Bank certificates of deposit are a federally insured way to save money while earning higher interest than a savings account would pay, and the longer the term the higher the payoff usually will be.
But what to do when interest rates are near rock-bottom and rising? Who wants to put money in a 2-year or 4-year CD at a fixed interest rate, when the rates offered could be higher in a few months or a year?
Just this past week, on Feb. 25, interest rates increased enough to send the stock market down sharply. (Higher bond yields make stocks relatively less attractive).
Despite the talk about inflation fears and rising interest rates, those rates are still incredibly low, whether for savings accounts or mortgage loans. When borrowing money for 30 years, it's great to lock in a low interest rate, but when saving money for years, locking in a low rate is obviously bad.
For people who like to keep money in CDs — a good place for at least portion of one's emergency savings — a good compromise could be a rising rate CD. Sometimes these are called bump-up CDs.
A traditional certificate of deposit has a fixed interest rate for the term of the CD, whether it's 3 months or 3 years. A rising rate CD allows the owner to change the interest rate a limited number of times. That can eliminate some of the concerns and risk about locking in for several years.
For example, Ally Bank (an online bank where I have an account) offers "raise-your-rate" CDs for 2-year or 4-year terms. With a 2-year term, you get to adjust the interest rate once; with a 4-year term, twice.
As with all federally-insured bank or credit union savings products, it's important to shop around for the best rate and check the terms.
A key term to check is how much interest you'd forfeit if you cash out the CD early.
Having money in a multi-year CD doesn't mean you can't access the money during that time, but it does mean you'll probably have to give up a few months of interest earned if the CD is redeemed early.
Ally gets high marks for CD rates from a number of rate-comparing websites, and I'm familiar with their products, so let's use them as an example of the options one might find when CD shopping. Based on rates posted Feb. 25, here are the interest rates offered for Ally CDs ranging from one to five years.
- 12-month or 18-month CD: 0.60 percent.
- 2-year "raise your rate" CD: 0.60 percent with one adjustment allowed.
- 3-year CD: 0.65 percent.
- 4-year "raise your rate" CD: 0.60 percent with two adjustments allowed.
- 5-year CD: 0.85 percent.
So, that's not much of an incentive to put money in a 5-year CD if you believe rates will rise, right?
The main point of a CD is to keep money safe while earning interest that helps keep it from losing value to inflation. Nobody's getting wealthy on these interest rates, but that's not the point.
In a rising rate environment, one easy choice is to stick to short-term CDs and roll into new CDs that pay higher rates as they mature. A CD that allows adjustments in the interest rate is another choice to consider.