Credit Union vs. Bank: Which Should You Choose?
What Is a Joint Bank Account, and Is It Right for You?
How to Write a Check: Your Step-by-Step GuideValue 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.
As Ken (and others) have pointed out, the devil is in the details. Some banks and CUs are explicit about restrictions on early withdrawals (allowed only in their discretion). Others allow EWs on liberal terms, but have general amendment terms that put the policy in some doubt (particularly in view of the ill-considered NCUA letter ruling on Fort Knox CU).
As for those confidently predicting that interest rates will absolutely, positively never go up again, what are you doing wasting your time nickel-and-diming with CDs? Put all your money into writing interest rate futures contracts on Globex, reaping in the big bucks from gullible hedge funds seeking protection from rising interest rates. What could possibly go wrong? ;-)
Seriously, I prefer short term CD's in this interest rate environment. Suze Orman's January newsletter says there is a 50% chance of stagflation in the next year (I think I remember the timing correctly).
I don't want to be all tied up if we go into rising rates. And I hate ladders. I've always been fearful of them..
The economic cycle has been repealed! It's all different this time!
Yup. In the late 1990s, we saw people giving elaborate explanations about why the stock market will go up 25% every year. In the mid-2000s, we saw long articles explaining that real estate MUST go up 20% every year from now on. We were assured that it was all different now. The old rules no longer applied.
But this time it really, really is different, right?
As for rates "never" going up...that is just foolishness. Rates won't be allowed to rise for many years, at least 5 years, but maybe 8-10 years. During that time, the central bankers are going to induce heavy inflation, while buying bonds to artificially reduce rates on savings and bond investment. Once we experience the 20-30% per annum inflation, and the debt burden is brought down to, perhaps, 1/4 of what it is now, they will reverse gears, as they did after the Great Inflation of the 1970s, and raise rates dramatically. We don't know when it is going to happen, or how fast they are going to debase paper currency, and that is why investing in CDs or bonds is so foolish.
Buy platinum, or even gold or silver. That is the best alternative to CDs, especially when the price takes a big dip, like now. Or, if you need money currently, buy high dividend stocks likely to maintain their dividends in a highly inflationary environment. Some will object to this as too "risky" for them. While it is true that no risk is attached to bonds and CD investments, that is only because the outcome is a certainty. You will find your savings wiped out by inflation.
That said, this is a great site to find good liquid savings accounts in which you can hold your ever deeply debasing paper money, for short periods of time, while you decide how to invest it in real assets.
[1]: 12 U.S.C. § 4305 http://codes.lp.findlaw.com/uscode/12/44/4305
(c) Distribution of notice of certain changes
If -
(1) any change is made in any term or condition which is required to be disclosed in the schedule required under section 4303(a) of this title with respect to any account; and
(2) the change may reduce the yield or adversely affect any holder of the account,
all account holders who may be affected by such change shall be notified and provided with a description of the change by mail at least 30 days before the change takes effect.
[2]: http://www.alliantcreditunion.org/pdf/global/AccountAgreementAndDisclosures_P105R0111.pdf
page 6:
"All accounts described in this Truth-In-Savings Disclosure are share accounts. The Truth-in-Savings Act allows for the change in terms of share accounts as long as 30 day advance notice is given."
[3]: 12 U.S.C. § 4303 http://codes.lp.findlaw.com/uscode/12/44/4303
"all fees, periodic service charges, and penalties which may be charged or assessed against the account"
"Any annual percentage yield."
"The period during which any such annual percentage yield will be in effect."
"any minimum time requirement which must be met in order to obtain the yields"
"Any provision or requirement relating to nonpayment of interest, including any charge or penalty for early withdrawal, and the conditions under which any such charge or penalty may be assessed."
Too many people are looking at CDs as financial trading vehicles rather than a savings vehicle of which CDs were original intended. Don't blame the banks and credit unions for changing the terms and conditions of their CDs to meet the changing attitude of many CD holders.
One must read the fine print caredully. Each bank and CU does it differently. But if you choose an institution that unequivocally allows early withdrawals; has a liberal EWD penalty; and does not reserve the right to amend, I'd venture to say that very few judges, juries or arbitrators would say that the institution could unilaterally alter that contract. After all, as others have noted, under that rationale, the institution could take a customer's 5 year 2.3% CD; give the consumer a 30 day notice that the CD was now 0% and 20 years. The EWD penalty is as much a material part of the deal as the term and rate.