Certificates of Deposit

Do CDs Make Sense in Today's Market?

Certificates of Deposit
December 10, 2013

Investors have long valued Certificates of Deposits (CDs) as a low-risk savings tool. Most types of CDs are straightforward; the more you deposit and the longer the term, the higher the interest rate and return. In addition, many come with insurance from the FDIC.

In today’s investment environment, historically low interest rates have made CDs much less attractive. If you need to withdraw your funds early, banks can charge stiff penalties. With the Federal Reserve committed to keeping interest rates low for the near future, what is an investor looking for safety to do? There are several strategies that can help you leverage CDs more effectively to make them a more worthwhile investment option.

  • Select CDs with shorter terms — When selecting shorter terms, you may have to sacrifice higher yields. However, should interest rates go up, you would be able to avoid getting stuck with underperforming investments and reallocate according to the rise in rates.
  • Implement a CD Ladder strategy — Say you have $10,000. Rather than getting one CD for the full $10,000 and a longer maturity rate (limiting your ability to access your cash), you may choose several CDs with staggered terms. The advantage is that your CDs will mature at different times, giving you more frequent access to funds without the risk of paying penalties. This approach will also yield higher returns than rolling over a single CD with a shorter maturation rate. Laddering also provides flexibility to make adjustments based on changes in interest rates.
  • Employ a barbell strategy — While similar to the ladder, the barbell allows you to split your funds into two groups of CDs: one with only short maturities, and the other group with only long maturities and higher yield rates. The advantage of a barbell strategy is that it provides you with short-term liquidity, as opposed to tying up all of your money longer.
  • Prepare for rising interest rates with bump-up CDs — If interest rates rise (which the Feds have indicated will happen mid-2015), longer-term bump-up CDs allow investors to request an increase on interest earned, typically one time per term. Bump-up CDs require higher deposit minimums, from $5,000 and up.
  • Consider indexed or structured CDs — These CDs correlate to another type of investment, such as the stock market, currency market or commodities. Market-linked CDs Yields are capped at a specific percentage of the returns of the index they are linked to, such as the S&P 500, and they generally carry more complex terms than traditional CDs.

If you are considering CDs, begin by assessing your anticipated cash-flow needs. Compare interest rates and terms from the more than 4,800 banks and institutions that offer CDs nationwide and be sure to read the fine print related to penalties for early withdrawal. As with any financial investment, clearly defining your short- and long-term financial goals and researching the investment tools you will use are key to creating a successful investment strategy.

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