The presence of inflation makes the typical CD a less attractive option for investors seeking long-term growth. While CDs do increase in value, their interest rates tend to move with inflation rates. If inflation is 3% and the interest rate is 3%, the CD's value increases, but only in accordance with inflation. When inflation is factored in to the equation, the CD does not add value to the investor's portfolio. It is important for investors, then, to put their money into CD accounts offering interest rates greater than inflation, if at all possible. (Read Coping With Inflation Risk to learn more.)
Another factor that may make CDs less attractive to investors is an automatic rollover. This feature is not attached to every CD, but investors will want to know if it is part of their CD investment. An automatic rollover predetermines what will happen to a CD when it matures. If investors do not act quickly to reinvest the money according to a personal plan (such as a CD ladder), the bank does it for them. This locks the money into a new account, making it inaccessible - apart from paying withdrawal penalties. Simply investing in a CD that does not have an automatic rollover will prevent the problem.
Unattractive penalty fees can discourage investing in CDs as well. An account that requires six months' interest for withdrawing money early on an account that is only two months old can take a significant toll on the CD investment. The four months' interest that would have accumulated is taken directly from the account's principal, resulting in a net loss. Again, to avoid this situation, investors need only to research features and requirements to select the CD investment they prefer.
Selecting the Best Investment
Examining the terms and conditions of a potential CD is key to selecting the best investment. Knowing what to expect in withdrawal fees and closure fees goes a long way toward an appropriate account decision.
Consider a callable CD that has been purchased to provide income. While it may pay a higher rate of interest than a non-callable CD, if the CD is called, the income drops to zero. If the call happens at an inopportune time, income generation could become a real challenge for the investor.
Similarly, it is important to know whether the CD permits partial withdrawals. In some cases, even if the investor is willing to pay a penalty, removing even a small portion of the principal prior to the maturity date may trigger an automatic closure of the CD. Also keep in mind that banks can delay withdrawals to stop a run on the bank. While bank runs are uncommon, they do occur, so investors should consider this possibility.
When examining the terms and conditions, investors should look at when interest payments are calculated. The more frequently they are calculated, the greater the annual yield, in general. Some CDs begin calculations on the date of deposit; others begin from the start of the month following the deposit. In this case, investing mid-month could result in no income generation for two weeks. Some CDs even start calculations from the start of the next quarter, a situation that could result in weeks or months of no interest accumulation, depending on the investment date. Similarly, the stop date for calculations can vary significantly. Some CDs end calculations on the date of withdrawal, while others stop at the end of the previous month or even the end of the previous quarter.
Investors can locate the right CD for their needs by taking all of the details into consideration.
Certificates Of Deposit: Conclusion
InvestingCertificates of deposit promise stable income in any market, but do they deliver?
Managing WealthLaddered certificates of deposit offer safe capital and predictable cash flow, while bringing simplicity to your portfolio.
InvestingWhen choosing between CDs and bonds, investors who seek to maximize their returns but also want a large measure of safety should consider the following:
Managing WealthFind out how a CD ladder can protect you from interest rate risk.
InvestingFind out which short-term savings vehicle, a money market account or a certificate of deposit, is a better investment for your needs.
InvestingUnderstand what a savings bond is, what a CD is and what sets them apart from each other. Learn why a savings bond is the right investment for 2016.