Are Long-Term CDs Really a Good Idea?


18 May,2015

It’s been a rough several years for savers. Thanks to efforts to stimulate the economy and keep the money flowing through the system, interest rates have been low, and that means lower yields on cash products, like savings accounts and CDs. There are hopes that there is a light at the end of the tunnel, and that rates might rise a little by the end of 2015, but there isn’t likely to be any huge gain for savers anytime in the near future.

One way that some savers try to squeeze a little extra out of their cash is to use long-term CDs. Often, CDs with terms of five, seven, and 10 years have higher yields than their shorter-term counterparts. Unfortunately, chasing these higher yields might not do you much good in the long run.

CDs for Retirement and College

It’s not uncommon for some long-term savers to decide to set money aside in CDs for retirement or college. This is because there is an idea that cash products like CDs are “safe” investments since you don’t run the risks we traditionally associate with investment losses.

On top of that, if you look at long-term CD rates, you see that they often have higher yields. It’s tempting to use a CD strategy to set money aside for your child’s college since you might worry that stock funds in a 529 plan might lose money. Additionally, many of those saving for retirement right now remember the most recent stock market crash, and worry about having money in the market, rather than cash. A 10-year APY seems very attractive when you are looking for something “safe”. As long as you keep your CDs at a bank with FDIC insurance (or a credit union insured by the NCUA), you are likely to have peace of mind.

With the retirement savings, there is the added draw of the fact that it’s possible to hold a CD in your IRA. You don’t have to worry about paying taxes on the interest right now when you keep your CD in your tax-advantaged retirement account.

For those who are concerned about market volatility and worry about losing their capital, CDs seem like the natural choice. However, before you lock your money away in a CD for the long-term, think about some of the drawbacks to CDs.

Cash Products Don’t Offer High Returns

If you are interested in capital preservation, a long-term CD can make sense. However, you need to be aware that cash products don’t offer high returns. Consider saving for retirement. If you happen to have $50,000 that you want to protect for the future, and watch it grow, you might get a 2% yield on it. After 30 years, you’ll have almost $100,000. That’s not quite enough to retire on — so you better have other sources of retirement income. On the other hand, a lump sum of $50,000 left to grow in stocks over 30 years, you’ll have almost $1 million (assuming 10% annualized growth).

For retirement, you have a little better hope with a lump sum investment, though. In the next 30 years, there is a possibility that CD rates will rise, and that you will see better yields on long-term CDs. You might be able to take advantage of a ladder strategy to help you in retirement. Even with this, though, you won’t have nearly enough to retire on if you just stick with CDs.

College savings with CDs is even worse since you are probably dealing with a shorter time frame. Many of us only really start college savings in earnest when children are about 10 years old, and you probably don’t have a lot to set aside. If you put $3,000 in a 10-year CD for your child to use in college later, that money is only likely to grow to close to $3,700. That might be enough to cover books for a couple of years.

Unless you already have the amount that you need for retirement or your child’s college, using a long-term CD strategy for the money isn’t the best plan. Long-term CDs can be acceptable if you’re looking for capital preservation, but they aren’t very helpful if you want to grow wealth over time — and that’s even without figuring inflation risk and taxes in the equation.