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
Heres 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 and independent salespeople now offer CDs.
These individuals and entities 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 todays markets, CDs
have become more complicated. Investors may now choose among variable rate CDs,
long-term CDs, and CDs with other special features.
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 youve invested in a
long-term CD and interest rates subsequently rise, youll 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 dont 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
theyve tied up their money for five, ten, or even twenty years. Before
you purchase a CD, ask to see the maturity date in writing.
Investigate Any Call
Features Callable CDs give the issuing bank the right to
terminate-or "call"-the CD after a set period of time. But they do not give you
that same right. If interest rates fall, the issuing bank might call the CD. In
that case, you should receive the full amount of your original deposit plus any
unpaid accrued interest. But you'll have to shop for a new one with a lower
rate of return. Unlike the bank, you can never "call" the CD and get your
principal back. So if interest rates rise, you'll be stuck in a long-term CD
paying below-market rates. In that case, if you want to cash out, you will lose
some of your principal. That's because your broker will have to sell your CD at
a discount to attract a buyer. Few buyers would be willing to pay full price
for a CD with a below-market interest rate.
Understand the Difference Between
Call Features and Maturity Dont assume that a
"federally insured one-year non-callable" CD matures in one year. It doesn't.
These words mean the bank cannot redeem the CD during the first year, but they
have nothing to do with the CD's maturity date. A "one-year non-callable" CD
may still have a maturity date 15 or 20 years in the future. If you have any
doubt, ask the sales representative at your bank or brokerage firm to explain
the CDs call features and to confirm when it matures.
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. Your broker may plan to put your money in a bank or thrift where you
already have other CDs or deposits. You risk not being fully insured if the
brokered CD would push your total deposits at the institution over the $100,000
insurance limit. (If you think that might happen, contact the institution to
explore potential options for remaining fully insured, or call the FDIC.) For
more information about federal deposit insurance, visit the Federal Deposit
Insurance Corporations web site and
read its publication
Insured Deposit or call the FDIC's Consumer Information Center at
Find Out How the CD Is
Held Unlike traditional bank CDs, brokered CDs are sometimes
held by a group of unrelated investors. Instead of owning the entire CD, each
investor owns a piece. Confirm with your broker how your CD is held, and be
sure to ask for a copy of the exact title of the CD. If several investors own
the CD, the deposit broker will probably not list each person's name in the
title. But you should make sure that the account records reflect that the
broker is merely acting as an agent for you and the other owners (for example,
"XYZ Brokerage as Custodian for Customers"). This will ensure that your portion
of the CD qualifies for up to $100,000 of FDIC coverage.
Research Any Penalties for Early
Withdrawal Deposit brokers often tout the fact that their CDs
have no penalty for early withdrawal. While technically true, these claims can
be misleading. Be sure to find out how much you'll have to pay if you cash in
your CD before maturity and whether you risk losing any portion of your
principal. If you are the sole owner of a brokered CD, you may be able to pay
an early withdrawal penalty to the bank that issued the CD to get your money
back. But if you share the CD with other customers, your broker will have to
find a buyer for your portion. If interest rates have fallen since you
purchased your CD and the bank hasn't called it, your broker may be able to
sell your portion for a profit. But if interest rates have risen, there may be
less demand for your lower-yielding CD. That means you would have to sell the
CD at a discount and lose some of your original deposit despite no
"penalty" for early withdrawal.
Thoroughly Check Out the
Broker Deposit brokers do not have to go through any
licensing or certification procedures, and no state or federal agency licenses,
examines, or approves them. Since anyone can claim to be a deposit broker, you
should always check whether your broker or the company he or she works for has
a history of complaints or fraud. You can do this by calling your state
securities regulator or by checking with the National Association of Securities
Dealers' "Central Registration Depository" at 1-800-289-9999.
Confirm the Interest Rate Youll
Receive and How Youll 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 youll be
paid for example, by check or by an electronic transfer of
Ask Whether the Interest Rate Ever
Changes If youre 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
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
Don't be embarrassed if you invested in a long-term, brokered CD
in the mistaken belief that it was a shorter-term instrument-you are not alone.
Instead, you should complain promptly to the broker who sold you the CD. By
complaining early you may improve your chances of getting your money back. Here
are the steps you should take:
- Talk to the broker who sold you the CD, and explain the problem
fully, especially if you misunderstood any of the CD's terms. Tell your broker
how you want the problem resolved.
- If your broker can't resolve your problem, then talk to his or
her branch manager.
- If that doesn't work, then write a letter to the compliance
department at the firm's main office. The branch manager should be able to
provide with contact information for that department. Explain your problem
clearly, and tell the firm how you want it resolved. Ask the compliance office
to respond to you in writing within 30 days.