Conservative investing: Certificates of deposit offer stability, protection in turbulent times

October 1, 2009
William J. Lynott

If you're of a conservative bent, you probably have some of your savings invested in bank certificates of deposit (CDs). If so, you're already well aware of the poor rates that CDs are paying these days.

Key Points

On the plus side, while you may not be enjoying robust interest on those investments, you aren't losing money, either. And, of course, your principal is protected by FDIC insurance. All in all, those are good reasons for socking at least some of your money away in CDs.

When you buy a CD, you are lending the bank your money for a specified time in return for an agreed-upon interest rate. As part of the bargain, you agree to pay a penalty if you withdraw all or some of your money before the maturity date.

The terms of a CD can range from as little as 30 days to five years or longer. Once you make CDs a part of your financial management strategy, you must decide whether to buy a short-term or long-term CD. This can be a problematic decision, depending on the current investment climate.

When interest rates are low, as they are now, conventional wisdom says that you should go for the shorter term, so your money won't be tied up when rates rise. However, when interest rates seem high or if you expect them to drop, you should opt for the longer term. This will allow you to lock in the high rate for as long as possible. The idea, of course, is to minimize the chances that you'll be tying up your money at less than optimum interest rates.

Shopping around

When you're ready to buy a CD, shopping around for the best interest rate is a practical necessity. Thanks to the Internet, finding the best current CD rates is easy. Sites such as www.Bankrate.com allow you to quickly locate the best CD deals.

Keep in mind that you needn't limit your search to CDs from local banks. You may find that rates are considerably higher outside your own state or from one of the online banks that have sprung up in recent years.

If you decide to deal with an online bank, check to make certain that it's a member of the FDIC so that your deposits will be protected by FDIC insurance.

Brokered CDs

There's one more place for you to consider in your search for the best CD interest rate. If you have a brokerage account, brokered CDs may turn out to be an even better buy.

In addition to providing CDs directly to their customers, some banks offer large blocks to brokers who then resell them to their clients. Most of the major brokerage firms offer these brokered CDs to their clients, and they often offer higher interest rates than are offered through direct bank purchases.

Brokered CDs carry the same FDIC insurance as those that are bought directly from the banks. For the most part, CDs bought through your broker will have the same provisions as regular CDs, but there are a few important differences.

If you need to withdraw your money from a regular CD before the maturity date, the bank will likely charge you a penalty amounting to three to six months of interest. With a brokered CD, you would simply have to sell it on the secondary market. If prevailing interest has risen since your original purchase, you could lose some of your principal.

In addition, some brokered CDs are callable. That means the bank retains the right to pay you back before the final maturity date if it is to their advantage to do so. For example, if interest rates fall, then the bank will likely call the CD, forcing you to find a replacement at a lower rate. However, if rates go up, you'll be locked in for the full term just as you would be with a direct purchase.

Still, brokered CDs may give you an opportunity to boost your monthly income. As long as you take the time to learn and understand the differences, buying a brokered CD may open the door to a world of higher rates.

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