Why the 10-Year CD Might Be the Worst Bank Product Ever

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The popularity of certificates of deposit and other fixed-income investments is due to the predictability of their returns. Unlike stock investments, CD returns are guaranteed. Investors put money in very safe but relatively low-yielding long-term investments such as CDs instead of angling for a bigger return by navigating the uncertain waters of the stock market.

However, tying up money for long periods of time in “safe” investments actually poses some risk. The 10-year CD is a case in point. Locking in a CD interest rate for a decade can seem like a route to certainty and security. But doing so also prevents you from taking advantage of interest rates when they finally begin to rise. Many experts expect rates to start ticking upward in 2017.

Right now, 10-year CD rates are lower than rates offered by some savings accounts. For example, a Bank of America 10-year CD with less than a $10,000 deposit amount gets you a 0.15-percent annual percentage yield. Bank of America’s penalty for withdrawing money from that CD before its maturity is equal to 365 days’ worth of interest on the amount withdrawn.

Related: 10 Best Savings Accounts of 2016

By contrast, Ally Bank offers a savings account that pays 1 percent APY on all balances. When savings account rates and CD rates are so closely matched, the wisdom of locking away your money for a decade starts to wane. Depositing $10,000 in a high-yield savings account with no penalty for withdrawing money early is likely going to produce a better result than purchasing a 10-year CD.

Impact of Inflation on a 10-Year CD

Inflation also impacts the value of the 10-year CD yield. Inflation is likely to reduce the purchasing power of any interest you’re paid over the decade. To find out how much you’ll actually earn in interest, you must subtract increases in the Consumer Price Index, or CPI, from the nominal yield. This is the amount you actually have after inflation, and it is appropriately called the “real yield.”

Even if you’re lucky enough to lock into the best CD rates available, your real yield might be lower than you expect if inflation is high. Inflation is a variable that cannot be accurately predicted.

Related: How to Open a CD Account

Alternatives to the 10-Year CD

If you need access to your cash or want a better return, opening a high-yield savings account or investing in the stock market might be better options than purchasing a 10-year CD. And there are other options as well.

CD Laddering

CD laddering is another option if you like the idea of locking in a rate but don’t like the notion of not having access to your money for a decade. With a CD ladder, you purchase short-term, medium-term and long-term CDs. Each CD will mature at a different time.

For example, if you invest in 12-, 24-, and 60-month CDs, the first rung on your ladder — the 12-month CD — matures in one year. Once that happens, you reinvest the proceeds of that CD into a long-term CD and so on, until you have only long-term CDs.

The reason you eventually want to hold just long-term CDs is because their interest rates are typically higher than the rates of CDs with shorter terms. CD laddering makes it easy for people to start slowly without locking up their funds for years and years.

Bump-Up CDs

Bump-up CDs — also known as step-rate CDs, among other names — might be a good option for those who like the security of a guaranteed return, but also want the ability to withdraw some funds without penalty. Some of these CDs allow you to increase the rate on the CD if interest rates rise. Others have built-in, automatic rate increases that kick in over time. Typically, there are limits to how often you can raise the rate.

Wells Fargo offers a 24-month step-rate CD product that allows the customer to withdraw money once every six months without penalty as long as the original investment amount remains in the CD. The CD also has guaranteed rate increases at seven-, 13- and 19-month intervals.

Bonds

Bonds are another investment alternative. They offer less risk than stocks, but more risk than CDs. In essence, bonds are loans you provide to various entities, from government to private business. In exchange for the loan, the borrower pays you interest.

As with many investments, the riskier the bond you purchase, the higher the return you earn. That means you’re likely to make more money from an entity that is less creditworthy than one that has a proven track record of good credit. But in doing so, you also take on more risk that the borrower will default on its obligation to you.

In short, the 10-year CD is not an ideal option for people who want to maintain liquidity. Also, people who want a greater return will probably benefit from a different type of investment, such as stocks and bonds. Finally, for those who want both security and liquidity, a high-yield savings or checking account is an option to consider.

Related: What Is a Bond and Why Is It a Risky Investment?