December 14, 2018

Understanding CD Types

Understanding CD TypesIf you have made the choice to invest into CDs, you will select among the various CD types for your personal investment portfolio. A CD by definition is an investment certificate that grants the bearer of the certificate a specific rate of interest at the certificate’s maturity date. CD rates will have maturity dates that vary from one month to 5 years in length and are most typically issued by a FDIC insured bank.

CD rates will often range based upon the maturity dates. For example, a $10,000 1 year CD may pay a rate of 2.5% at its maturity. And, a 5 year CD rate may be paying 4.25% at its maturity date. The longer maturity CD rates will offer higher rates as they have a higher risk to the investor than a shorter term CD.

Some of the major CD types are Callable CDs, Jumbo CDs, Inflation Linked CDs and Zero coupon CDs.

Callable CDs

 

Similar to fixed equity products, CDs can have a callable feature. A callable feature is often included on fixed investments to give the Issuer the option of calling the investment in the event that interest rates change enough to place the Issuer in an unfavorable position. The benefit to the investor is that Callable CDs often bear a higher interest rate to compensate for the added risk that the investor is taking with relating to the chance that the CD will be called prior to its maturity date. If interest rates decline, investors should be prepared for the possibility that their CDs will be called, causing them to reconsider their overall investment strategy with the money released from their CDs.

Jumbo CDs

Jumbo CDs are sold in denominations above $100,000 and while individual investors can invest into them, they are most commonly purchased by institutional investors. Institutional investors can include corporate investors or mutual fund managers. The CD rates for Jumbo CDs will range based on their issuers and maturity dates.

Inflation Linked CDs

 

Inflation is a common concern of investors using cash instruments within their portfolio, as it can erode purchasing power over time. An inflation linked CD is a federally insured type of debt instrument that provides investors a form of inflation protection through the use of variable interest rates. The interest rates will vary based upon a set standard, tied to the national Consumer Price Index (CPI). These offer CD rates that are below traditional CDs as they pose significantly less risk to the investor as they offer this added inflation protection.

Zero Coupon CDs

Zero Coupon CDsInvestors may have heard of zero coupon bonds, but may not be familiar with zero coupon CDs. A zero coupon CD is one that is purchased well below the coupon rate. With regards to CD rates, the coupon rate refers to the interest rate expected and the term ‘zero coupon’ refers to a CD that will not in fact make interest payment. The interest stated will be paid to the investor when the CD matures, but the investor will be charged what is called phantom income for the interest payments not received on an annual basis. The advantage is that the CD rate is often higher, but the investor needs to be aware of the annual taxes in order to set aside those needed funds.

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For other information on CD Investing Visit these sources:

The Securities and Exchange Commission
The Federal Trade Commission

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