Personal finance experts at Kiplinger’s recently ran a report entitled What You Need to Know About CDs, designed to reflect modern times. With a recession in progress and national economic health in a poor state indeed, historically accepted rules about investing and savings have changed dramatically – if not gone right out the proverbial window. These are their tips for using certificates of deposit.
1.) Remember that things aren’t completely as bad as they seem. CD rates are disappointingly low right now, and have been for over a year. It seems like the rates have fallen slowly but steadily in the last twelve months, but take heart – inflation is also very low at the moment. With yearly inflation holding on at 0.2%, your CD is still worth more in buying power than it was during this time last year. Also, keep in mind that the average rate is almost never the best you can get. When it comes to CDs, shopping around is the best thing you can do. The national average rate as of this week is 2.26%; at least one bank (Intervest National) is offering a full percentage point more.
2.) Climb the ladder – the CD ladder, of course. This refers to investing your money into several CDs with staggered dates of maturity. You will want to take out a few CDs each for a different length of time ranging from six months to five years. The purpose of this is dual fold. If rates fall, you have locked in a good rate for at least the length of your longest CD. If rates start rising, you are never too far away from the maturity date of at least one, so you can lock in that deal. Also, you know that you are never more than a few months away from an influx of cash, should you fall upon tough financial times. As one CD matures, replace it with another of equal length to keep the cycle going.
3.) Don’t fall for scams. CDs are always issued by an American bank and backed by the federal government. If the product in which you are thinking of investing fails to meet either of these criteria, you should probably stay away. The so-called CDs being pushed by Robert Allen Stanford, for example, were based in Antigua and were actually promissory notes. Consumers were tempted by explosively-high interest rates, but the old adage that “if it sounds too good to be true, it probably is” applies. Stanford’s victims lost a collective eight billion dollars on his racket.
4.) Use a broker. It may be more expensive than handling your finances yourself, but a financial expert can take over some of what the Kiplinger article calls the “heavy lifting” of dealing with your money. For example, the brokerage can help you spread a big sum of cash among many (reputable and insured) banks, and receive just a single statement on your account. Also, if you should ever find yourself in the position of needing the cash from your CD before it comes to maturity, your broker may very well be able to sell your certificate on the secondary market and spare you the considerable penalty for an early withdrawal. You will also have the peace of mind that comes with knowing that CDs in brokerage accounts are protected by the FDIC.
5.) “Caveat emptor” applies to market-linked certificates. Putting your money in a CD with a stock market-linked interest rate can potentially earn you quite a bit more interest than one with a fixed rate. On the other hand, you might not make ANYTHING on your investment, if the market sours. You are guaranteed at least the principle amount of the deposit back at maturity, but nothing else is assured. Since the whole reason for utilizing CDs is to have a safe place to save your money and one with a guaranteed yield (even a small one), marked-linked certificates pretty much make that point moot. Look into an index fund if you are looking to take a chance on stocks, or into a trip to Vegas if you want to gamble.
6.) Make sure that you are insured. You should never invest more in a CD than is covered by the FDIC’s limits at any time. Right now, depositors are insured for a quarter million dollars per bank, but that will drop down to just one hundred thousand dollars on the first of January next year. It’s easy enough to see how you are doing by checking out the FDIC’s insurance estimator tool, located on their website.
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