Certificate of Deposit Investor Tips
Investor Tips - CDs - Certificates of Deposit
Certificates of Deposit can be a great place for a certain portion of your monies. Read for more CD information and tips.
Investors searching for relatively low-risk investments that can easily be converted into cash often turn to certificates of deposit (CDs). A Certificate of Deposit is a special type of deposited account with a bank or thrift institution that typically offers a higher rate of interest than a regular savings account. Unlike other investments, CDs feature federal deposit insurance up to $100,000.
Here’s how CDs work: When you purchase a CD or Certificate of Deposit, you invest a fixed sum of money for fixed period of time – six months, one year, five years, or more – and, in exchange, the issuing bank pays you interest, typically at regular intervals. When you cash in or redeem your CD, you receive the money you originally invested plus any accrued interest. But if you redeem your CD before it matures, you may have to pay an "early withdrawal" penalty or forfeit a portion of the interest you earned.
Although most investors have traditionally purchased CDs through local banks, many brokerage firms and independent salespeople now offer CDs. These individuals and entities – known as "deposit brokers" – can sometimes negotiate a higher rate of interest for a CD by promising to bring a certain amount of deposits to the institution. The deposit broker can then offer these "brokered CDs" to their customers.
At one time, most CDs paid a fixed interest rate until they reached maturity. But, like many other products in today’s markets, CDs have become more complicated. Investors may now choose among variable rate CDs, long-term CDs, and CDs with other special features.
Some long-term, high-yield CDs have "call" features, meaning that the issuing bank may choose to terminate – or call – the certificate of deposit after only one year or some other fixed period of time. Only the issuing bank may call a CD, not the investor. For example, a bank might decide to call its high-yield Certificates of Deposit if interest rates fall. But if you’ve invested in a long-term CD and interest rates subsequently rise, you’ll be locked in at the lower rate.
Before you consider purchasing a certificate of deposit from your bank or brokerage firm, make sure you fully understand all of its terms. Carefully read the disclosure statements, including any fine print. And don’t be dazzled by high yields. Ask questions – and demand answers – before you invest. These tips can help you assess what features make sense for you:
- Find Out When the CD Matures – As simple as this sounds, many investors fail to confirm the maturity dates for their CDs and are later shocked to learn that they’ve tied up their money for five, ten, or even twenty years. Before you purchase a CD, ask to see the maturity date in writing.
- Investigate Any Call Features – Callable CDs give the issuing bank the right to terminate or "call" the CD after a set period of time. But they do not give you that same right. If the interest rates fall, the issuing bank might call the CD. In that case, you should receive the full amount of your original deposit plus any unpaid accrued interest. But you'll have to shop for a new one with a lower rate of return. Unlike the bank, you can never "call" the CD and get your principal back. So if interest rates rise, you'll be stuck in a long-term CD paying below-market rates. In that case, if you want to cash out, you will lose some of your principal. That's because your broker will have to sell your CD at a discount to attract a buyer. Few buyers would be willing to pay full price for a CD with a below-market interest rate.
- Understand the Difference Between Call Features and Maturity – Don’t assume that a "federally insured one-year non-callable" CD matures in one year. It doesn't. These words mean the bank cannot redeem the CD during the first year, but they have nothing to do with the CD's maturity date. A "one-year non-callable" CD may still have a maturity date 15 or 20 years in the future. If you have any doubt, ask the sales representative at your bank or brokerage firm to explain the CD’s call features and to confirm when it matures.
- For Brokered CDs, Identify the Issuer – Because federal deposit insurance is limited to a total aggregate amount of $100,000 for each depositor in each bank or thrift institution, it is very important that you know which bank or thrift issued your CD. Your broker may plan to put your money in a bank or thrift where you already have other CDs or deposits. You risk not being fully insured if the brokered CD would push your total deposits at the institution over the $100,000 insurance limit. (If you think that might happen, contact the institution to explore potential options for remaining fully insured, or call the FDIC.) For more information about federal deposit insurance, visit the Federal Deposit Insurance Corporation’s web site and read its publication Your Insured Deposit or call the FDIC's Consumer Information Center at 1-877-275-3342. The phone numbers for the hearing impaired are 1-800-925-4618 or (202) 942-3147
- Find Out How the CD Is Held – Unlike traditional bank CDs, brokered CDs are sometimes held by a group of unrelated investors. Instead of owning the entire CD, each investor owns a piece. Confirm with your broker how your CD is held, and be sure to ask for a copy of the exact title of the CD. If several investors own the certificate of deposit, the deposit broker will probably not list each person's name in the title. But you should make sure that the account records reflect that the broker is merely acting as an agent for you and the other owners (for example, "XYZ Brokerage as Custodian for Customers"). This will ensure that your portion of the CD qualifies for up to $100,000 of FDIC coverage.
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