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Consider Buying Long-Term Certificates of Deposit

My friend once asked me why anyone would put their money in a 60-month certificate of deposit. In our age of instant gratification and blockbuster returns, the thought of putting a sum of money, even if it’s just $100, locked away for 5 years with a pittance of a return seems preposterous. Why put it in a 5 year CD when a high yield savings account [3] can give similar returns? Thirty year Treasury bonds? Forget about it, they’re not even on the radar.

The Fed Will Lower Rates

However, recent market events have really knocked those ideas on their head as people are looking for a safe place to put their money. The economy is looking shaky and many are anticipating that the Federal Reserve will lower the target federal funds rate. Investors typically use options on federal funds futures as a way of predicting how the Fed will move rates in their next meeting. You can review the summary of those futures on the Cleveland Federal Reserve Bank’s website [4]. The futures are absolutely certain the rate will be lowered, it’s just a matter of how much (50 basis points to 1.00% is the most probable). As the federal funds rate drops, so will high yield savings accounts interest rates [5] and any incentive for Americans to save.

When they lower interest rates, it’s almost certain that high yield savings account rates will move down with them (it’s just a matter of when). In an environment of declining interest rates, remember certificates of deposit. [6] It’s a bit disheartening to think that I wrote that post as a post script to what I, and many, thought was the start of a period of increasing interest rates. The economy wasn’t stellar, there was still talk of a recession, but the Fed was more fearful of inflation than recession. Now, its the fear of an economic slowdown that has the Fed acting.

Mitigate Risk

Another good reason to go with a CD is that it helps mitigate risks. If you put some of your savings into a CD, you won’t be tempted to withdraw it and chase after an investment. You earn a little return for your funds but you also lower your investment risk. It’s a bit of a stretch to say it but it’s a point that shouldn’t be overlooked. With the tumultuous market and low prices, you might be tempted to put a lot of money into an investment that you otherwise wouldn’t have. By having some of your funds already locked into a CD, you preclude that from happening.

Early Redemption

Locking in a so-so rate of return into a CD doesn’t look so bad right now. And to those who are concerned about having their money “stuck” in a CD, you are usually allowed to withdraw your funds after a penalty. For example, ING Direct [7] will deduct 3 months of interest on CD’s with maturity periods of 12 months or less and 6 months of interest on CD’s with maturity periods of greater than 12 months (the penalty could be more than the interest earned to date).

I keep a list of the best CD rates [8] available for CDs of 12-18 months or less, with links to the CD rates pages so you can see how the longer term rates are.

While I’m not saying long term CDs are the best option, I don’t know what is (feel free to chime in with your vote), but in our current economic environment, long term CDs may be cool once again.

(Photo: baronbrian [9])