CD Tips To Remember

These days credit cards seem to be very hard to get but this website can find you a good deal.
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November 13, 2008 – 5:40 am

As yields dwindle and income investors scurry to find reasonable rates of return, I thought it might be helpful to point out a few key ideas when it comes to CD’s.

Certificates of deposit are savings vehicles that lock in a rate of return for a specific period of time. The money that is invested supposedly is tied up for the entire duration of the CD, and therefore cannot be quickly converted to cash. If you shop around CD’s usually pay more than savings accounts and money market funds. This makes sense because the CD buyer is taking more risk (interest rate risk) and is giving up flexibility compared to other investments. Therefore the return should reflect this added risk.

There are a lot of “hybrid” CD products on the market now, so please be careful to know what you’re buying. Some CD’s let you take one-time adjustments to the interest rate, make 1-time withdrawals penalty free, etc. Most still follow the traditional rules of locking you in to a specific annual percentage rate for the duration of the CD.
Be aware of when you can redeem your CD’s. Most banks require notification within a specific time period (usually 1-2 weeks before the CD matures). If they don’t hear from you they will reinvest the proceeds into another CD (typically) of the same duration.
If you shop around you can usually find shorter-term CD’s that will yield more than a savings account. Therefore if you have a full emergency fund (3-6 months of living expenses) and don’t expect to need much of your emergency fund, you might want to consider CD’s for part of your emergency fund. You can still get to the funds for a small penalty if you absolutely have to (i.e. illness, job loss, etc), but most of the time it will just sit there earning more interest.
CD interest, like interest from savings accounts, is fully taxable at your income tax rate. Therefore you don’t receive a lower tax rate on this interest like you do on qualified dividends and capital gains.
Most CD’s are FDIC insured, but be sure to check with your bank or adviser to be sure. I believe you can buy CD’s through brokerage houses as well, and some of these products may not be FDIC insured.
Some banks will nickel and dime you when the funds are withdrawn. Make sure you figure out how much it will cost you to get your money back if you choose to use a separate bank for your CD(s). For example, some banks will only write you a certified check and charge you $20 for it. Others may only allow you to do a wire transfer, and they may charge you for it, etc.
CD ladders can be set up, as can bond ladders, in order to insulate you from some interest rate risk. A CD “ladder” is essentially a portfolio of CD’s that all have different durations. You can create a ladder one of two ways. Your situation and needs will differ than those of others, so please consult your financial adviser if you think setting up a CD or bond ladder is right for you.
- You can create a ladder over time by purchasing a CD every so often for the same duration. For example, if you purchased one 18-month CD for $1000 every month for 18 months eventually you would have an $18,000 CD portfolio that has one CD that matures each month. Then if interest rates go up you can theoretically reinvest the mature CD at a higher interest rate. If rates go down you would also have to reinvest at a lower rate.
- You could purchase a bunch of CD’s all at the same time, each with a different duration. For example you could purchase a 1-month, 2-month, 3-month, 6-month, 9-month, 12-month, and 18-month CD today and create a ladder that way. Unlike the previous example you wouldn’t have an CD that matured every single month, but you would be able to invest your funds more quickly than waiting for 18-months to go by.
Bankrate.com is a good place to shop around for the highest CD rates. You’ll need to check out each bank though before you invest. Although most banks are safe, I’m personally willing to give up a little yield to go with a well-known bank. Also note that your local neighborhood bank may also have competitive rates.
Banks are in the business of selling and marketing products like every other company, and sometimes you can find “deals” on CD’s. What does a deal look like? Well, you would expect to receive a higher annual percentage rate (APY) on a CD if you’re willing to accept a longer duration. Therefore you would expect a better return on a 1-year CD than on a 6-month CD, and a 5-year CD should pay more than a 3-year CD. Some banks may have a need for funds for a certain duration, however, and you may find higher yields for some durations than others. As of this writing Capital One is offering a 4.00% APY for the 2-year, 30-month, and 3-year CD’s, but is also offering a 4.41% APY for an 18-month CD. Clearly Capital One has a need or a reason behind offering a higher return on the 18-month CD. You’ll have to decide for yourself what duration is best, and this may be based to some degree on where you feel interest rates are headed.