How to Invest In Certificates of Deposit

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Sustained, historically low interest rates have made CDs a less interesting part of an investor's portfolio, but can they still provide value when compared to a savings account?

Consumers seeking risk-free returns above savings rates frequently turn to Certificates of Deposit (CDs) because these securities traditionally feature interest rates higher than regular savings accounts and offer the same FDIC insurance. Banks have a contractual obligation to pay out interest over the life of the security and to pay back depositor principal when the security matures, The United States government, through the FDIC, insures up to $250,000 per bank per individual, thus eliminating institutional risk, making it an even more attractive investment option for the risk-averse investor.

Traditional CDs involve depositing a fixed amount of money for a fixed period of time in exchange for a fixed rate of interest, paid out at regular intervals, plus the repayment of the principal once the CD matures. They also carry significant penalties should the owner seek to redeem the CD early (usually ranging from the forfeiture of 3 months to 1 year of interest which may, depending on the circumstance, include the loss of principal). In today's low rate environment banks have become creative and many structure CD products with additional features suited to investors seeking additional upside (such as CDs with variable rates tied to a specific equity or bond index) or more flexibility (lower withdrawal penalties and special redemption features should the owner die). The downside to these more exotic CD products is that they are more complicated and carry more risk.

There are several factors an investor should consider prior to investing in CDs. How long is the investor willing to tie up their money? Since cash invested in CDs cannot be accessed early without penalty, it's important an investor be sure they won't need the funds prior to the security’s maturation. Another important consideration of the security is the interest rate and overall yield of the product. The interest rate, presented by the bank to investors as the APR or Annual Percentage Rate is the interest rate being offered on that particular CD. The APY, or Annual Percentage Yield, quantifies how much an investor will earn over the life of the CD as their money compounds. For example, if a CD pays an APR of 3%, that is the offered interest rate. If 1,000 is deposited into a CD that has an APR of 3%, an individual will earn $30 by the end of the first year. That $30 is then added to the principal and the 3% APR is applied to this new, higher total resulting in a higher level of interest earnings by the end of the second year, in this case $31.

Interest expectations are also an important factor. An investor who believes that interest rates will rise in the short term, will want to invest in shorter term CDs or even savings accounts, to keep their funds more liquid. An investor who believes that interest rates will fall in the future, should invest in longer term CDs, locking in higher rates.

Historically, “laddering” CDs has been a highly popular and effective method of investing. Laddering involves depositing money into a number of different CDs with varying maturities, short term, medium term and long term. This ensures a regular cash flow and provides liquidity as CDs mature that can enable the investor to take advantage of changes in interest rates. Unfortunately in a low interest rate environment this strategy has proven to be less effective than in the past.

To remain liquid in a low rate environment, some investors modify the traditional laddering approach by employing what is known as “short laddering”, where the maturities of the CDs are not as spread out but instead concentrated on short duration certificates. This maintains some yield and also keeps the investor's funds relatively liquid should interest rates rise or other investment opportunities arise.

Another option is an instrument known as the Bump Up CD. This security features a one-time option held by the investor to request a rate increase on their investment should interest rates rise. The drawback is that the initial APR offered is lower than a comparable CD without the Bump Up option embedded. Thus, if interest rates do not rise, your return will be lower than it would have been if you had stuck to investing in traditional CDs. The most interesting Bump Up CDs these days are offered by Ally Bank where they are called Raise Your Rate CDs and can be purchased for 2-year and 4-year time periods. As of this writing, these are offered at 1.09% APY and 1.35%, respectively.

Simply shopping around for the best rate might represent the most effective and least risky approach to generating satisfactory return from investing in CDs. One way to do this is to seek out institutions offering promotional or bonus rates on their products. These are typically offered by credit unions or smaller community banks, so they can be hard to find. Additionally, they frequently only apply to funds coming from elsewhere, so existent customers cannot take advantage of the offer. Another drawback is that many credit unions have membership restrictions so if you don’t live in a certain geographic area or aren’t employed by a specific company you aren’t eligible. All current CD rates at online banks, local and regional banks and credit unions are detailed here.

The most effective and time saving approach is to use websites like BestCashCow, which displays rates from throughout the industry in one place. This enables investors to make quick and comprehensive comparisons of the rates currently available and make an informed decision based off that information. With yield often hard to find, resources like this are becoming increasingly valuable tools for those determined to squeeze every last penny out of their investments.

Michael Cancella
Michael Cancella: Michael Cancella graduated magna cum laude from Columbia University with a B.A in History in 2010. After graduating he worked in the finance industry at a hedge fund startup and is currently going through the CFA Program in an effort to broaden his knowledge of finance and the economy. Prior to returning to school to finish his degree at Columbia, he spent a number of years i

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Today's Highest Online CD Rates

Bank Product Term Interest Rate (APY)
Finworth, a division of InsBank 1-Year 5.38% APY with $50,000 minimum
TotalDirect, a division of City National Bank of Florida 1-Year 5.35% APY with $25,000 minimum
First Internet Bank of Indiana 1-Year 5.31% APY with $1,000 minimum
Dollar Savings Direct, a division of Emigrant Bank 3-Year 5.00% APY with $1,000 minimum
First Internet Bank of Indiana 3-Year 4.66% APY with $1,000 minimum
IncredibleBank 3-Year 4.58% APY with $1,000 minimum
First Internet Bank of Indiana 5-Year 4.55% APY with $1,000 minimum
BMO Alto, a division of Bank of Montreal Harris 5-Year 4.50% APY with no minimum
Department of Commerce 5-Year 4.34% APY with $500 minimum

See More Online CD Rates →

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