2 Reasons You Should Be Unhappy About CD Rates Above 5%

There are many CDs right now offering annual percentage yields (APYs) above 5.00%. Since investors used to get excited about rates at 2.00% or 3.00% just a few short years ago, these unprecedented high yields may seem like great news.

They aren't, though. There are two reasons that just about everyone should be unhappy about CD rates being so high.

1. CD rates are only high because inflation has surged

The first and most important reason why higher CD rates should be upsetting is also the reason for the high yields.

CD rates have skyrocketed because the U.S. central bank, called the Federal Reserve, raised interest rates in:

• March 2022
• May 2022
• June 2022
• July 2022
• September 2022
• November 2022
• December 2022
• January 2023
• March 2023
• May 2023
• July 2023

Now, the Federal Reserve doesn't set interest rates on CDs. But it establishes the benchmark rate or the overnight rate (the rate banks pay to borrow money from each other overnight). This influences what banks pay to CD investors. So, as these rates have gone up, CD yields have skyrocketed.

Unfortunately, the Federal Reserve is raising interest rates because of record high inflation. So, the only reason why CDs are paying so much is because everything you're spending money on is so expensive. Prices rose an average of 4.7% year over year in 2021, 8% in 2022, and 4.1% in 2023. And in 2024, inflation has been trending above 3% for the first three months of the year. So, while CD rates are high, so are the costs of everything else.

The Federal Reserve has signaled an intent to lower rates as soon as inflation cools, but that may not be happening anytime soon. Rates will most likely stay this high only if inflation is still a big enough concern to prevent a rate cut. Savers (and everyone else) will likely be worse off if that happens, since inflation eats away at your buying power.

2. Your real returns after inflation aren't that impressive

There's another big reason why you shouldn't be happy about CD rates above 5.00%. It also has to do with inflation.

See, it's true that you can earn yields above 5.00% right now by investing in a CD. But you need to calculate your real returns after accounting for inflation's impact since it's the increase in buying power that matters most to most people -- not just having more money on paper.

If you are earning 5.00% but prices on goods and services are up 3.50% as they were in March, then the first 3.50% of your gains are just allowing you to keep pace with the cost increases. So, your real returns are just 1.50%. That's a much less impressive number.

Unfortunately, after inflation causes big price increases, it's rare for costs to come down later. When inflation cools, that just means costs don't go up as quickly. The higher prices remain. So, the 5.00% you're getting on your CD isn't going to buy you 5% more in the future.

When you take these factors into account, CD rates above 5.00% don't sound so great.

Now, it's still better to have your money in CDs or other accounts paying high rates than it would be to have your money somewhere where it isn't earning enough to beat inflation. So it's still worth checking out CDs with high yields or high-yield savings accounts (which are also offering competitive rates right now). In fact, if you aren't doing that, this high inflation is going to hit you even harder and leave you with less money to spend. So start looking into these options today to help you prosper in this difficult financial climate.