December 14, 2018

High CD Rates

Finding a Great CD Rate Is No Easy Task

CD Rates at BanksEver since the financial crisis of 2008, investors have been scrambling in an attempt to find whatever yield was available while still making safe and prudent capital allocations. Bank Certificates of Deposit

(“CDs”), have long been a safe way for an individual to obtain a slightly higher interest rate than available in a savings account without giving up a significant degree of liquidity. Given that most CDs do allow for early withdrawal, albeit with a penalty, these instruments have been a source of return and peace of mind for many years. In the wake of the meltdown, however, yield has been extremely hard to find in any capacity, so understanding the role current interest rates play is essential before dedicating any capital to them.

The Latest CD Interest Rate Landscape

For the past several years now, the Federal Reserve has kept interest rates at historically low levels in an attempt to protect the economy by stimulating borrowing, and thus, economic activity. Regardless of one’s view as to the potential cost of the approach relative to its effectiveness, it has forced rates down across the board. Prevailing low CD rates have meant that the available rate of return of most instruments, particularly those in the cash market, have been extremely low (the cash market is generally defined as the market for securities with maturities of less than twelve months including CDs, repos, Eurodollars, and corporate paper). This makes intuitive sense as these instruments have had a chance to mature and be reissued at lower rates. As long as rates stay low, finding yields that are attractive is a challenge, and one must readjust his or her perception of what a competitive rate is under these conditions – therefore finding the highest yielding rates is still relative, but must be understood in context.

How to Use CDs in a Low Interest Rate Environment

In order to construct a competitive and well-diversified portfolio, it will likely be necessary to maintain some allocation to cash, particularly in the wake of the debt ceiling debacle and the seemingly daily currency devaluations around the globe. Given the need for a cash allocation, the specific instruments should be evaluated and understood and their limitations acknowledged. Currently, while savings accounts are paying rates below 0.5%, competitive high CD rates are around 1.2%. While this rate may seem rather low, on a relative basis, it is very attractive. Under the current regime, there is an added layer of protection for CDs issued by money-center banks – the U.S. Government has sent very clear signals that no additional banks of this size will be allowed to fail. This means that, in addition to being FDIC insured, a bank CD comes with the implicit guarantee of the federal government.

On the upside, while it is highly unlikely, should rates begin to rise rapidly, invested capital can be accessed with a penalty. Since the penalty is usually the interest that was accrued, this is little incentive to remain locked-in given current CD rates. What this means is that CDs are essentially demand deposits that pay a better yield than many similar choices. For this reason, even though high CD rates is something of a misnomer, CDs still should have a place in one’s portfolio.