With the Federal Reserve expected to hike interest rates in the coming months, so-called rising-rate certificates of deposit may sound like a good deal to savers eager to capture the higher returns.
But looks, in banking as in life, can be deceiving. A survey from personal finance website Bankrate.com suggests this year's crop of rising-rate CDs leaves much to be desired. In most cases, online savings accounts, traditional CDs or a combination of both are a better choice for investors, according to the research, which is based on an analysis of rising-rate CDs offered by 150 of the country's largest banks, thrifts and credit unions.
Rising-rate CDs have been around for some time. But with the Fed pushing ahead, albeit cautiously, with its planned rate hikes, they may have more allure to consumers. Banks are certainly eager to drive more deposits to CDs, which have lost considerable luster since interest rates hit rock bottom in the years immediately after the housing crash During the one-year period ending in April, there was a net outflow of about $100 billion from CDs, according to the central bank.
Traditional CDs pay a fixed interest rate over a specific period of time, and the penalty for withdrawing money before a CD matures can be hefty. Rising-rate CDs, which come in several forms, are designed to offer investors some protection against being locked into a low yield if rates rise, either by allowing them to withdraw their money without a penalty or giving them a mechanism to raise their rates.
But the Bankrate.com study found that, while some rising-rate CDs are a good value for consumers, many are duds.
Liquid CDs, for instance, allow account holders to withdraw some or all of their principal without paying the dreaded early-withdrawal penalty. But they are useful to investors only at longer terms, according to the study. Some liquid CDs with terms of three to five years have yields that are competitive with traditional CDs, which means that account holders get a "free" liquidity option, according to the study.
Liquid CDs with terms of two years or less also offer significantly lower yields than online savings accounts, which don't have the same restrictions on when and how account holders can make withdrawals.
So-called bump-up CDs are also a mixed bag. These CDs allow account holders to "bump up" their rate one or more times to the prevailing rate on CDs. In some cases, the amount of the increase is capped.
But Bankrate.com argues that only those with terms of two years or longer are worth considering. That's because "there is slightly less than a snowball's chance in hell" that rates will rise fast enough to allow account holders to come out ahead, according to the study.
"You need rates to go up by a notable amount, but that needs to happen quickly enough to allow you to exercise the bump up and still have enough time in the remaining term to benefit from the higher yield," explained Greg McBride, chief financial analyst for Bankrate.com.
Callable CDs are an even worse deal for consumers, according to the study. A callable CD has an "embedded call option" that allows the bank to call the CD back at any time during its term, paying account holders their principal and earned interest.
Since these options benefit banks, CD investors should expect some compensation in return, but in most cases they are left empty handed, according to Bankrate.com. Of the 12 callable CD offers that were reviewed by Bankrate.com, none offered a yield comparable to the highest-yielding conventional CDs.
"Callable CDs are a 'heads I win, tails you lose' proposition," McBride said.
If rates rise, banks aren't likely to exercise their call option, he said. If rates drop, they are likely to do so, leaving savers to look for ways to reinvest their money in a lower-rate environment, added McBride.