Certificates
of Deposit:
Tips for Investors
Concern
over market fluctuations has led some investors to seek the security
of certificates of deposit (CDs), an investment product with
lower risk. CDs typically offer higher interest rates than a
regular savings account, and unlike other investments, CDs feature
federal deposit insurance up to $100,000. But, like many other
products in today's markets, CDs have become more complicated.
Investors may now choose among variable rate CDs, long-term CDs,
and CDs with other special features. With all the options, consumers
must be especially cautious to ensure that the CD they purchase
meets their needs.
Some long-term, high-yield
CDs may 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 you've
invested in a long-term CD and interest rates subsequently rise,
you'll be locked in at the lower rate.
At one time, most CDs
were offered through banks or other financial institutions. They
paid a fixed interest rate until they reached maturity, and carried
a penalty if the depositor cashed in the CD before the specified
term. Today, however, many brokerage firms and independent salespeople
now offer CDs. These "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.
Before you consider
purchasing a CD from a bank or brokerage firm, you should fully
understand all of its terms. Carefully read the disclosure statements,
including any fine print. And don't 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 they may have tied up their money for 20 years.
- 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. So if interest rates rise, you'll be stuck in along-term CD paying below-market rates.
- Understand the difference between call features and maturity -- Don't 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 CDs maturity date. A "one-year non-callable" CD may still have a maturity date 15 or 20 years in the future.
- 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.
- 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 persons name in the title. But you should make sure the account records reflect that the broker is merely acting as an agent for you and the other owners. This will ensure that your portion of the CD qualifies for up to $100,000 of FDIC coverage. Also be sure to get a written record confirming the name of the registered owner, amount of the investment, interest rate, maturity, call provisions, and penalty for early withdrawal.
- 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 generally have to go through any licensing or certification procedures, and generally, 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. Good places to start your investigation include the Florida Comptrollers Hotline at 1-800-848-3792 and the National Association of Securities Dealers Central Registration Depository at 1-800-289-9999.
