Are 5-Year CDs Still Worth Buying With Rates Down to 3.40%?

In case you haven't heard, the Federal Reserve recently made a big decision: After a year of keeping its federal funds rate the same, it made a big 50 basis point cut (0.50%) at its last meeting in September.

While the impact of this decision is still rippling out, many certificates of deposit (CDs) have already shown big rate drops. Even before the Federal Reserve made this decision, banks, in anticipation of it, were slowly lining up their CD products, like soapbox derby cars at the top of a hill, ready to let them propel downward on their own rolling momentum. Now that it's here, however, the days of 5.00%-plus APYs are pretty much over.

But does that mean a long-term CD, like a 5-year CD, is not worth investing in? Let's take a look.

Get a 5-year CD if you want a fixed return on your investment

Even though rates on CDs are steadily declining, the timeless reasons for getting one haven't changed.

For one, a CD could still be a useful investment if you have money sitting in a savings account that isn't earmarked for any short-term purpose, like an emergency fund, large purchase, or down payment. If your money is not being used toward these purposes, or you have savings in excess of them, it could be better placed in an account that earns a fixed interest rate, like a CD.

To be sure, many savings accounts have similar rates to CDs right now, which is why they've been great places to keep your savings. But since rates on savings accounts are also dropping, a CD can offer you something they can't: A fixed interest rate for its term length. With a 5-year CD, you get the same rate over 60 months, no matter what the Federal Reserve decides in that timeframe.

For example, if you opened a 5-year CD from Discover® Bank, you would get a 3.50% APY. Your money would earn interest at that same APY, even if new accounts with the same CD start offering 1.00% APY next year. Check out this competitive 5-year CD and other terms from Discover® Bank before rates start dropping even more.

Although CDs can offer you guaranteed returns, they also come with hefty early withdrawal penalties. Before you open an account, be sure you're ready to commit to your CD's full term, as you can lose money on a CD.

Don't open a 5-year CD if you're willing to take on more risk for greater returns

When I say CDs have competitive rates right now, I'm comparing them to other bank products, like savings accounts. But if we add brokerage accounts into this comparison, then CDs shine a little less radiantly -- at least, if you're investing for the long term.

Truth is, for long-term goals, like saving for retirement, CDs won't get you far. Even with a large initial deposit, like $100,000, a CD won't yield much. For example, if you put $100,000 in a 5-year CD with a 4.00% APY, you would earn $21,665 by the end of your term.

Now, if we put that same $100,000 in an exchange-traded fund (ETF) that tracks the S&P 500, we might get a yield that's a little more significant. Historically, average annual S&P 500 returns are usually around 10%. While that's not a guaranteed number -- some years could be lower, some higher -- over long periods, it tends to produce this average.

If that average is correct, then $100,000 in an S&P 500 ETF would yield about $61,000 over a five-year period. Again, since that average is more accurate over long periods, you would want to stay invested longer than five years.

For example, if your S&P 500 ETF produces average annual returns of 10% over 30 years, then a $100,000 investment would yield over $1.6 million. This is why it's crucial to start investing early, as you can get better returns over long periods.

So, is a 5-year CD worth it?

Ultimately, it depends on your goals. Even if rates are dropping, a CD could help you earn more interest than other bank products, like savings accounts. Now is a good time to lock one in before rates drop even more.