Low CD rates leave laddering shaky
The last few years have not been kind to those who invest in certificates of deposit.
CDs were once a good way to keep cash safe and earn a decent yield to grow your savings or give you extra cash to meet expenses. CD ladders -- created by buying CDs in a range of different maturities and rolling over cash from maturing CDs into the longest "rung" of the ladder -- were an especially popular way to maximize returns and liquidity for safety-minded investors.
However, with yields languishing these days at historic lows -- one-year maturities are earning an average of 0.24 percent -- CDs are about as popular as a Marilyn Manson children's album.
The total amount of money kept in CDs of less than $100,000 has fallen from $1.46 trillion in 2008 to around $571 billion today, a decline of 61 percent, according to the Federal Reserve.
The basic premise of CDs -- allowing investors to trade easy access to their funds for an extra cushion of yield -- has been undermined in recent years. While the highest one-year CD rates out there are still higher than the best money market accounts, the difference has shrunk to about 15 basis points, or $150 per year worth of yield on a $100,000 CD, according to research from Bankrate.com. That's not a lot of return to lock down an investment of six figures for a year.
"When rates on term deposits go down, sometimes they reach a level that the differentiation between the yield on term and liquid becomes insignificant, so people prefer to keep their money in liquid accounts," says Dan Geller, executive vice president at Market Rates Insight, a banking industry research firm based in San Anselmo, Calif.
Brian Antenucci, an investment adviser with Bartlett & Co. based in Cincinnati, says maybe that's why many investors are choosing not to roll the cash from maturing CDs from their CD ladders into new CDs.
"The clients who would be apt to use CDs are those who have to have the highest quality, and their main purpose is principal protection. You can earn a slightly better yield than U.S. Treasuries," Antenucci says. "Otherwise, there's not a lot of utility in continuing a CD ladder."
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CD ladders were at one time a great way to gain liquidity while hedging oneself against interest rate volatility, but they aren't so viable anymore.
Savers have had no good news for the last four years. Interest rates on certificates of deposit have week by week, month by month ticked down, setting record lows. So, the old standby investing tactic of buying multiple CDs with staggered payout dates, called CD laddering, seems a little less worthwhile.
A CD ladder may still be viable for those preparing for an education expense or needing liquidity. If you are considering a CD ladder, opt for shorter term CDs. Long-term five-year CDs aren't paying dramatically higher than their two-year or shorter counterparts and once rates turn around, you won't want to be locked in a terribly low interest rate for years to come.
Another option for liquidity comes in the form of money market accounts, which have interest rates that rival those of CDs.
Beyond poor yields, a quick glance at the yield curve for CDs shows why ladders have fallen into disfavor. The major attraction of laddering is earning the higher rates available on longer-term CDs while still getting access to a portion of your cash at regular intervals. But that advantage has been substantially reduced by crumbling yields.
A five-year CD opened in 2008 and maturing now likely yielded around 3.5 percent compared to about 2.24 percent for one-year CDs, a difference of 1.26 percentage points. In Bankrate's latest survey, five-year CDs are averaging 0.78 percent, just 54 basis points higher than a one-year CD, according to Bankrate.com data.
Why rates are low
Why are banks so stingy with CD rates?
To be sure, banks are in the business of taking deposits and lending them out, Geller says. When interest rates on those loans are low, as they are now, banks aren't willing or able to pay CD investors a lot of interest on their deposits.
"As long as interest rates on loans, which is the income for the banks, are low, the banks have to maintain low interest rates on deposits, which is the expense," Geller says.