3 Reasons You Shouldn't Be Happy About 5% CD Rates
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For a long time, savers were lucky to earn an APY of 2.00% in a CD. So once rates started climbing, many people jumped on the bandwagon and started putting more money into them.
At this point, it's pretty easy to find a CD that will pay you a 5.00% APY. And you may be inclined to dive right in since, well, that's a risk-free 5% return coming your way.
But while today's CD rates may be appealing to savers, they're not a totally good thing. Here's why you shouldn't necessarily jump for joy over the fact that CDs are paying rates of 5.00%.
1. Rampant inflation is what (indirectly) got us here
Rampant inflation didn't directly cause CD rates to rise. But the chain of events leading to today's impressive CD rates was fueled by a bout of soaring inflation that kicked off in 2021 and came to a head in 2022.
When inflation rises, it can impact everything from grocery prices to rents to utility costs. And while the pace of inflation has slowed over the past year, ask just about anyone you know, and they'll tell you the same thing -- it feels as if just living is still incredibly expensive. Worse yet, there doesn't seem to be much relief in sight.
2. CD rates are up, but so are borrowing rates
The reason inflation indirectly caused today's CD rates is that the Federal Reserve had to do its part to respond to rising living costs and give consumers relief. To that end, the central bank spent much of 2022 and 2023 raising the federal funds rate in an effort to slow the pace of inflation.
Thankfully, inflation has cooled off. But as the Fed's benchmark interest rate has risen, so too have interest rates across the board.
Now that's a good thing in the context of CDs and savings accounts as well, as it means that people with money in the bank are getting to earn more interest on their cash. But the Fed's rate hikes have also made borrowing more expensive. So now, those needing to finance purchases or take out loans are looking at higher interest rates -- and higher monthly payments.
3. A 5% return on your money isn't that great in the long run
It's a nice thing to get a 5% return on your money for cash that's parked in the bank on a short-term basis. But you should know that in the grand scheme of things, a 5% return isn't all that great -- especially when the stock market's average annual return over the past 50 years is twice as high.
A CD is a fine place to put your money for the next 12 months if you're not sure exactly what you want to do with it. But over time, your goal should be to invest your money so you're able to grow it at a much quicker pace than what CDs might allow for.
Case in point: If we were to be optimistic (not realistic) and assume you could get a 5% return on CDs for the next 20 years, a $10,000 deposit today would be worth about $26,500 in two decades from now. But with a stock portfolio delivering a 10% return, in 20 years, your $10,000 could be worth a little more than $67,000 instead. Which ending balance would you rather have?
CD rates at 5.00% might seem great. In reality, they're a mixed bag. And it's important to know that, even if you're going to open one anyway.
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