Money managers are dusting off their low-risk investment options for consumers who are finding certificates of deposit attractive again.
The run-up on CDs corresponds with rising interest rates that are meant to cool inflation by making the cost of borrowing more expensive. The federal funds rate-the interest banks charge one another on overnight loans-is the highest it’s been since early 2001.
While that’s not so good for home buyers, it does benefit investors searching for short-term savings returns. Interest rates on six-month CDs, for example, have climbed from roughly 1 percent in 2003 to 5 percent now, making the CD market much more appealing.
“I think CDs will remain attractive probably for the rest of the year,” said Steve Tolen, president and CEO of Symphony Bank in Carmel. “We may have seen the last of the big interest-rate increases, and people are beginning to lock in good rates now.”
The Federal Reserve met May 10 and raised the federal funds interest rate a quarter-point, to 5 percent, extending a string of increases. It has raised rates 16 straight times, starting in June 2004.
Many market analysts predict the string of increases will end at the next Fed meeting in late June as strong economic growth moderates slightly.
A few banks that list interest rates in IBJ indeed are offering 12-month CDs with annual returns of 5 percent or better. And some six-month CDs are not far behind, topping out at 4.96 percent.
The higher interest rates are driving investments in CDs, money-market funds and Treasury notes. At the end of last year, time deposits in the United States totaled $2.2 trillion, according to the Federal Deposit Insurance Corp. That’s up from $1.6 trillion in March 2003, about a year before the Federal Reserve began raising interest rates.
That’s causing banks and investment firms to shop their offerings more aggressively to customers, while hoping to attract new clientele.
Symphony Bank offers a 12-month CD with an annual percentage yield of 5.23. The startup is paying one of the highest rates in the region, Tolen said, to help lure patrons to the new bank.
Indiana Members Credit Union is advertising a 24-month certificate with a 5-percent yield. The south-side credit union normally promotes one or two CDs as specials, said Todd Habig, IMCU’s senior vice president of finance.
It introduced a five-year CD a few years ago with an annual yield of 5 percent, more than 1 percent above the market rate. The south-side credit union “made a splash” with its bold initiative to attract investors uninspired by the low interest rates, Habig said.
“During that period of time, we ran a number of CD specials to keep the growth going, which it did,” he said. “Now, we are seeing more demand as the rates have gone up.”
JP Morgan Chase declined to divulge its CD rates, because they can change daily, said Garland Frazier, Chase’s head of consumer banking in central Indiana. The bank advertised a special 5-percent rate for 12-month CDs on its Web site in early May.
Chase, in some instances, will quote existing clients a better rate than what is promoted, Frazier said. The idea is to build customer relationships.
“We’ve got more of our customers coming in and inquiring about [CDs],” he said. “We’re advertising along with the rest of the competition out there.”
Investment brokerage Edward Jones is seeing more demand for CDs as well. The reason: The average annual percentage yield on a six-month investment is the highest it has been since 2000, said Bob Campbell, Edward Jones’ regional leader in Greenfield.
“Short-term rates are yielding about the same as long-term rates, and that gets a lot of interest,” Campbell said. “You can get more interest on a one-year CD than you can on a 20-year bond.”
Short-term CDs normally have less attractive returns than safer, long-term investments of three to five years. But sometimes, such as now, short- and longterm rates are about the same, causing what is known as a flat-yield curve. In a fully inverted yield curve, all short-term rates are higher than long-term rates. That hasn’t happened in more than four years.
But Campbell cautioned against getting too excited about short-term investments, which are the most volatile. If interest rates suddenly drop, he said, the earned income is reinvested at a lower rate.
He further said institutions usually offer the highest yields on short-term CDs when interest rates are about to peak. That way they can pay 5 percent once on a 12-month CD rather than shelling out that amount annually for the next five years, Campbell said.
Financial advisers recommend investors spread their fixed-income portfolios over several years-a practice known as laddering. The way it works is, an investor purchases five CDs with varying maturity dates. When the first comes due in one year, the investor purchases a new fiveyear CD. In two years, when the second CD matures, it also is rolled over into a five-year CD, and so on.
Using that strategy, 20 percent of a CD investment will mature each year and income will be more predictable. If interest rates rise, investors still can take advantage of them each time they reinvest in a CD. If the rates fall, they still have most of their investments locked in at higher rates.
“We’re probably near the end of rising interest rates. That’s why it’s important for the investor to not get greedy,” Campbell said. “This is the time to consider locking in some of your money at those interest rates for a longer time.”
The average annual percentage yield for a six-month CD during the past 20 years is 5.1 percent, according to the Federal Reserve. Rates topped out at 9 percent in 1989 and hit bottom at 1.1 percent in 2003.