Another reason to rethink CDs: Your return is less than it seems

Published Fri, Oct 11 20243:06 PM EDT

Americans can still get attractive yields on cash alternatives like certificates of deposit — but the real returns may not actually be as high as they are expecting. An analysis from Hartford Funds shows that one-year CDs provided real negative returns in 17 of the last 20 years, once taxes and inflation were taken into account. "If you want to give yourself real income, you need to think about other asset classes other than cash," said Joe Boyle, fixed income investment specialist at Hartford Funds. Investors began flocking to CDs as interest rates began climbing in early 2022, eventually reaching more than 5% in many cases. Now that the Federal Reserve has started to cut the federal funds rate, those yields are moving lower. The central bank decreased rates by half a percentage point in September and indicated another half a point cut by the end of the year, as well as further cuts in 2025. Over the last two weeks, Sallie Mae , American Express , Bread Financial , Goldman Sachs ' Marcus and Synchrony Financial all lowered their one-year CD rates, according to Wells Fargo. Since the Fed started lowering rates in September, the average one-year CD rate has declined by 32 basis points, analyst Michael Kaye wrote in a note Friday. One basis point equals one one-hundreth of a percent, or 0.01%. In addition to the impact of taxes and inflation on CDs, there are opportunity costs involved, said Jayson Bronchetti, chief investment officer at Lincoln Financial. Putting money to work in an investment account has historically resulted in better long-term savings outcomes, he said. Lincoln Financial's analysis shows that cash yields have historically fallen by 2%, on average, twelve months after the start of a Fed cutting cycle. Meanwhile, U.S. stocks posted a positive return of 7.2% after the initial rate decrease — although whether the economy avoids a recession or not within that year has resulted in dramatically different results, according to the firm. What to do with excess cash Instruments like CDs, high-yield savings accounts and money market funds are a good place to stash cash for emergencies and upcoming expenses. Yet, any money beyond that may be better put to work elsewhere. "If we were just to tread water and rates stayed range bound, bonds at these levels are going to outperform cash," Boyle said. While cash has earned around 5% this past year, the Bloomberg U.S. Aggregate Index, which tracks the U.S. investment grade bond market, has a one-year total return of 10%. As bond yields go lower, the price of the underlying fixed income security moves higher and, as a result, the assets should "meaningfully outperform" cash, he added. Boyle likes investment-grade corporate bonds for income and total return. "We are trying to get people to take a little step out of their comfort zone. They don't have to take a lot of risk to get a lot better return," he said. "Extend out into intermediate-, high-quality duration to get a better return than cash, especially if you are not considering the impact of inflation and taxes." Lincoln Financial's Bronchetti also sees opportunity in investment-grade corporate bonds and likes equities for those who can handle more volatility. In addition, multi-year guaranteed annuities are attractive for their principal protection and tax deferral, he said. Multi-year guaranteed annuities, or MYGAs, are a type of fixed annuity that can last three to 10 years and have a guaranteed interest rate. Bronchetti also likes fixed-index annuities , which earn interest that is calculated based on the changes within a market index. There are participation and cap rates, but there is also downside protection. "We are seeing some of the best yields, best returns that we've seen really in decades," Bronchetti said. Just be sure to understand the terms and what you are buying. Still, Barclays doesn't see money leaving cash assets just yet. The firm's economists anticipate the Federal Reserve will cut rates to 3.5% to 3.75% by September 2025, which may not be low enough to push cash from money funds into other assets, strategist Joseph Abate said in a note Wednesday. "We have found that historically, front-end investment grade [IG] corporates is the natural first asset rotated into," he said. "Right now, IG corporates do not look that attractive in relative terms; their yields are still lower than money fund yields." However, the forward market implies that they should start to look appealing relative to money funds in about six months, Abate wrote. "We expect investors to rotate from money funds into IG only if compensated for the risk," he noted. "If we estimate that investors will require an extra 50bp, we find that valuations will not be an obstacle to the rotation in about six months, assuming that rate yields follow the path priced in by the forward markets and that credit spreads continue to trade at about the current level."