The 7% CD? Don’t believe the hype

Certificates of deposit are investment vehicles where people can park their cash for a set amount of time with a guaranteed annual percentage yield or APY. Banks can borrow from the Federal Reserve, but retail deposits are often regarded as a more stable source. As interest rates rise, financial institutions are now offering CD rates hovering at 5% and above, double the top rate seen 12 months ago.

Rates are competitive as large banks and, particularly, local banks and credit unions jockey for business, but experts say investors should not get too excited about CDs offering a 7% APY. They are few and far between, have too many restrictions, and you may get ghosted after they suddenly expire. In other words, they are promotional rates designed to create buzz for an institution — and headlines.

These kinds of CD “specials” can raise hope among consumers who are looking for risk-free, inflation-beating alternatives to an unpredictable stock market and uncertain economic outlook. They may believe there will be a wave of CDs offering such high APYs. Are big banks and credit unions that desperate for our cash? No. Hence, the low caps on deposits, and the long list of sign-up restrictions. 

Case in point: The Alpena Alcona Area Credit Union in Alpena, Mich. recently attracted a lot attention for its seven-month certificate of deposit at 7.19% APY, but it was only available to people who live, work or own property, worship, attend school in Michigan, or who work at the credit union or have a family member who is an existing member. It also has a maximum deposit of $7,000.

So much for the 7% CD. “We don’t count promotional rates such as those,” said Ted Rossman, a senior industry analyst at Bankrate.com. He says smaller institutions are more likely to have doorbuster CD promotions as larger banks have all the deposits they need, and compete in other ways with extensive branch networks, national television commercials, and stadium naming rights, etc.

Average yields are a better guide to where you can park larger amounts of cash. “There’s a big disparity between average yields and the top yields,” Rossman told MarketWatch. “I think that speaks to market factors, including smaller- and mid-size financial institutions competing more on rates, and large banks not feeling the need to match them since they have all the deposits they need.”

High interest rates are good for savers, but can impact consumers’ ability to take out loans. “There’s probably also a component of smaller/mid-size banks wanting to raise more capital due to the recent bank failure tumult, whereas the largest banks don’t have that concern,” he said. But the amount of capital that even smaller institutions can raise with such seemingly generous offers, he added, is limited.

CD specials are all about creating a buzz 

Investors are storing their cash for a year to see how the economy shakes out, said Dr. Dan Geller, a behavioral economist based in San Francisco. “That’s why the balances of 1-year CDs are at a record high,” he said. “The shorter the term, the higher the interest rate. But the 1-year is now the same as the 5-year CD. This shows that people want to stay in the middle. That’s very unusual.”

Banks know that the 12-month CD is a sweet spot for investors right now, said Ryan Greiser, a financial adviser in Doylestown, Pa.. As such, he said these rare 7% CD offers are supposed to grab your attention, but instead will leave most people with a significant amount of money to invest disappointed. “Such elevated rates are designed to generate visibility and buzz within the financial sector,” he said.

Most attractive rates for both institutional and retail CDs tend to be in the low 5% range and, like all CDs, are backed by the Federal Deposit Insurance Corp., so the money people invest is secure. “A 7% rate on a CD can be captivating and seemingly exceptional,” Greiser told MarketWatch. “However, it’s prudent to approach these offerings with a discerning eye and a focus on the details.”

Another rule of thumb: the higher the rate, the lower the maximum deposit, and the more hurdles people will need to clear in order to qualify. “Such remarkable rates often serve a dual purpose: to entice new clientele and to stand out in the crowded financial market,” Greiser said. “These exceptional offers, while attention-grabbing, typically come with terms and conditions that necessitate careful examination.” 

Stocks still offer better long-term growth

CDs offer short-term security. People are confused about the economy. Inflation and prices are high, yet the economy grew by 2.4% in the second quarter. “People would never have believed that a billion-dollar bank could go out of business within days,” Geller said, citing the failures of Silicon Valley Bank, Signature Bank in New York and First Republic in San Francisco earlier this year. 

“Since inflation has come down in recent months, it’s really nice to see these top savings and CD yields exceeding inflation,” Rossman added. “Savers are not just maintaining their purchasing power, but actually increasing it a bit. Of course, stocks still offer much better long-term growth potential, but CDs are more attractive now than they have been in years.”

But there are limits to the CD gravy train. When an institution offers a special CD rate far above the competition — especially if it carries a relatively high maximum deposit demand — the institution is typically forced into ending the special offer early, said Ken Tumin, founder of DepositAccounts.com, which tracks CD rates. In some cases, he added, the offer can close in a matter of days.

A final warning for investors: Many special CD rates are set up to auto renew into a standard CD with a similar maturity, and the depositor may not read the bank’s notification of a rollover, or simply forget to move their money. “Those standard CD rates can be way below market levels,” Tumin said. “When this happens, the institution may be able to offset the extra cost of the CD special.”

That’s when the special rate turns from a CD prince into a frog.