A yield curve shows the change in interest rates between investments with the same credit risk but different maturity dates. A normal yield curve shows lower interest rates on shorter durations, with rates rising as the duration increases because long-term investments have additional risk.
Before you invest in a certificate of deposit, consider the fact that its annual expected yield can be directly tied to the yield curve for investing in U.S. Treasury bonds.
Yield Curve Patterns
Yield curves typically fall into one of three patterns: steepening, flat or inverted. A steepening yield curve, where the interest rates increase as the duration increases, generally suggests a growing economy based on market data. A flat yield curve means the interest rates are the same regardless of duration, and typically indicates lower expectations for future growth. On the flip side, an inverted yield curve — also known as a negative yield curve — has traditionally been interpreted to mean a recession is coming.
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You likely will only need to check the current yield curve when you are considering opening new CD accounts or reinvesting CD money on accounts that are due to mature. You can check yield curve rates through various online sources, such as Treasury.gov’s Treasury Yield Curve chart.
How Yield Curves Affect CD Rates
Banks typically set rates for CDs slightly higher than the rates on U.S. Treasury bonds with similar durations. Treasuries can be bought and sold, allowing the investor more flexibility, so banks need to set the APY for a CD higher to incentivize investing.
As the yield curve for U.S. Treasuries increases with longer durations, CD rates usually follow suit. Similarly, if U.S. Treasury rates fall, banks will lower the rates they pay on CDs.
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What to Consider Before Investing in CDs
Typically, you’ll earn a higher interest rate on your CD if you agree to a longer term — such as three years instead of six months. But, if you take your money out before your CD matures, you might pay an early withdrawal penalty. To hedge your risk, consider laddering your CDs, in which you divide your money into several CDs with varying maturity dates, so you have access to a portion of the money every few months and you have the option to reinvest the money in a new CD — an enticing option if CD rates have risen.
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Different CDs might have additional beneficial features or challenging requirements to meet. For example, the advertised interest rate might require a minimum investment. You might also consider getting a bump-rate CD, which allows you to convert to the market rate once or more before your term expires.
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