health -- namely, the tenuous nature of continued consumer spending amid mounting layoffs and the deteriorating conditions in foreign markets.

The prospect of, and uncertainty regarding, the extent of further rate cuts makes short-term CD yields subject to further declines.

However, the yields on long-term CDs, such as the five-year maturity, seem poised to rebound as the average yield sits no lower now than one month ago.

For cash investors with an indefinite investment horizon -- those diversifying an existing portfolio for maximum yield, for example -- the dilemma arises when long-term yields start climbing while short-term yields hold steady or, worse, continue to fall.

Adding to the dilemma are the promotional yields that will begin popping up on maturities of one year to five years in length. As rates begin to rise, such offers become more common as institutions attempt to attract funds for a longer period at an advantageous rate.

As an investor, the temptation is to snag the highest yield currently available. But if your investment horizon is truly indefinite, meaning you have no predetermined need for those funds, wouldn't you rather lock in at a higher yield later? If someone offered you $50 right now for your shoes, would you sell if you knew you could get $60 next week? Of course not. Only if you absolutely needed the money before next week would you settle for the lower price.

To avoid exposure to any further declines in short-term yields, consider using three-month or six-month CDs in the interim. Although money market accounts provide maximum liquidity, and thus, flexibility, any further cuts in interest rates will carry over to MMA yields.

Truly consider your investment horizon, and be cautious about locking up funds for too long now, especially if the prospect of seeing higher yields three, six or 12 months from now bothers you. The penalties for early withdrawal make the "buyer's remorse" a costly proposition on certificates of deposit.

Greg McBride is a financial analyst for Bankrate.com. For advice regarding your specific situation, please e-mail one of Bankrate.com's Q&A experts or visit the Personal Finance Advice channel on Bankrate.com.

-- Posted: July 20, 2001