With interest rates rising in response to soaring inflation and continued market volatility, the time to borrow and invest can seem uncertain. But there is an upside for savers: the returns from lower-risk savings vehicles – including CDs and Series I bonds – are becoming much more attractive.
If you’re looking for a place to hold short- to medium-term savings and earn interest, both of these can be solid options, although the right choice for you may depend on your financial goals and timeframe.
Here’s how CDs and Series I savings bonds differ and why they’re both attractive options for many savers today.
What is a CD?
A certificate of deposit (CD) is an account that holds money at a fixed interest rate for a set period of time. It’s an attractive option if you’re looking for a guaranteed return, as CD rates are typically higher than the variable rates offered by savings or money market deposit accounts.
You can find a CD at any bank, including online banks, or a credit union. CDs are considered incredibly safe because they are insured deposit accounts. Your deposits are insured up to $250,000 by the Federal Deposit Insurance Company (FDIC) or the National Credit Union Administration (NCUA), depending on the type of financial institution you choose.
Currently, CD rates are on the rise, with some longer-term CDs offering over 3% APY. As with other account types, you’re usually likely to find the highest interest rates with online banks.
Yields on CDs have risen significantly from record highs during the pandemic, says Greg McBride, CFA, chief financial analyst at Bankrate. Like NextAdvisor, Bankrate is owned by Red Ventures. As the Federal Reserve continues to actively raise interest rates, he expects those yields to continue to rise, and even faster than they have already.
A CD requires you to lock in funds for a fixed term, usually between three months and five years. The longer the term, the higher the interest rate you can earn on your deposit. Typically, there are no monthly fees. However, you may have to pay a penalty if you withdraw the money early.
For an emergency fund or other short-term savings that you might need access to at any time, a high-yield savings account is often the best type of account. You’ll earn slightly lower interest rates, but can enjoy easier access to your money while earning a competitive APY.
Types of CDs
While certificates of deposit come with a fixed term and fixed rate of return, different types of CDs offer different options for how you earn money and how much flexibility you’ll have.
For example, a penalty-free CD can help you avoid early withdrawal penalties, allowing you to access your money at any time. But the trade-off is usually a lower interest rate.
If, instead of flexibility, your goal is to get the highest yield possible, look for high-yield certificates of deposit, which are usually found in online banks. Or, if you’re looking to lock up a large sum of money, you might be interested in a jumbo CD, which may offer higher rates but often requires a high minimum balance.
What is a Series I Savings Bond?
A Series I bond has two rates: a fixed interest rate (currently at 0%) and a floating rate that adjusts for inflation twice a year. Because inflation is now at its highest level in 40 years, this type of bond is particularly attractive at the moment.
The US government backs and issues Series I bonds, which means they are low risk. In addition, they benefit from certain tax advantages, in particular exemption from local and national taxes.
The floating interest rate of the I Bonds is currently 9.62%. That’s a great rate, but it won’t last forever. “It will only pay 9.62% for your first six months,” McBride says. “After that, the rate will fluctuate like inflation.” The next adjustment will take place in November.
Terms of the Series I Bonds
Like any type of savings bond, I bonds have withdrawal conditions and limits to keep in mind.
Series I bonds pay interest for 30 years or until you redeem them. However, you cannot withdraw your money for the first 12 months. And if you cash in before the bond’s fifth anniversary, you’ll pay a penalty of three months’ interest.
Series I bond limits
Along with somewhat strict period requirements, there are also limits to the amount of money you can invest in Series I bonds.
In a calendar year, you can purchase up to $10,000 in e-bonds from TreasuryDirect. If you receive Paper I Bonds with your federal income tax refund, you can purchase an additional $5,000. This means that in total you can get up to $15,000 in Series I Bonds in a calendar year.
How Rising Interest Rates Affect Certificates of Deposit and Series I Bonds
The Fed has raised its target federal funds rate aggressively this year to rein in inflation. In June, the rate jumped 75 basis points. When the Fed meets again in July, it is expected to raise its target rate again.
“[Rates] are not directly tied to that benchmark rate,” says Kenneth Chavis IV, senior wealth manager at LourdMurray, a California-based wealth management group. But it is in a bank’s interest to make savings products more attractive to consumers, so that they have more money to lend and make a profit.
As a result, interest rates on savings products are on the rise and will most likely continue to rise in the coming months.
On the other hand, I bond rates tend to run on the opposite side of the scale.
Since I bonds are directly linked to inflation, they become more attractive when inflation is high, as it is today. But if the Fed succeeds in its strategy of lowering inflation with interest rate hikes, I bond rates will also fall.
Since I-bond rates are set every six months, fluctuating inflation rates can result in a wide range of pay rates over time. “If inflation goes down to 1%, at some point you will earn 1% on your I Bonds,” McBride says.
How to Choose Between CDs and Series I Bonds
Both CDs and I Bonds can help you round out a diversified financial portfolio, especially since both currently offer competitive interest rates.
Consider the goals you have for your money to help you decide.
If you’ll need that money in the next five years, a certificate of deposit is a better choice. For longer-term savings goals, Series I bonds may be a better option. For example, if you are looking to increase your college savings, I Bonds can offer tax advantages and protect your funds from inflation.
Over time, pay attention to changes in overall economic conditions, says Chavis. Since CDs and I bonds are highly dependent on what is happening in the broader economy, different economic environments can alter your strategy.
Right now, for example, is a great time to buy I Bonds, “because of the benefit you get from keeping pace with a high level of inflation,” McBride says. As for CDs, he recommends waiting to survey the landscape again in another six to 12 months, when yields might be higher.
On the other hand, “if we’re in, say, a declining interest rate environment, locking in some of that guaranteed rate on CDs for a certain period of time makes sense,” Chavis says.
It’s also important to remember that none of these account types will be the best for every savings goal. For example, if you’re building an emergency fund, keep it in a more flexible high-yield savings account that you can access when you need it.
Plus, you’re more likely to get better returns on your long-term savings goals by keeping your investments in a low-cost, diversified index fund. These funds are riskier, but you will likely earn higher returns on your balance over time.