Analysis

I Used to Be Opposed to 5-Year CDs. Here’s Why I’ve Changed My Tune

If you have money allocated for near-term goals or emergency expenses, then a savings account is the best place for that cash. You need easy, perpetual access to your emergency fund. And you should never take money you might need within a year and invest it in stocks. If the market tanks, you won’t have time to ride out that downturn and avoid locking in permanent losses.

But there’s a difference between saving within a one-year time frame and a five-year time frame. And in the latter scenario, I used to think that CDs were a poor choice for five-year goals. The way I saw it, why put money into a CD for five years when you could make much more in the stock market and you had time to ride out an extended slump?

But I’ve since changed my tune on 5-year CDs. And I now think that under the right circumstances, opening one can be a very wise choice.

When rates are favorable, it could pay to pounce

Generally speaking, I’m not going to tell you to put your money into a 5-year CD when the rate on it is 1.50% or 2.00%. There are a number of relatively stable five-year investments that are apt to offer a higher return, like bonds or bond funds. But at a time when 5-year CDs are paying upward of 4.00%, it’s a different story.

The Federal Reserve spent much of 2022 and 2023 raising interest rates in an effort to cool inflation. And while that’s driven the cost of borrowing upward, it’s also resulted in higher savings and CD rates.

These days, you can find 5-year CDs paying around 4.50%. And if you open a CD at an FDIC-insured bank and limit the amount of money you have in that account to $250,000 ($500,000 for a joint account), that CD is protected, making it pretty much a risk-free home for your money. Even bonds, which are fairly stable, carry some risk of losses, such as if an issuer defaults and can’t return your principal.

Why CDs are a good idea for a five-year goal

So let’s say you’re saving for a goal that’s five years out. You could put your money into the stock market, and there, you might enjoy a higher return than 5% — especially since the market’s average return over the past 50 years has been 10%. But remember, that’s an average taken over 50 years.

In five years, the market might average 7%, or 4%, or -3%. So while there is some upside to investing in stocks for a five-year period, there’s also risk.

With a CD, you really aren’t taking on risk if you stick to the rules above (choose an FDIC-insured bank and make sure your deposit falls within the FDIC limit). So at a time when CD rates are up, a 5-year CD does make sense because you might be getting 4.00% on your money or more risk free.

In fact, I’m not just someone who will now recommend 5-year CDs — I recently opened one myself. I have about five years until I may have to start paying college tuition. I have investments for that purpose, but what if those investments sink right as those tuition bills start coming due?

That’s why I recently put a chunk of cash into a 5-year CD. I can earn 5% on that money without losing sleep.

Don’t wait to lock in a 5-year CD

Because of where interest rates are at today, I think that in some cases, a 5-year CD makes sense. It doesn’t make sense if you’re 35 and are saving for retirement, but it does make sense if you’re saving for a nearer-term goal.

However, don’t wait to open a 5-year CD. The Fed is expected to start cutting rates later on in 2024. And once that happens, you may not be able to earn as much interest on a long-term CD. So if you’re interested in finding a safe place for your money for the next five years, get moving ASAP.

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