Why I Wouldn't Open a 1-Year CD -- Even With Rates at 5%

The Federal Reserve has not yet cut interest rates in 2024 -- but that could change soon. If the Fed cuts interest rates later in 2024, that means right now (July 1, 2024) could be the best time to open a 1-year CD. 

Opening a 1-year CD gives you a chance to lock in a higher APY for a full 12 months. In case the Fed cuts interest rates during the term of your CD, your money will keep earning a higher APY than might be available at other banks. But is a 1-year CD the best place to put your savings?  

Despite growing chatter about the possibility of future Fed rate cuts, I'm not convinced that opening a 1-year CD is the best move for my cash. Here are a few reasons why the best savings accounts and money market accounts are still better than the best CDs. 

1. No one knows if the Fed will cut interest rates 

Trying to make predictions about the Fed's interest rate cuts can be a fool's errand. Back in December 2023, the conventional wisdom from Wall Street experts was that surely the Fed was going to cut interest rates, starting soon, in 2024. Well, we're halfway through 2024 and so far there have been no interest rate cuts.

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And even if the Fed cuts rates, no one knows when. Or how much. Or if a (presumably) 0.25% rate cut would be the last for a while. The Fed could cut rates in September 2024 or November 2024 or both, or neither. The Fed's decision makers don't even know; they're trying to make complex choices based on changing information. 

But the point is: don't open a 1-year CD because you're 100% certain the Fed will cut interest rates. Even if the Fed cuts rates by 1.25% during the course of your CD's 12-month term, is that really worth locking up your money? Because…

2. A 1-year CD makes you lock up your money for 12 months 

CDs make you lock up your money. Whether it's a 1-year CD or a 6-month CD, every CD wants you to keep your money committed for a certain term of time.

And if your plans change and you need to pull money out, you'll have to pay an early withdrawal penalty. This penalty can eat up most (or all) of the interest you would've earned from the CD. 

Early withdrawal penalties feel too risky. I couldn't stomach the feeling of losing money on something that was supposed to be a guaranteed, risk-free investment. If CDs paid APYs that were several percentage points higher than the best bank savings accounts, then maybe I'd be willing to risk that early withdrawal penalty. 

In my opinion, CDs don't compensate you enough for the risk you take if you need to take out that money sooner than expected. 

Early withdrawal penalties are a big downside of CDs, and they're a deal-breaker for me. I'd rather keep my money in a savings account or money market account, and have complete freedom for when and how to use my cash. I'd rather run the risk that the Fed will cut interest rates (likely causing my savings APY to decline).  

3. A 1-year CD's extra earnings aren't much better than a savings account 

Here's the best case scenario for a 1-year CD: you open a CD today and get 5.00% APY. In one year, your CD term is up, and during that time, the Fed has cut interest rates by 1.25%.

So congratulations -- your yield was 1.25% better than what you might have gotten from the best savings accounts. (This assumes the best savings account APYs would go down by 1.25%, in lockstep with the Fed's interest rate cuts -- which is likely, but not 100% guaranteed.) 

Here's how much you'd earn on $10,000 of savings from a 1-year CD at 5% APY vs. a savings account paying 3.75% APY after 1.25% of Fed interest rate cuts: 

So in exchange for locking up your $10,000 of cash in a CD, you'd earn an extra $125 in 12 months -- about $10 per month. Is that worth it?

And this is not a perfect calculation, because it assumes that savings account APYs went down dramatically, all at once, from 5% to 3.75%, and paid that lower rate for the full 12 months.

In reality, if the Fed gradually cuts rates over 12 months, the best savings accounts would keep paying nearly 5% APYs for part of that time.

Bottom line

Unless you have $100,000 to put in a CD, and you're absolutely certain you won't need to take it out, most everyday savers should not lock up their money in a 1-year CD.

The best savings accounts and money market accounts (for now) are paying the same or better APYs, and you don't have to pay penalties to withdraw your cash when you need it.