As interest rates rise in response to rising inflation and ongoing market volatility, it can feel like an uncertain time to borrow and invest money. But there’s an upside to savers: The yields on low-risk savings vehicles — including CDs and Series I bonds — become much more attractive.
If you’re looking for a place to store short- to medium-term savings and earn interest, both can be solid options — although the right choice for you may depend on your financial goals and timeline.
Here’s how CDs and Series I savings bonds differ and why both are attractive options for many savers today.
What is a CD?
A certificate of deposit (CD) is an account that holds money at a set 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 a bank, including online banks, or a credit union. CDs are considered incredibly safe as 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 increasing with some longer term CDs offering over 3% APY. As with other account types, you will likely find the highest interest rates at online banks.
CD yields have increased significantly since the record low during the pandemic, they say 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 faster than they have already done.
A CD requires you to freeze funds for a fixed period of time, usually between three months and five years. The longer the term, the higher the interest rate you can earn on your deposit. Usually 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 may need to access in the short-term, a high-yield savings account is often the best account type. You deserve slightly lower interest rates but have easier access to your money and still earn a competitive APY.
While certificates of deposit have a fixed term and rate of return, different types of CDs offer different ways you will make money and the flexibility you will have.
For example, a no-penalty CD can help you avoid penalties for early withdrawals, allowing you to access your funds at all times. However, the trade-off is usually a lower interest rate.
If your goal, rather than flexibility, is getting the highest possible rate of return, look into high-yield certificates of deposit typically found at online banks. Or, if you’re looking to secure a large sum of money, you might be interested in a jumbo CD, which can offer higher rates but often requires high minimum balances.
What is a Series I savings bond?
A Series I bond has two interest rates: a fixed rate (currently at 0%) and a floating rate that adjusts for inflation twice a year. With inflation now at a 40-year high, this type of bond is particularly attractive right now.
The US government supports and issues Series I bonds, which means they are low-risk. They also have some tax benefits, including exemption from local and state taxes.
The variable interest rate for I Bonds is currently 9.62%. This is excellent value – but it won’t last forever. “In the first six months, you only pay 9.62%,” says McBride. “After that, the rate will fluctuate like inflation.” The next adjustment will come in November.
Series I Bond Terms
Like any type of savings bond, I-Bonds have conditions and withdrawal restrictions that must be observed.
Series I bonds accrue interest for 30 years or until paid. However, you cannot withdraw your funds for the first 12 months. And if you redeem before the bond’s five-year anniversary, you’ll pay a penalty of three months’ interest.
Series I Bond Limits
In addition to somewhat strict deadline requirements, there are also limits to how much money you can invest in Series I bonds.
You can purchase up to $10,000 worth of electronic bonds in a calendar year TreasuryDirect. If you receive Paper I Bonds with your federal income tax return, you can purchase an additional $5,000. That means you can receive up to $15,000 in total in Series I bonds in a calendar year.
How Rising Interest Rates Affect Certificates of Deposit and Series I Bonds
The Fed has raised interest rates aggressively this year to curb inflation. In June, the interest rate increased by 75 basis points. When the Fed meets again in July, it is likely to raise interest rates again.
“[Rates] are not directly tied to this benchmark interest rate,” he explains 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 it can lend more money and make a profit.
As a result, interest rates on savings products are rising – and will most likely continue to rise in the coming months.
On the other hand, I-bond rates tend to operate on the opposite end of the scale.
Because I-Bonds are directly tied 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 by raising interest rates, I-Bond rates will fall as well.
Since interest rates on I-Bonds are set every six months, fluctuating rates of inflation can result in a wide range of rates of return over time. “If inflation goes down to 1%, eventually you’re going to earn 1% on your I Bonds,” says McBride.
How to decide between CDs and Series I bonds
CDs and I-Bonds can help you round out a diversified financial portfolio, especially since both currently have competitive interest rates.
Consider the goals you have for your money to help you decide.
If you need that money in the next five years, a certificate of deposit is a wiser choice. For longer-term savings goals, Series I bonds may be a better option. For example, if you’re looking to top up college savings, I Bonds can provide tax benefits and protect your money from inflation.
Watch for changes in overall economic conditions over time, Chavis says. Because both CDs and I-Bonds are highly dependent on what’s happening in the broader economy, different economic environments can change your strategy.
For example, now is a good time to buy I-Bonds “because of the benefits you get from keeping up with high inflation,” says McBride. As for CDs, he recommends revisiting the landscape in another six to 12 months when yields could be higher.
On the other hand, “if we’re in, say, a falling interest rate environment, it makes sense to lock in a portion of that guaranteed interest rate on the CDs for a period of time,” says Chavis.
However, it’s also important to remember that none of these account types are best suited for every savings goal. For example, if you are building an emergency fund, keep it in a more flexible, high-yield savings account that you can access at any time.
Additionally, you’re more likely to earn better returns for long-term savings goals by keeping your investments in a diversified, low-cost index fund. These funds are riskier, but you are likely to earn higher returns on your funds over time.