As market volatility continues to keep investors cautious, many are holding cash on the sidelines where interest rates remain dismally low. And with interest rate increases looming, no one wants to get locked in to today’s low rates. Financial institutions know that too. So to attract and keep your deposits, more of them are offering certificate of deposits (CDs) with flexible options.
CDs are offered to consumers by banks, thrifts and credit unions. They are similar to savings accounts in that they are covered by the Federal Deposit Insurance Corporation (FDIC) or by the National Credit Union Administration (NCUA).
So as long as your institution is insured and your investment amount stays within the insured limits, you have some measure of safety. But even with insurance coverage, you’ll want to be sure you’re putting your money in a safe institution.
Why? Because insurance may take time to kick in, possibly leaving you without access to your cash when you need it. And the entities that provide insurance have a set amount of funds, which could leave folks holding the bag if too many institutions fail in a short timespan.
Keep Your Money Safe
While all federally insured institutions are regulated and examined by the U.S. government, those government entities don’t share that information with the public.
So it’s smart to do some checking on your own before turning over your money. And always refer to Weiss Ratings to be sure the bank, thrift or credit union is financially sound. The ratings are free! All you need to do is register.
Different than a Savings Account
Although CDs are similar to savings accounts, they’re different in that they have a specified time to maturity. Maturity terms usually run from three to six months, or from one to five years. For a consumer to receive their full principal and interest return, the deposit must remain for the full term.
CDs are especially good if you have a time-specific savings need or if you just want to diversify risk in your portfolio. CDs allow you to decide how much money to put in and for how long.
Usually financial institutions offer CD customers higher interest rates than on regular deposit accounts. That’s because you can withdraw money from a regular deposit account whenever you want. The higher interest rate for CDs is a reward to customers for keeping money with the institution for a set timeframe.
Generally institutions also pay higher rates for longer-term CDs. But in today’s economy where rates are expected to go higher in the future, locking in today’s rate might not be the smartest move. It would tie up your cash and keep you from grabbing a higher rate later.
Ladder Your CDs
Laddering CDs can help keep your cash invested, and also give you an opportunity to take advantage of rising rates. To implement a “ladder” strategy, you would try to take advantage of the highest available current rate, and then have your CDs mature at different intervals.
For example, you could invest one amount for three months, another for six months, yet another for one year, three years and five years.
This way, as your CDs mature, you’ll be able to renew the CD or withdraw the funds. And not all of your money will be subject to whims of the rate environment that exists at that particular time.
This is a strategy that you manage rather than the bank. So you can distribute your money to different institutions. And you can change institutions at maturity if better rates are available elsewhere.
Step-Up CDs
Some institutions are offering step-up CDs as an incentive for investors concerned about locking in their investment at today’s low rates.
A step-up CD usually has a built-in schedule for when the interest rate will be adjusted. The rates change at intervals specified at the time you purchase. The rate at each step up may also be specified. Or they may be based on movements of the U.S. prime rate or the London Inter-Bank Offered Rate (LIBOR), both of which are often used as benchmarks.
Often the initial rate on a step-up CD will be lower than rates for traditional CDs. So if rates don’t actually rise, you may end up with a lower yield to maturity. Depending on your needs the flexibility may be worth it.
Bump-Up CDs
This is another way to earn interest without worrying about missing out on rate increases after you’ve signed on the dotted line. They’re similar to the step-up, with just a slightly different twist.
Most banks allow only one bump up to a higher rate before maturity. You may find a few banks that do allow it on a more frequent basis.
Again, these CDs usually start out with lower rates than traditional fixed-rate CDs. But this may be a small price for the flexibility to get in on a rate increase.
These are not recommended for shorter-term maturities because there is a much smaller chance rates will rise in that timeframe. And if they don’t, you’ll earn less than with a traditional CD.
No-Penalty CDs
The no-penalty CD allows you to withdraw from a CD before maturity without incurring a fee.
The step-up and bump-up options are forms of no-penalty CDs. Without the bump and step options, you would have to pay a fee to close the CD early and buy a new one at a higher rate.
Customers like the flexibility of these CDs. Financial institutions like them too because they can offer lower entry rates and quite possibly pay the customer less over the term of the CD.
Where Can I Find Them?
Most large institutions have some form of flexible CDs. But you might find more variations at smaller banks that want to attract and retain customers. Check online and visit local branches. Often branches have special offers or walk-in offers that you won’t see advertised.
Compare, Compare, Compare
The next time you’re considering a CD, make sure you compare the different features offered.
Look at the time to maturity. Make sure you know how long your money will be tied up and how that compares with alternate investments.
Compare the rate and the yield. Interest compounding methods, daily versus monthly or quarterly, can make a real difference in the interest your investment will earn.
Find out whether the interest will change. Is the rate fixed or variable? Are there bump-up or step-up terms? And find out whether and how much of a penalty there might be if you withdraw your money before the CD matures.
Know what the minimum is for you to qualify for the stated interest rate.
Understand when and how you will get paid. How often does the bank pay interest? It could be for instance: Monthly, semiannually, or at maturity. Also find out how you’ll get paid. Will they send a check or transfer funds into your account electronically? And how long after maturity can you expect to receive your original deposit.
If you have any questions, ask the sales person to explain the terms and features.
And while you’re doing that, make an assessment of the answers you get and the customer service you receive during your shopping process. That’ll give you a good feel for the institution’s personnel.
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