In the fall of 2022, surging interest rates—driven by the Federal Reserve’s aggressive efforts to combat inflation—caused significant turbulence in both stock and bond markets, leading to declines across many asset classes. However, for savers, this spike in rates offered a silver lining in the form of higher returns on bank deposits, including savings accounts, money markets, and certificates of deposit (CDs). After years of historically low yields, savers finally had the opportunity to lock in rates of more than 4% on their cash reserves.
This prompted many to question whether staying invested in diversified portfolios was worthwhile when they could lock in seemingly attractive CD rates. For the three years leading up to late 2022, a globally diversified balanced portfolio—represented by the Dimensional Funds Global Allocation 60/40 portfolio—delivered an average annual return of approximately 4%, slightly less than the rates CDs were offering for the next three years. With the guaranteed nature of CDs, some investors began to wonder: Why take the risk of investing in the markets when I can earn over 4% with a guaranteed CD?
While the question might seem logical on the surface, it overlooks several key principles of investing.
Comparing Past Returns with Future Expectations
It is misleading to compare historical returns of a portfolio with future expected returns. Doing so results in using past performance to make decisions about the future. In the example above, the 4% return on the balanced portfolio reflects historical performance, while the CD rates being offered at a given moment represent a guaranteed future return. Comparing past returns from one investment to expected future returns from another is a flawed approach to evaluating investment opportunities.
How It Actually Turned Out
If an investor locked into a 36-month CD at 4.5% in November 2022, how would that have played out? From November 2022 to September 2024, the Dimensional Funds Global Allocation 60/40 portfolio delivered a cumulative return of 31%, or more than 15% annually—over three times what the CD would have provided during the same period!
This outcome shouldn’t be surprising. CDs provide low risk and a fixed return, but with limited growth potential. Diversified portfolios, though more volatile in the short term and not guaranteed, tend to outperform safer options like CDs over time. The fundamental principle of investing remains: to achieve higher returns, you must be willing to take on more risk.
The Role of CDs in a Financial Plan
This is not to say that CDs or high yield savings accounts do not have a place in a financial plan; in fact, they most certainly do. They offer a secure spot for cash reserves, ideal for short to medium term needs. However, relying too heavily on CDs for the portion of your portfolio that is invested for the long term, in our opinion, is a mistake. As this analysis shows, a diversified portfolio has delivered better returns, even during periods of rising interest rates.
The Bottom Line
High CD and savings account rates can be appealing for managing cash reserves. However, they are not effective for building and maintaining wealth over the long-term, especially when inflation is considered. They simply are not an alternative for a well-constructed investment strategy designed to grow wealth over time.