CD Rates Above 5.00% Are Bad News for Investors. Here's Why

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Competitive certificate of deposit (CD) rates are good for investors, right? Since CDs are currently offering yields above 5.00%, investors have an opportunity to take minimal risk while earning a pretty good return.

This may seem like a great thing. It's not. In fact, here's why today's high CD rates are not good for those who want to grow their wealth.

CD rates are high for a nefarious reason

Today's CD rates, which are the highest in decades, are not good for investors despite the opportunity to earn competitive yields. That's because of the underlying reason why rates have climbed so much.

CD rates are very high right now as a result of out-of-control inflation that happened in the post-pandemic era. The Federal Reserve's annual target for inflation is 2.00%. Unfortunately, inflation has been far exceeding the levels the central bank prefers.

In 2022, the inflation rate was a whopping 8.00%. In 2021, it was 4.70%, and in 2023, it was 4.10%. This year, it's been hovering around the 3.00% to 3.50% range.

The Federal Reserve has tried to get inflation under control by raising the federal funds rate. These moves by the Fed are a big part of the reason why CD rates are so high right now. So, investors are earning around 5.00%, but they're losing over 3.00% of their buying power. This means their real rate of return is a lot smaller.

With everything that you buy costing so much more than it did a few years ago, inflation is also making it harder for most people to find money to invest in the first place. The benefits of CD yields above 5.00% simply cannot outweigh these huge downsides for investors.

Investors could earn better returns even if CD rates were a lot lower

Even at 5.00%, CDs don't provide a great return compared to an S&P 500 index fund. If you open a brokerage account and put money into an S&P 500 fund, you can reasonably expect to earn a 10.00% average annual return over the long haul, since that's what this index fund has consistently provided.

You don't need massive inflation to earn 10.00% on an S&P 500 index fund and, in fact, you're better off with low inflation so your real returns, or the gain in your buying power, is higher.

Now, it's true that there is more risk with buying equities. But as long as you can leave your money alone for at least a couple of years to wait out any potential downturns, that risk is minimized. CDs require you to tie up your money for a while anyway, so the market can be a better bet in most scenarios. CDs could be a good fit if you happen to have money you definitely won't need for a few months or a few years, but your timeline isn't long enough that you can put it in the market.

Since the inflation levels that cause record-high CD rates also leave you with less money to invest in the stock market because everything else in your life is so expensive, that's yet another reason high CD rates really aren't that great.

Ultimately, investors should hope CD rates decline because that will mean inflation has returned to normal levels, which is far better for them -- and everyone else as well.

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