Why High Yield Savings Accounts Are Now A Better Deal Than CDs

Investing-in-High-Yield-BondsWhat are the current yields on high rate CDs and savings accounts?

High Yield Saving Accounts are now offering yields of 0.90%. See Rates

High Yield Two Year CDs are now yielding 1.15% (if you’re willing to purchase a long-term CD, such as a 5 year CD, the yield can reach 2.00%) See CD Rates

There is really minimal difference, 0.25%, between the highest yielding 2 year CDs and savings accounts, and savings accounts give you more investment flexibility.

A New Fed Chairman Could Lead To A Spike In Rates

If interest rates rise over the next 2 years, a savings account gives you much more flexibility to take advantage of the higher rates. Unlike CDs where there can be huge penalties for early withdrawals (like giving up all your interest), savings accounts give you the opportunity to move your money out of savings with no costs.

There is a great deal of uncertainty about interest rates. No one expects interest rates to fall but, there is a tremendous amount of disagreement about when and how much interest rates will rise. Essentially, US interest rates in the short-term will be highly influenced by the actions of the Federal Reserve. To make things more interesting, there is about to be a major leadership change at the top of the Federal Reserve. In January 2014, Ben Bernanke’s term as chairman of the Federal Reserve will end and there is no clear successor in the wings. There are in fact two candidates, Vice-Chairman Janet Yellen and Larry Summers (former Treasury Secretary under Clinton). If Summers gets the nod, interest rates are expected to rise much faster than under Yellen.

Inflation May Serve As A Lid On Rising Rates

While the Fed has artificially kept rates low by buying bonds, that doesn’t mean that interest rates should be dramatically higher.  Conventional wisdom is that inflation is the long-term driver of interest rates and that medium-term (5 year interest rates) should be between a half percent and 2 percent higher than inflation.  Over the last few years, inflation has been very mild, in the range of one to two percent, implying that five year interest rates should be in the neighborhood of 2.5% or about one percent higher than the current market.

Risk Reward Analysis Of A High Yield 2 Year CD Versus A High Yield Savings

If rates stay the same, the CD will earn a quarter point more per year or half a percent over 2 years. On $10,000, a CD should earn you $50 more. All scenarios assume that you move your money from the savings account to a one year CD after 12 months.

If rates rise about 0.5% on 2 year CDs over the next 12 months, the returns will should be more or less equal. (Assumes the 1 year CD rises about 0.1% less than the 2 year.)

If rates rise 1% (the fed starts sharply cutting back its bond buying) over the next 12 months, starting out with a savings account will return about $100 more.

If you give each of these scenarios an equal probability of happening, the better strategy is investing in the savings account.  Click here for rates on high yield savings accounts.

Print Friendly
                                   

Leave a Reply

Your email address will not be published. Required fields are marked *