Certificates Of Deposit: Details To Consider
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.
The amount of time an investor must wait until he or she can ...
The online market where investors can purchase federal government ...
The return on investment, expressed as a percentage, on the debt ...
A security backed by a pool of debt, often low-rated corporate ...
An interest-bearing account that typically pays a higher interest ...
A type of security whose cash flows come from residential debt ...
To address this question, let's employ the concept of distance. In the city, a short taxi ride from your hotel to a convention ...
Find out how to calculate the yield to maturity for a zero coupon bond, and see why this calculation is more simple than ...
Find out why financial analysts and publications track and quote bond yields in basis points, or bps, rather than simply ...
Discover how Treasury Bills (T-bills) are a safe-bet investment for short-term returns. The percentages on the returns vary.