Many Americans immediately turn to Certificate of Deposits when seeking out a low-risk investment that’s a step beyond a standard savings account. Recent stock market volatility has added to the resurgence of interest in these investment and savings vehicles, and more and more institutions are offering “specialty” CDs as a means of attracting new customers. That being said, consumers should be aware that CDs aren’t quite as simple as they once were. This goes doubly so for CDs that carry special terms and conditions as part of a promotional offer. To minimize your risk, we recommend the following steps:
Learn the basics.
Since a Certificate of Deposit has become more complicated – like most everything else in the modern world – it would be wise to start at the beginning.
Don’t fall for marketing flash.
Specialty CDs are becoming a favorite way for banks to bring in new clients. Promotional deals are always the most questionable, so that means you must take extra care when reading the fine print.
Most importantly, don’t let yourself be dazzled by a high interest rate without checking all of the other details.
Watch out for call features.
This is one of the main “sneaky tactics” that can turn a great CD into a mediocre one. Call features allow the issuer to “call” the CD after a set period of time. What does that mean, exactly? It means that the bank can cut the term short or even lower the interest rate on the CD.
Usually, the bank will simply terminate the CD and pay you whatever interest has already been accrued, leaving you to start over with a new CD that has a lower rate of return.
Be clear on the interest rate and how it might change.
If you have a fixed-rate, non-callable CD, then your interest rate will be clearly stated and won’t be subject to change. If you have a variable-rate CD, however, you’ll need to find out how and when the rate can change.
Some variable-rate CDs will change based on a predetermined schedule, while others are linked to a market index such as the Dow Jones Industrial Average.
What’s a good rate on a CD?
Watch your back with brokered CDs.
Brokered CDs are offered through an intermediary, and they carry a few special considerations. First and foremost, you’ll need to take extra steps to make sure the broker is legitimate. Check out their background and history – the SEC database is a good place to start. You can also contact your state’s consumer protection board.
Once you’ve established the broker’s trustworthiness, be sure to check for any added fees or penalties that might be involved. Brokered CDs are a bit more risky, and penalties for early withdrawal are often steeper.
You may even lose part of your principal if you withdraw before the end of the CDs term. These are things you’ll want to investigate before buying a brokered CD.
Make sure a CD fits within your own financial goals.
CDs have their advantages, but they’re not for every investor. Be sure that your financial goals and investment plans has a place for CDs before opening one.
The last thing you want to do is sink your capital into low-risk, low-yield investments during a time when you’re positioned for a bit more risk and higher yields.
Questions to Ask Before Investing in Certificates of Deposit
Like any other investment, CDs aren’t for every investor or every situation. It’s important to determine whether or not a certificate of deposit is the right addition to your portfolio before committing to such an account.
Towards that end, we recommend asking yourself the following questions before deciding on a CD:
Can you deal with the loss of liquidity?
Almost everyone who banks knows the basic rule of a CD: you put the money in, and you don’t touch it until it matures. This loss of liquidity is often the major point against CDs, but the blow is softened if you won’t need access to the account.
Does your portfolio need stability?
If you’re already invested in riskier options, then the guaranteed returns of a CD might be a good way to add some stability to your portfolio.
Can you accept the risk of loss-on-inflation?
Investing in a long term CD means exposing yourself to the risks of inflation loss. In other words, if the rate of inflation climbs higher than your interest rate, you’ll suffer a loss of purchasing power on your investment.
Do you have funds put aside for emergencies?
Remember that one of the defining characteristics of a CD is the restricted access to your funds. While you won’t be entirely cut off from your money, you will likely suffer costly penalties if you withdraw early. You definitely don’t want to be in a position where your only source of emergency money is your CD.
Are you considering an IRA CD?
An IRA CD is essentially the same as a standard CD, except that you can leverage them to create some tax advantages. Be aware that opening an IRA CD through a bank counts as an IRA contribution, so it will impact the rest of your retirement investments for the year.