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Certificate of Deposit Rate Tip for 2013 – Stay Invested in Shorter Term CDs

The new year brings us more of the same, very low CD rates on all certificate of deposit maturities, from the shortest term to the longest term certificates of deposit. The CD rate curve is flat, which means the rate difference between 3 month and 5 year certificates of deposit is minimal. With such a small difference in CD rates, it makes financial sense to stick with shorter term certificates of deposit.

For example, right now on our rate list the best CD rates 3 month certificates of deposit are at 0.65 percent and the highest CD rates on our 60 month certificate of deposit list are at 1.80 percent, a 1.15 percent rate difference. In the Federal Deposit Insurance Corporation's national rate and rate cap survey, the rate spread is even lower.

In this week's survey, bank CD rates on 3 month certificates of deposit are averaging 0.10 percent while the average rate on 60 month certificates of deposit are at 0.88 percent, only a 78 basis point difference. Comparing shorter term CD rates at banks, the rate curve is even flatter, with some banks the rate difference between 12 month and 18 month rates is less than 15 basis points. Some banks actually offer the same CD interest rate on 12 month and 18 month certificates of deposit.

Looking back several years, the rate spread between certificates of deposit was larger. Back in 2008, the difference between a 1 year CD rate and a 5 year CD rate was over 3 percent at some banks. The average CD rate difference in the FDIC rate survey back in July 2008 was narrower at 99 basis points. This week's average rate difference between 1 year and 5 year rates is narrower at 0.63 percent.

Another reason to stay "short" is CD rates are so low they won't be going much lower and will eventually start moving higher again. Staying short allows you to ride the rate increase sooner than you would be able to if you are invested in longer term certificates of deposit. Yes, you can cash out a certificate of deposit at any time but you pay a penalty. These days the penalty on certificates of deposit of more than two years' maturity is usually at least one year's interest earned. Some banks have the gall to take some of your principal (up to 3 percent) as an early withdrawal penalty.

As you can see, investing in longer term certificates of deposit won't earn you much of a higher return. I certainty wouldn't lock in a 5 year rate at 1.80 percent since rates are expected to move higher before then. The Federal Reserve said they expect to keep the Fed funds rate at exceptionally low levels (near zero percent to be exact) until mid-2015, less then three years from now. Once the Fed increases the Fed funds rate and discount rate, banks follow suit by increasing certificate of deposit rates so if you're locked in a 5 year CD you'll miss out on higher CD rates.
Author: Robert Till
December 30th, 2012