Considering cash deposits amid high-interest rates and inflation

For many years, Certificates of Deposit (CDs) offered low-interest rates, thus limiting their investment potential. However, CD rates are on the rise and, in many cases, exceed 3 percent. So are they good investments? As is often the case, that depends.

CDs are similar to bonds: You fork over a lump sum of cash, and you’re paid interest in exchange. With CDs, you agree to deposit your money with a bank or credit union for a specific time period, typically between six months and ten years. In return, you receive safe, predictable interest payments.

Certificates of Deposit are perhaps the safest investments around. Why? The federal government insured the deposited money (up to $250,000). So even if the bank goes belly up, you’ll still get your deposit back. With bonds, if the company you lent to goes bankrupt, you might lose your investment.

Meanwhile, as the Fed raises interest rates, rates for CDs should also rise. In recent weeks, five-year CDs have offered interest rates of around 3.5 percent, owing to Fed rate hikes. In 2018, the average rate offered by banks for five-year CDs was merely 1.5 percent.

Compared to years past, 3.5 percent is a solid return. However, there’s a catch: High inflation reduces buying power. Inflation hit 7 percent in 2021. Thus even as your deposit earns 3.5 percent, you could lose purchasing power. One thousand dollars in 10 years might be worth a lot less than $1,000 right now.

That said, CDs have a key advantage, especially long-term ones: The interest rate is fixed. Let’s say you invest in a five-year CD right now, offering 3.5 percent. Next year, inflation slows, and the Fed cuts interest rates again. Interest rates for new five-year CDs would almost certainly decline. If the 2023 rate for five-year CDs drops back to 1.5 percent, your 5-year CD at 3.5 percent is suddenly a great investment.