Interest rates are on the rise.
The Federal Funds Rate – which sets the market for most interest rates – was up to 1.51% as of March 2018, its highest mark since the stock market crash in 2008.
And while this does mean higher interest rates on mortgages and other loans, it also means that you can finally earn a reasonable return on the money you have in savings accounts and CDs, if you know where to look.
So, are savings accounts and CDs suddenly smart investments? Should you be putting some of your long-term money into these accounts?
The answer depends on what your goals are and what you’re investing for. Let’s figure it out.
The Primary Purpose of Savings Accounts and CDs
Before even considering the idea of using a savings account or certificate of deposit as an investment, let’s take a step back and remind ourselves how these accounts are primarily meant to be used.
The main reason to use a savings account or CD is not to earn a return. The primary purpose of these accounts is to keep your money safe when you either:
- know that you’ll need to use it in the near future, or
- might suddenly and unexpectedly need to use it.
The first scenario might include saving for a down payment, a new car, or any other goal you hope to reach within the next couple of years. With such a short time period, the safety and certainty offered by a savings account or CD far outweighs the potential extra return you might earn from the stock market.
The second scenario is the primary function of your emergency fund and would also include saving ahead for things like home maintenance, car repairs, and medical bills. You never know exactly when you’ll need to spend that money, but you do need to know that your money will be there when the moment comes.
Both savings accounts and CDs guarantee that your money will be there when you need it. That, more than anything else, is the value they offer.
But Your Return Does Matter
Even with the rise in interest rates, many big banks are still paying next to nothing on their savings accounts. As of this writing, Bank of America is paying 0.03% on their Rewards Savings Account and Wells Fargo is paying 0.01%. At that point, your money really is just sitting there doing nothing.
Online banks and local credit unions offer much better interest rates. Ally is currently paying 1.90% on its savings account and Synchrony Bank is paying 2.15%. You can find more online savings accounts here, and you may also be able to find a local credit union offering even better rates.
While I wouldn’t recommend hopping from bank to bank chasing the best rate, it is worth your time to find a bank you like that offers a competitive interest rate. That way your money will be safe, you’ll have easy access to it, and it will earn you something in the meantime.
Why CDs Might Make Sense as a Long-Term Investment
With that out of the way, let’s get back to the original question: Do savings accounts and CDs ever have a place in your long-term investment portfolio?
The answer is a definite maybe.
First, it’s almost always a good idea to keep some kind of cash reserves, even if you’re completely financially independent. Having that money available is helpful when the need arises and can contribute greatly to your peace of mind.
But even beyond that, a CD in particular could be a useful piece of your investment portfolio.
You would never substitute CDs for the stock portion of your portfolio, since they are completely different types of investments. But given where interest rates are today, it may make sense to use CDs for some of the bond portion of your portfolio.
For example, Ally Bank’s two-year, high-yield CD is currently paying 2.50% interest with a $25,000 minimum deposit.
If you compare that to the 2.86% SEC Yield on Vanguard’s Total Bond Market Index Fund – which is a good estimate of its future return – the CD’s return is a little lower but comes with more certainty. Bonds are a lot less risky than stocks, but they can still lose value. The only real risk with a CD is the potential for paying an early withdrawal penalty.
And while you won’t be able to invest in CDs within your 401(k), Ally and other banks do offer IRA CDs, so it is certainly possible to use them for at least some of your long-term, tax-advantaged investment portfolio.
Bonds do offer some advantages, such as the potential for better returns and easier trading when it comes time to rebalance. And it may be difficult to keep track of multiple IRAs if you’re using one for traditional investments and one for CDs.
But in the right situations, investing some of your portfolio in CDs may be a smart move.
Match Your Investments with Your Goals
There is no such thing as a “good investment” or a “bad investment.” Investments are simply better or worse for the specific goals you are trying to achieve.
If you’re saving for a short-term goal, a savings account or CD is likely the best option, no matter what the interest rate is, simply because they keep your money safe. No other factor is even remotely as important.
But with interest rates on the rise, CDs in particular could be a helpful piece of your long-term investment portfolio. The returns are comparable to what you might expect from a high-quality bond fund, and the extra stability could help you weather even the roughest market downturn.
Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families.