MarketWatch had some good advice about avoiding the various pitfalls in an article titled “Know Your CD.” Here are some highlights, but be sure to read the entire piece and follow the listed links if this subject interests you:
Given the financial meltdown, certificates of deposit are king.
After all, CD yields now range from 3% to 4.5%, while shorter-term U.S. Treasuries are yielding from below 1% to about 2%.
Another attraction of bank CDs: The federal bail-out bill, adopted Oct. 3, increased government-backed FDIC and NCUSIF (National Credit Union Share Insurance Corp.) insurance to $250,000 per owner, up from $100,000.
The following are also covered up to $250,000: Each holder of a joint account; certain bank-deposit IRA funds and some other retirement accounts; and each trust owner and beneficiary if specific rules are followed. But beware. The higher $250,000 federal insurance limit expires Dec. 31, 2009 — even if your CD has a later maturity date.
Understanding CDs is tougher than it once was. Here are some issues to consider:
1. Check early withdrawal penalties carefully. It’s no longer standard for banks to charge you three months’ or six months’ worth of interest. Some institutions may use complex formulas based on current rates and, in some cases, the term remaining. Some even charge interest that has not yet been earned, which could cut into your principal if you withdraw early.
2. Check whether another account or a specific minimum required balance is required to earn a high advertised rate.
3. Stay within federal insurance limits. Visit FDIC.gov or NCUA.gov to confirm your account is fully protected.
4. Check the institution’s condition. You can do this for free for a number of institutions at Bauerfinancial.com. While a financial institution’s condition should not matter if you stay within FDIC insurance limits, you could find your interest rate lowered in an FDIC-assisted merger. Find a federally-insured credit union you might be able to join at CreditUnion.coop.
5. Find out how you will be notified when your CD matures and what will happen to your money. Many institutions today automatically roll over your CD. However, some may put it into a low-interest or no-interest account. You might not want any of this to happen.
6. Watch for CDs with rates that are not fixed for the entire term. You may not earn as much as you think.
Sometimes, it’s more convenient to buy a CD through a broker. However, this also may be a tad riskier. Generally, brokered CDs are issued by banks via a “master CD” to deposit brokers or broker-dealers, which in turn, sell interests to you.
The individual CDs still are FDIC-insured. But usually broker-sold CDs are considered securities and may be more complex than a CD you get from a bank.
For one thing, they may come in longer terms — as long as 20 years. They may have variable interest rates and “call” features, which mean the institution has the one-sided option to return your deposit, usually at specified intervals, forcing you to reinvest at lower interest rates.
The interest rate may fluctuate, based on a published index. The hottest new types of brokered CDs, for example, have interest rates that may change based on the performance of derivatives.
Unlike most bank CDs, you may not be able to withdraw early from a brokered CD. And although most CDs will allow withdrawals if the owner dies, not all do.
If you wish to withdraw early, your only option at a brokerage may be to sell your CD on the secondary market. Not all brokers will do this for you. Plus, you frequently can expect to take a haircut on your CD’s value if you sell early, especially if interest rates have risen. After all, who would want your lower-rate CD?
With a broker, there could be more administrative delays in getting your money if your institution fails. When the FDIC closes a bank and sells deposits, it often will not pass brokered funds to an acquiring bank because it’s considered “hot” money, says FDIC spokesman David Barr.
Although the FDIC notifies brokers the day a bank closes that it needs to verify records, brokers have taken as long as eight weeks to get the FDIC necessary documentation. Some customers have earned no interest during this period.
Still, Barr says that after some recent big failures, brokers have gotten faster in providing required documents.
Whenever you invest through a broker, check whether your deposits are being sent to a bank at which you already have accounts. You don’t want to inadvertently exceed FDIC insurance limits.
Above all, note that not all brokers selling CDs are FINRA-registered, like your stockbroker. If the entity selling a CD is not well-known, confirm the issuer is not a scam artist. One way to do that is by checking up on the company through your state securities division or state attorney general.
There you have it; it’s not as simple as it used to be, and you have to make the decision whether the due diligence is worth the effort. If you decide to go that route anyway, how long should you commit yourself? Personally, I recommend no more than 6 months maximum so you are ready to participate in a market trend reversal should one materialize.