Financial adviser Jeremy Keil has become an expert in chasing yield over the past two years – first Series I bonds, then Treasury bills and other fixed-income products. In the past year, he proudly got his clients to move more than $10 million in cash from big banks where it was earning practically nothing and helped them make more than $400,000 in extra interest income.
But now, with all economic indicators pointing to a looming drop in interest rates, they are dragging their feet about locking into long-term rates at 5%. Some are still hoping to get even higher rates down the road. Some don’t want to move out of high-yield savings accounts or money-markets accounts that are finally earning good interest, even though those will be among the first rates to drop if interest rates turn downward.
“I can’t get anyone to lock in rates at 2 or 3 or 4 years,” says Keil, who is based in Milwaukee. His argument is that 5% is a good rate that we haven’t seen in years, and the bond market is indicating that it’ll be lower in six months or so. “The bond market is smarter than you and me,” he says.
Investors often miss the best time to make an investment, but usually we think about this in terms of the futility of trying to time the stock market. The equivalent for that with fixed income is trying to pinpoint when interest rates will peak, which is just as frustrating.
“When you get that email from your bank that the rate is down, it’s too late,” says Ken Tumin, founder of DepositAccounts.com.
Investors today are still pouring money into fixed income, from high-yield savings accounts to CDs to Treasurys, some of which are already starting to dip below 5%. Currently, CDs are sporting the highest rates for longer terms like 2 to 5 years, while the 10-year rate is still inverted and offering the lowest yields. Fidelity says it has seen fixed-income transactions increase 10-fold since 2021. CD Valet, an online marketplace for CD offers, says its seeing the highest volume for 6-month and 12-month CDs.
If you go by the amount of interest institutions are paying out to customers, the increase over the past few years has been enormous. Tumin’s site tracks this every spring via FDIC data, which showed $24 billion paid in interest to customers in 2021 and $79 billion in 2022. “I expect in 2023, it will be much more. I wouldn’t be surprised if it’s close to $200 billion,” Tumin says.
Why lock in now?
The best argument Tumin has for locking in a longer term CD now rate is how he fared with investing in CDs over the last 20 years. In 2007, some online banks offered 6% for some 5-year CDs, which was equivalent to what you could get with some savings banks at the time. “Another year or two and rates had fallen to close to 1%,” says Tumin. For Tumin and some of his readers who also saw the writing on the wall, it paid off very well, as they kept collecting 6% for the whole term.
Fast-forward to the start of the pandemic in 2020, and Tumin ended up on the losing-end of the equation. He thought the Federal Reserve was going to start cutting rates and that a zero-rate environment could last a long time, so he locked into some 5-year CDs paying 2.3% – which was pretty good at the time. He was right for a while, but by 2022, savings accounts were paying more than that. “I took the early withdrawal penalty, which wasn’t too bad really, and reinvested at a higher savings rate,” he says. “And now I locked it in again. We might never see a rate-hike cycle of this magnitude again.”
One of the major reasons why 5% might be a peak interest rate is that banks may eventually want to pay less. “Typically, rates below the 3% range tend to be much more appealing,” says Kevin Miller, chief executive of Travis Credit Union, which is based in California and has nearly $5 billion in assets.
Banks are willing to pay more than that while they are getting a corollary amount of money in interest from borrowers, but they have to constantly keep an eye on their balance sheets to make sure they are taking in more than they are paying out. They also have to pay attention to the competition, and smaller banks looking to expand their customer base tend to be more aggressive with offers. For instance, Travis Credit Union recently offered a 7-month CD at 5.4%. “That’s obviously way on the top end for new money,” says Miller.
These offers typically also come with a lot of caveats. More often these days, that top rate is promotional, says Mary Grace Roske, head of marketing for CD Valet, and the CD reverts to a lower rate at some interval noted deep in the fine print. Many CDs these days are also callable, which means that the bank can pay out the balance at a designated time if market conditions change, and the investor would be stuck having to reinvest at lower rates.
Roske says there are also bump-up CDs, where the investor gets a one-time chance to refinance their CD rate during the term of the contract, but many may miss that opportunity if they aren’t paying attention. And Tumin’s experience shows that it’s key to know the early withdrawal penalties of any CD that you buy, because this could be your escape hatch if the market does not act as expected and you want to get out of the deal.
“A lot of people worry about having money locked in — or being hit by a big long-term withdrawal penalty, which can be 12 months or even 30 months of interest,” says Tumin.
But you can find better terms than that – which he did himself, paying only a small penalty. And you can layer your CDs or other fixed-income products in ladders, where you stagger the maturities so you always have money to redeploy if conditions are good. “A good strategy is not to put all your eggs in one basket,” says Tumin.
