Short-Term vs. Long-Term CD Rates

A certificate of deposit (CD) is a time deposit account offered by banks and credit unions to their customers. It is a stable-value vehicle that offers a guaranteed rate of return. The only requirement is that you keep your deposit in place for a specified amount of time, which is known as the CD term.

What Are Short-Term CDs?

Short-term CDs typically have maturity terms of one year or less. This limits exposure to inflation risk and ensures your money will not be tied up for long periods of time. However, these benefits come at the cost of forgoing the higher yields attainable via longer terms.

Common Term Lengths

Short-term CDs typically have terms that range from one month to a year. The most common terms include one month, three months, six months and 12 months. According to the Federal Deposit Insurance Corporation (FDIC), the national average rates for these tenures range from 0.18% to 1.49%, depending on the term.

These rates are far from attractive, but remember, they are national averages. The most competitive rates are consistently about four to five times higher than the national averages. In 2023, the highest-yielding short-term CDs offer around 5%. 

When a Short-Term CD Is Right for You

A short-term CD makes sense for your personal finances if you want to generate some low-risk interest income over the near term, but do not want to lock up your money for an extended period. They make even more sense if you expect rates to rise. Many people use short-term CDs to save for a big expenditure planned within the next year, such as a vacation, wedding or new car.

What Are Long-Term CDs?

Long-term CDs typically have terms of 48 months or more. The relatively long tenures expose investors to heightened levels of inflation risk and illiquidity. 

Fortunately, during times of economic stability and growth, long-term CD investors are compensated for assuming the elevated risks with incrementally higher yields. However, the yield premium does not exist in the current economic environment.

Common Term Lengths

Long-term CDs typically have terms of 48 months, 60 months or, while rare, 120 months. According to the FDIC, the national average rates for the 48-month and 60-month tenures as of March 2023 are 1.25% and 1.35%, respectively. The FDIC does not report on the 120-month tenure, given its rarity. As noted previously, the top-tier rates are consistently about four to five times the national averages.

When a Long-Term CD Is Right for You

A long-term CD makes sense if you have ample liquidity, are comfortable locking up some of your cash for an extended amount of time (four years or more), and do not expect interest rates to rise. The objective is to generate guaranteed interest for an extended period without exposing yourself to any credit risk or asset price volatility.

That said, investing in long-term CDs does not make much sense in the current environment. For most investors, short-term CDs are a better option.

Comparing Rates for Short-Term and Long-Term CDs

The main driver of CD rates is the federal funds rate, which is the overnight lending rate for banks and the foundation for all longer-term lending arrangements. As the federal funds rate increases, CD rates typically rise. As the federal funds rate decreases, CD rates typically fall. 

In addition, there is another rule of thumb that governs CD rates. Holding all else constant, the longer the CD term, the higher the interest rate.

That said, the positive relationship between the CD term and CD rate only holds true during times of economic stability and growth. During bouts of uncertainty and instability, which often precede recessionary environments, short-term CD rates can exceed long-term CD rates – a phenomenon known as a yield curve inversion.

Rates have inverted due to the following two factors, with the first being more significant than the second.

Two Reasons Rates Have Inverted

1. Since early 2022, the Federal Reserve has been aggressively driving up interest rates to blunt extreme inflationary pressure. 
2. Savers and investors are growing increasingly concerned about the possibility of a near-term economic recession. This is prompting some investors to pull money from short-term instruments and invest in long-term instruments. The rationale is to lock into longer-term fixed rates in case the Federal Reserve reverses its course and begins to rapidly cut short-end rates.

Will a Short-Term or Long-Term CD Generate More Money?

In the current economic environment, the best CD investment is a 12-month CD. Going longer exposes you to incremental illiquidity and inflation risk without corresponding yield compensation.

 Moreover, unless you can find a short-term CD offering an annual percentage yield over 5%, I discourage CD investments altogether. A more flexible alternative is a high-yield savings account, which gives you full access to your funds and up to 5% interest (via the most competitive institutions).

If you’re looking at a short-term CD because you can’t keep your money locked up for a long period of time, a high-yield savings account can give you a comparable return with even more flexibility than a short-term CD. The only drawback is that the rate on a high-yield savings account can be changed at any time.

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