Value of Short-Term Certificates of Deposit?

One thing that has surprised me over the years is the popularity of short-term CDs. Several of my friends and colleagues would never consider CDs with maturities over one year. The 6-month term was often the most popular. It appears my friends weren't unusual. I reviewed call report data from the NCUA for two large credit unions, and the data shows more deposits in short-term CDs than long-term CDs.

You can review call report data from all the credit unions at the NCUA Find a Credit Union tool. This data includes the amount of deposits held in share certificates (CD) with maturities under 1 year, from 1 to 3 years and over 3 years. I reviewed the deposit data of two large credit unions: Navy Federal Credit Union and Pentagon Federal Credit Union (PenFed).

Both Navy Fed and PenFed have a long history of offering very competitive long-term CD rates. Their short-term CD rates have been fair, but rarely have they been near the rate leaders. So one would expect that most money would be in the long-term CDs. This is not the case.

For Navy Fed, $5.1 billion (54 percent) of the CD deposits were in terms under one year, $2.6 billion (27 percent) were in terms from 1 to 3 years, and only $1.8 billion (19 percent) were in terms over 3 years. I've graphed these numbers in the following pie chart.

Not only does PenFed have a history of very competitive long-term CDs, it has also made it easy for anyone to join. So it would be reasonable to expect that long-term CDs would be the most popular. However, mid-term CDs (terms from 1 to 3 years) actually hold the most money with $2.4 billion in deposits (44 percent). Short-term CDs with terms under one year hold $1.8 billion (32 percent). Long-term CDs hold the least amount of money with $1.3 billion in deposits (23 percent). The pie graph below shows the distribution:

Short-Term CDs vs Savings Accounts

It's surprising to see the popularity of short-term CDs. In my opinion, it makes more sense to keep your money in savings or money market accounts instead of short-term CDs with terms under one year. You might earn a little more in interest with short-term CDs than in a savings account, but the slightly higher interest rate doesn't make up for the reduced liquidity.

As an example of how little benefit 6-month CDs provide over savings accounts, I reviewed the savings account and 6-month CD rates at Ally Bank over the last year. A year ago, Ally Savings Account yield was 1.09% and Ally's 6-month CD yield was 1.04%. Six months later Ally Savings Account yield had fallen to 1.04% and new 6-month CD yields had fallen to 0.99%. Today, the savings account yield is 0.84%. I estimated that the average yield over the last year for Ally Savings account is about 1.00%. The average for two 6-month CDs is 1.02%. The 6-month CDs may provide a little higher average rate than the savings account, but I wouldn't consider this high enough to make up for the reduced liquidity.

The liquidity feature of savings accounts may not be too important if you don't need the money for a while. However, it can be important if you want to take advantage of a good CD deal that pops up. The CD deal may end before your 6-month CD matures, and if you break the CD early, you'll be hit with an early withdrawal penalty. In addition, it can take a while to close the CD and move the funds into a liquid account. Even with an internet bank where you also hold a liquid account, it can take take some time. For example, when I closed Ally Bank's no-penalty CD, it took two business days before the money was transferred to my Ally savings account.

Short-Term CDs vs Long-Term CDs

If you want to maximize interest rates on the money that you want to keep safe, short-term CDs don't provide much value. Savings accounts are better choices especially at internet banks. To maximize interest rates, long-term CDs make more sense than short-term CDs. If you're concerned about having too much money locked into long-term CDs, using CD ladders and choosing CDs with mild early withdrawal penalties can help.