If you invest in CDs then you may be noticing a trend that has been occurring lately: inverted yield curves. However, if you’ve never invested before – but are interested – and are scratching your head at this term, then the time is now to learn more about what this means and how it impacts certificates of deposit.
What Are Inverted Yield Curves?
To understand inverted yield curves, you’ll have to understand the annual percentage yield (APY) and how it works in relation to CDs. When you invest in a CD, there is an interest rate applied to give you that financial return. For instance, if you purchase some certificates of deposit for $1,000 each, and they offer an annual interest rate of 5% then at the end of the year, you will have gained $50. Now, if you add the APY (which is also an interest rate) into the equation then you’re figuring interest on top of interest. This means, instead of just adding interest at the end of the year, it may be added two, three, or even 12 times a year – and your principal amount is incorporated with each addition. The more it’s added within the year, the greater gain you have at year-end.
Now, when investing in CDs, it’s understood that the APY increases with the amount of time you agree to invest. So if you agree to a 3-month CD, your APY will be lower than with a 5-year CD. This is called a normal yield curve. But when the curve seems to be moving in the opposite direction, thus allowing the 3-month CD to have a higher APY than the 5-year CD, these are called inverted yield curves.
What Do Inverted Yield Curves Mean to You When Buying CDs?
When you start to see inverted yield curves with certificates of deposit, this is usually a sign that the market assumes the economy will decline in the future. So if you’re looking to invest right now, you may want to consider savings accounts that offer similar APYs and still give you access to your money – that is, at least until things are looking up for CDs.
Unfortunately, because the economy is in the midst of a recession, all investment activity is very uncertain. However, by watching the markets – and your money – very closely, you may be able to lessen the impact of inverted yield curves with your investments.