10 Tips for Investing and Saving with CDs

  • 6 min read

Low returns on investment are still a part of our economic landscape as we move into 2016. We’ve all become more accustomed to low interest rates, and most investors have realized that they can’t get an even mediocre ROI without taking on a sizeable amount of risk. With that in mind, many investors are turning to vehicles such as the humble certificate of deposit as a means of shoring up their portfolios.

Whether or not your want to join the CD crowd depends entirely on your position and financial goals, but we have some tips to help you make the most of a decision to do so:

Seek out CDs with an add-on feature.

One of the concerns about long-term, low-interest rate investments like CDs is that they may not be able to keep up with inflation. Add-on CDs allow you to make ongoing deposits into the account so that you can keep saving and adding new money to the principal This is one of the best ways to beat inflation loss, so don’t pass it up.

Short maturities are safer.

You don’t want to be locked into a 15-year CD and find out three years into the term that inflation is higher than your interest rate. You would be left with very few options, the most common being to withdraw early and suffer the penalties.

This would not only put all of your accrued interest at risk, but also eat into the principal itself! To keep yourself from getting into this sort of dilemma, choose CDs with shorter terms,—6-months to a year, for instance.

How long to invest in CDs?

Look for indexed CDs.

One way to minimize your risk is to find a CD that’s linked to a market index. You won’t have to worry about losing money as long as you don’t withdraw early, but there is a downside. Indexed CDs are notoriously complex, which can be a major hurdle for some investors.

Spread your money around.

There are several proven strategies for diversifying your CD spread, including “laddering” and the “barbell.” Laddering involves splitting your principle among several CDs with a range of maturity dates — such as a 1-year, a 3-year, a 5-year, and a 10-year – rather than lumping it all into a single CD.

This sort of hedge allows you to maintain some liquidity while still taking advantage of the higher returns on the long-term CDs. Barbell strategy is very similar, except that the investor will split their principle in two rather than into multiple “ladder rungs.” The first CD will be short term, while the other will be a very long-term CD.

Don’t forget that CDs carry risk.

It’s easy to forget that an investment vehicle with a guaranteed return can also be risky. You’re not risking a loss of principal, but rather you’re risking purchasing power. This becomes particularly painful if you’re stuck in a long-term CD that’s being ravaged by inflation loss.

Many investors are more positioned to take risk than they think they are, and in this market, you want to take all of the risk that you can bear. There’s simply no other way to enjoy current high returns.

Be sure to evaluate your position thoroughly and determine if you’re better suited for the safe road, or the road the that will deliver higher yields.

5 Things You Didn’t Know About CDs

You may already know the basics of Certificates of Deposit, but there are several unique aspects to these vehicles that you should understand before making any decisions.

If you’re considering a CD, we recommend keeping the following in mind:

• Certificates of deposit will usually renew automatically.

• When your account matures, you’ll need to advise the bank in regards to your desired disposition for the funds. If you don’t let them know what you’d like to do with the funds, the funds will almost always be rolled into a new CD. This can be a good thing or a bad thing, depending on your situation and your investment plans.

• If you’re planning on keeping that money vested (and the interest rates are still acceptable), then the automatic rollover is simply a convenience: your money is reinvested without requiring you to open a new CD. However, if you want access to those funds (or the interest rate has fallen to a level that you find unacceptable), then a rollover will result in your funds being tied up in a long-term deposit until it reaches maturity again.

• To avoid this, be sure to check the account’s rollover policy and grace period for informing the bank of your decision – you’ll want to do this before opening the account.

• Not all CDs are the same.

Certificates of deposit were once extraordinarily simple, with most banks offering only what’s now called a “traditional CD.” These days you’ll encounter a variety of options, including:

• Liquid CDs: These allow you to withdraw funds before the maturity date without incurring a penalty. You’ll usually need to maintain a minimum balance to enjoy this benefit.

• Bump-up CDs: This type of CD usually begins with a lower interest rate, but will “bump up” your interest rate mid-way through the account’s term.

• Callable CDs: These CDs incur a bit more risk, as they allow the bank to “call” the interest rate originally offered and replace it with a lower one. The reward? You’ll usually enjoy a higher-than-average interest rate when the account is created.

Certificate of deposit basics:

• There are viable long-term strategies for investing in CDs: One of the main complaints you’ll hear regarding CDs is that they tie up your funds for long periods of time (sometimes while guaranteeing only mediocre returns.) Using a strategy called “CD laddering,” you can spread your principle across several long-term CDs.

• By staggering the maturity dates, you can ensure access to a portion of your invested capital every six months to a year. By laddering in this fashion, you don’t have to completely sacrifice liquidity to enjoy a higher interest rate than a savings account.

• The CD’s “call period” and its “maturity date” are two different things: When a CD has a term like “one-year non-callable” attached, it has nothing to do with the date of maturity. The call period determines when the bank can (or can’t) redeem the certificate, but it doesn’t influence the date that the account reaches maturity. This means that a CD with a one-year call period can still have a maturity date that’s years down the road.

• You can also invest in CDs within your retirement account: Most forms of investment have taxable returns, and CDs are no exception. It’s possible to avoid these taxes by keeping CD funds in an IRA or 401(k) – although the tax rules that apply to these accounts, such as those regarding early withdrawal, are still in effect.

Christopher - BSc, MBA

With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.