| Investors searching for relatively low-risk
investments that can easily be converted into cash often
turn to certificates of deposit (CDs). A CD is a special
type of deposit 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, 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 now offer
CDs. These brokerage firms – 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 special redemption features
in the event the owner dies.
Some long-term, high-yield CDs have "call"
features, meaning that the issuing bank may choose to
terminate – or call – the CD 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 CDs 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 CD 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.
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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. In other words, find out
where the deposit broker plans to deposit your
money. Also be sure to ask what record-keeping
procedures the deposit broker has in place to
assure your CD will have federal deposit
insurance. For more information about federal
deposit insurance, read the FDIC's publication
Your Insured Deposits or call the FDIC's Central
Call Center at (877) 275-3342 or (877) ASK-FDIC.
For the hearing impaired call 1-800-925-4618 or
1-202-942-3147 in Washington, D.C.
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Investigate Any Call Features
Callable CDs give the issuing bank the right
to terminate the CD after a set period of time,
but they do not give you that same right. If the
bank calls or redeems your CD, you should receive
the full amount of your original deposit plus any
unpaid accrued interest.
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Understand the Difference Between Call
Features and Maturity
Don’t assume that a "federally
insured one-year non-callable" CD matures in
one year. 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.
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Confirm the Interest Rate You’ll
Receive and How You’ll Be Paid
You should receive a disclosure document that
tells you the interest rate on your CD and
whether the rate is fixed or variable. Be sure to
ask how often the bank pays interest – for
example, monthly or semi-annually. And confirm
how you’ll be paid – for example, by
check or by an electronic transfer of funds.
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Ask Whether the Interest Rate Ever
Changes
If you’re considering investing in a
variable-rate CD, make sure you understand when
and how the rate can change. Some variable-rate
CDs feature a "multi-step" or
"bonus rate" structure in which
interest rates increase or decrease over time
according to a pre-set schedule. Other
variable-rate CDs pay interest rates that track
the performance of a specified market index, such
as the S&P 500 or the Dow Jones Industrial
Average.
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Research Any Penalties for Early
Withdrawal
Be sure to find out how much you’ll have
to pay if you cash in your CD before maturity.
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Ask Whether Your Broker Can Sell Your CD
Some brokered CDs are issued in the name of
the "custodian" or deposit brokers. In
some cases, the deposit broker may advertise that
the CD does not have a prepayment penalty for
early withdrawal. In those cases, the deposit
broker will instead try to resell the CD for you
if you want to redeem it before maturity. If
interest rates have fallen since you purchased
your CD and demand is high, you may be able to
sell the CD for a profit. But if interest rates
have risen, there may be less demand for your
lower-yielding CD. That means you may have to
sell the CD at a discount and lose some of your
original deposit.
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Find Out About Any Additional Features
For example, some CDs offer a death benefit
that allows a CD owner’s heirs to redeem the
CD without penalty when the owner dies.
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The bottom-line question you should always ask
yourself is: Does this investment make sense for me? A
high-yield, long-term CD with a maturity date of 15 to 20
years may make sense for many younger investors who want
to diversify their financial holdings. But it might not
make sense for elderly investors.
If you have a complaint about a CD you purchased
through a bank, try to resolve your complaint directly
with an officer of the bank before involving an outside
agency. Financial institutions value their customers and
most will be helpful. If you are unable to resolve the
matter with the financial institution, use the following
guidelines to determine where to direct your complaint.
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