I Bonds look good next to miserable interest rates on CDs
Inflation has been so high that many Generation X and younger people have never seen prices go up so fast. The Federal Reserve is on track this summer and later to keep pushing interest rates up to try and calm things down.
Borrowers end up paying more for home loans, car loans, and other loans. But the savers? They complain that the interest rates they receive on their savings remain stuck in a ditch. Why don’t savers also see much higher rates?
The average one-year yield on a certificate of deposit is 0.26% today, down from 0.17% a year ago, according to Bankrate.com.
Of course, it’s almost 53%. But such low rates mean that on a $10,000 CD you’d earn about $26 in interest per year, which isn’t even enough to cover a tank of gas. That’s $9 more than what you’d earn with a rate of 0.17% a year ago.
Why CDs Don’t Track
Savings accounts and short-term CDs can be great, low-risk places to put money to cover unexpected events like a big car repair or even a short-term job loss. But they are incredibly uninspiring to keep up with inflation when the consumer price index climbed 8.3% for the 12 months to April.
Why is there such a disconnect?
“During the pandemic, deposit rates had fallen to historic lows,” said Ken Tumin, founder of Deposit accountswhich is part of LendingTree and tracks and compares bank rates.
This was prompted by the Federal Reserve’s policy of cutting short-term interest rates 0% rate at the start of the COVID-19 pandemic in March 2020 to combat the economic downturn.
Now the Fed is raising rates to fight inflation. But savings rates, including those on short-term CDs, have a a long way to go to even reach 1% or 2% in many cases.
The overall return of savings accounts tracked by DepositAccounts — including mostly brick-and-mortar banks — rose just 0.13% from 0.12% in the past six months, Tumin said.
Tumin, senior industry analyst at LendingTree, said big banks are often slow to raise rates on deposits, especially when deposit levels remain high.
“Physical banks, especially large banks, have been the slowest to react to the rate hike,” Tumin said.
“On the other hand, online banks have started to react much more aggressively in the last couple of months.”
According to Greg McBride, chief financial analyst for Bankrate.com, which lists prices on various products, including CDs.
“Most banks currently have enough deposits, especially the big banks, and will be even slower than usual to increase deposit payments,” McBride said.
After: Why savers are rushing to buy I Bonds in the last days of April
After: Detroit Metro Rents Rise 8.8% Over Past 2 Years As Inflation Sizzles
Savers who want to find higher rates will need to look for places, McBride said, where their “money will be welcomed with open arms and higher returns — online banks, small local banks and credit unions.”
Best CD rates often below 2%
Just leaving money at low rates doesn’t create much wealth. It can pay to shop around for better than average rates.
The average yield on one-year CDs offered by online banks has skyrocketed over the past two months — from 0.74% to 1.49% — for savers, Tumin said.
“And I expect the rise to continue,” he said.
It is possible, he noted, that one-year CDs offered by online banks in the future could eventually rise higher and reach 3% by the end of this year.
Synchrony Bank, an online bank, for example, offers a return of 1.5% with no minimum deposit on a one-year CD. Some other banks offer yields of 1.4% to 1.7% on one-year CDs with minimum deposit requirements ranging from $500 to $1,000.
Ally Bank, an online-only bank that is part of Detroit-based Ally Financial, has a 12-month CD with an annual percentage yield of 1.4%. No minimum balance is required. Ally has a 9 month CD at 1%.
As of June 1, Marcus By Goldman Sachs, an online-only bank, had a CD yield of 1.4% on a one-year CD with a minimum deposit of $500. Marcus highlights a 10-day CD rate guarantee with the promise that if the rate for your selected CD term increases during that time, you’ll get that rate automatically.
Genisys Credit Union, based in Auburn Hills, has a 13-month savings certificate with a yield of 1.4%. Minimum balance: $500.
We will likely see interest rates rise in general in 2022 as the Federal Reserve raises short-term interest rates to cool demand and fight high inflation.
The next Federal Reserve policy committee meeting is June 14-15, when the Fed is expected to raise short-term rates another half a percentage point.
A potential half-point rate hike in June – which would be the third hike in 2022 – would drive the fed funds rate to a new target range of 1.25% to 1.5%.
Another Fed meeting is scheduled for July 26-27, where some say the Fed should hike rates another half a point.
What future for savers?
CD rates are likely to climb higher going forward as the Fed raises rates again.
As long as the Fed keeps raising rates, Tumin said, it makes sense not to put all of your savings on CDs.
Although you might be tempted to seek a slightly higher rate on a five-year CD, for example, you might miss locking in an even higher rate in the months ahead.
Often you want to stagger your CD savings to take advantage of new higher rates in the future.
McBride said banks and others offering one-year CDs that are currently at 1.75% could offer new one-year CDs at 2.75% by the fall.
“I would wait to lock in multi-year CDs because yields haven’t peaked yet,” McBride said.
Why many watch I Bonds
Today’s pitiful CD rates, however, give savers more reason to put some of their savings into US inflation-adjusted savings bonds or I Bonds.
I Bonds purchased from May to October pay an annualized rate of 9.62% for a period of six months. Interest is compounded semi-annually.
The high rate applies to the first six months. After that, another inflation-adjusted rate would apply to the bond, depending on whether inflation heats up or cools down.
The annual purchase limit for I Bonds is $10,000 per person. I Bonds can be purchased online at TreasuryDirect.gov.
Some savers may be able to add an additional $5,000 per year if they choose to order a federal income tax refund to I Bonds. But you must do this when you file a tax return and file Form 8888 with the return.
It is therefore possible for some to buy up to $15,000 per year.
High rates that reflect rising inflation began to drive interest in I Bonds in 2021 and, again, in 2022.
For example, savers who purchased I Bonds from November 1, 2021 to April 30, 2022 will receive an annualized rate of 7.12% which applies to the first six months. Then, the latest annualized rate of 9.62% comes into effect for the next six months.
Result: the average rate would ultimately be 8.37% over 12 months. On $10,000 of savings for this I Bond scenario, the interest for the first year would be at least $837 if you hold the bond for at least 15 months.
Limitations: I Bonds cannot be cashed at all during the first 12 months. If you cash them before the end of the five years, you will lose the last 3 months of interest. If inflation were very low, you would lose a minimal amount of interest.
If you only plan to hold a bond for a short time, you might want to wait at least 15 months to avoid losing three months of interest at this current ultra-high rate, according to Daniel Pederson, a bond expert at savings based in Monroe and founder of www.BondHelper.com.
I bonds proved to be a hot commodity in April as savers tried to lock in these two sets of high rates.
About $4.26 billion in I bonds were issued in April alone, compared to $211 million in April 2021, according to the Treasury’s monthly public debt statement. That’s about 20 times last year’s sales in April alone.
Over $10.4 billion was invested in I Bonds from January to April this year.
What if you still haven’t bought any I Bonds?
Even if you haven’t locked in a buy rate in April or earlier, it might still make sense to buy I Bonds from May to October, according to Pederson.
We don’t yet know what the new inflation-adjusted rate would be from November to April 30, 2023. So you don’t know what return you would get over 12 months.
If the inflation rate were to drop to 0 — and it’s not expected — the overall 12-month return would still be 4.81% for the year for those buying from May through November, Pederson said.
“Compared to CDs, money markets and savings accounts, you’re always going to beat them,” he said.
If inflation continues, as many expect, you would add an inflation-adjusted rate on the savings bond that would drive the 12-month yield above 5% and possibly more.
Pederson said it can be a good idea to keep emergency savings in easily accessible accounts, like a savings account. But other savings, which can be used for larger emergencies, can also be set aside in I Bonds, if that money won’t be needed for 12 months.
It is important to note that you can withdraw money earlier from a 1 year CD, but you will generally lose 3 months interest if you withdraw earlier from a CD with a maturity of 1 year or less .
For young savers who are still in school or starting their careers, I Bonds offer a great way to earn a higher rate with as little as $25 in savings when you buy direct online.
Someone who has accumulated more savings over the years and has money just to check or save can obviously get a better return now on some of that savings, up to $10,000 per person and per year with I Bonds.
Many people recognize the opportunity for higher rates – and we’ll likely hear more grunts about savings rates and more conversations about I Bonds.