Rising interest rates may be tough on home buyers, but they’re a godsend for savers on a fixed income.

Decades ago, certificates of deposit (CD) were considered investment gold. In the early 1980s, the average annual percentage yield (APY) on a one-year CD was more than 11%. Three-month CDs averaged an eye-popping 18.3% APY in 1981.

By the 2000s, these returns plummeted. Following the global financial crisis in 2008, the average one-year CD paid less than 1% APY, and rates have hit historic lows over the last decade.

Now CDs are making a comeback. Following the Federal Reserve’s recent interest rate hikes designed to tame inflation, higher-yielding CDs have surged.

“The Federal Reserve has raised interest rates at the fastest pace in 40 years in the ongoing battle against inflation, with savers seeing the best returns on savings accounts and CDs in more than a decade,” said Greg McBride, Bankrate’s chief financial analyst in a recent Bankrate article.

Learn tips for coping with inflation during retirement.

How a CD works

Offered by most banks, credit unions, and brokerage accounts, CDs are a type of short-term savings account in which you invest money for a fixed period of time, earning interest during that period. CDs are low-risk assets that usually have a low or no minimum investment. A CD bought through a federally insured bank or credit union is insured up to $250,000.

The pros of CDs

• Guaranteed rate of return
• Low to no risk
• Federally insured up to $250,000

The cons of CDs

• Lack of access to your money for the length of the CD
• If interest rates rise, you can miss out on higher rates
• Penalty assessed if you terminate the CD early
• Typically lower returns over time than stocks

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Should you build a CD ladder?

Historically, longer-term CDs have paid a higher interest rate than short-term CDs. That makes sense: A bank should pay you more for the right to use your money longer.

Of course, that also means you’re tying up your money for four or five years. One way investors sometimes offset this disadvantage is by building a CD ladder.

A CD ladder staggers your investment across short- and long-term CDs. For instance, you might invest $5,000 in five $1,000 CDs: a 1-year, 2-year, 3-year, 4-year, and 5-year. When the low-paying 1-year CD matures, you can invest it in a new (presumably higher paying) 5-year CD. After four years, all of your money would be earning the higher five-year rate, but you’d have access to some of it sooner.

CD ladders can provide an attractive balance between the advantages and disadvantages of CDs. Unfortunately, banks at the moment aren’t offering as much incentive for longer terms as they once did. You may have to look harder to find a long-term rate that makes it worthwhile to tie up your money. Many banks are offering atypical terms – Bank of America, for example, recently offered an APY of 5% for terms of 7 and 13 months, while 1-year and 5-year CDs paid only .03%.

That’s right. Tying your money up for 12 months earned you 3/100 of a percent in interest. Committing to just one more month resulted in a 5% return.

Clearly it pays to be flexible when looking at term lengths! It also pays to shop around if building a CD ladder. You may find the best combination of rates and term lengths by using more than one bank. And because of their lower overhead, online banks often offer the best rates around.

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What if you already own a low-paying CD?

With short-term interest rates spiking, you might be tempted to break an older long-term CD and re-invest. Breaking the CD may make sense if you are in, say, a 5-year CD that pays 1% APY but can buy a short-term CD yielding 5%.

In order to benefit, you first have to weigh the lost interest and the hit that the early withdrawal penalty fee will have on your earnings if your CD is cashed out before its maturity date. Early-withdrawal penalties are usually calculated as a period of interest, such as 180 days. The penalties vary considerably and depend on the bank, the term of your CD, and when you withdraw your money. Longer CD terms often have a larger penalty.

You can call your bank and ask what the penalty would be for breaking your old CD. Then you’ll want to compare that to the potential return on another CD. You can also find online calculators that will do the math for you.

With short-term CD’s offering relatively high returns, it pays to do the math!

Are you paying too much for Medicare?

When you’re looking to stretch your dollar farther, don’t forget to look at your healthcare expenses. Co-pays and out-of-pocket costs for things like eyeglasses and dental work can quickly add up. Make sure you have the right plan for your budget and your needs. Call us at 888-992-0738, or compare your plan options with our easy-to-use Find a Plan tool.

Additional resources

• ClearMatch Medicare: Find a Medicare Plan
• Deposit Accounts by Lending Tree: Is It Worth Paying an Early Withdrawal Penalty to Break My CD (Calculator)
• Bankrate: Historical CD Interest Rates: 1984-2023