Pros and Cons of CD Investing

Investing into any investment vehicle will present both advantages and disadvantages to an investor. Both should be considered when evaluating options for an investment portfolio so that the products and services selected are the best possible match for the investor’s financial goals, time frame and risk tolerance.

Advantages

Fixed Investments- One of the most attractive things about a CD investment is that they offer a fixed rate of return, attractive to many different kinds of investors. Conservative investors as well as those who are seeking income are often the most suitable investors for CDs.

FDIC Insurance- For many investors, having the backing of insurance for their investments is attractive. Most CDs are backed with FDIC insurance, protecting investors in the event that the financial institution issuing them was to go bankrupt.

Maturity Date Choices- CDs are offered with a variety of maturity dates, ranging from one month to 5 years. The maturity dates offer differing CD rates to investors, with the longer maturity dates typically offering the investor the higher rate.

Income Possibility- In addition to conservative investors, those who are interested in a fixed income stream are often attracted to CDs. A common strategy that is utilized by investors to create ongoing income is called a CD ladder. A CD ladder involves purchasing CDs at varying maturities on an ongoing basis, so that after a year, CDs are maturing regularly. The investor will receive their original principal investment plus the stated interest upon maturity.

Simplicity- CDs are attractive investments to those who want simplicity as they are easy to invest into and require little to no maintenance until their maturity date.

Disadvantages

Zero Coupon CD Taxation- While there are many advantages to a zero coupon CD, one of the disadvantages is that the phantom interest income, not received until maturity, is taxed annually. Investors need to be aware of these annual taxes so that they can set aside the income to pay them when they are due.

Callable CDs- Investors are often attracted to these CDs for their higher CD rates, however they carry the risk of being called before their scheduled maturity dates.

Withdrawal Penalties- Due to the nature of penalties, often associated with the forfeiture of interest, CDs are often not good investment choices for investors who have the possibility of needing the capital prior to the CD maturity dates.

Low Interest Rates- While CDs offer higher rates than many other forms of cash investments, their interest rates are often substantially lower than other fixed investment options and equity investment options. It is important to take these rates of return into consideration when designing an ideal investment portfolio.

Inflation Rate Risk- One of the largest external risk factors to investing into CDs is inflation risk. Inflation risk refers to the risk of eroding purchasing power over time. While interest rate payments are fixed with CDs, it is important that they will out pace inflation so that an investor does not lose purchasing power during the investment period.

Understanding Brokered CDs

While an investor may be familiar with a CD as an investment, they may not be familiar with a brokered CD. A brokered CD is an investment option offered by a financial intermediary. When considering this investment option, it is important to understand what they are, how to purchase them and what considerations to have to create the best investment situation possible.

One thing to understand about a brokered CD is that they are brokered by financial professionals, meaning that the professional is searching the investment landscape for the best CD rates possible for investors. They are similar in concept to a CD that would be purchased at a bank, as they will pay a certain interest rate for the money deposited during the specified investment time period.

Features of a Brokered CD

There are some unique characteristics to become familiar with in regards to a brokered CD, including:

• Investing into a brokered CD is an effective way to open up the selection field to a larger selection of issuing banks. For investors searching for the best rate on their own, this can cut down the time spent visiting local banking institutions or the personal time that it would take to search for CD rates online.
• As brokered CDs are more similar to other fixed investment types and are in less supply than a traditional bank CD, the minimum purchase amount is often greater than the common $1,000 minimum that is often seen in a bank.
• While there is not a great deal of trading volume, brokered CDs can actually be traded in the secondary market. In some cases, this can allow for some flexibility in exiting the investment.

Buying Brokered CDs

If you are interested in brokered CDs for your investment portfolio, you are likely wondering where you may find them. You can locate brokered CDs through financial advisors or brokers in your area as well as financial planners or financial consultants. There is a wide variety of options available to purchase brokered CDs. When you select a professional to work with, be sure to interview several in order to find one that is best suitable for your personal and financial objectives.

Brokered CD Fees

Both traditional and brokered CDs have associated fees, generally taken out of the interest rate offered to the investor. While in most cases there is not a separate or up front fee for purchasing a brokered CD, there are some instances in which there may be an account fee associated with the method to purchase the brokered CDs. Be sure to inquire with the financial institution that you are purchasing the brokered CDs from if there are any applicable fees or charges so that you are not caught off guard if you notice anything on your financial statement.

Brokered CD Risk

The most significant investment risk associated with brokered CDs is that of market risk, as the supply and demand factors of the economy can affect returns. However, this risk only applies if the investor chooses not to hold their investment until its maturity and is forced to sell it in the secondary market.

Why Should I Invest Into CDs?

CDs (certificates of deposit) are a well known investment, utilized by investors around the world. Just like most any type of investment, there are advantages and disadvantages that should be taken into consideration when building a personal investment portfolio. Some of the advantages to consider of investing into CDs include: liquidity, CD laddering, current income, preservation of capital, and FDIC insurance.

Liquidity

One of the most significant benefits to investing into CDs is the overall liquidity. Investing into CDs often gives investors the ability to gain access to their cash in the event of a short term need, without paying significant penalties. While there are generally interest rate penalties for early withdrawal, many investors will stagger their CDs so that they have less of a chance of paying a penalty if they need access to their capital.

One of the methods for creating additional flexibility for their capital is to create a CD laddering strategy. CD laddering is a strategy that involves purchasing CDs with different rates and at different maturity dates. This creates a method where CDs will be maturing on a regular basis. This will present the opportunity to have access to capital on a regular basis without early withdrawing penalties. If the investor does not need access to their capital, they can simply reinvest it into a new CD when it becomes mature.

Competitive Cash Rates

CD rates are generally higher than most other savings products or cash products offered by banking institutions. Other common cash products include savings accounts, checking accounts and money markets. For investors who have extra cash on hand and who desire to earn a higher interest rate, CDs are an excellent option for consideration.

Preservation of Capital

Another primary reason why CDs are popular investment choices is that on top of the CD rates being paid to investors, the capital investment will also be returned to the investor at the CD’s maturity date. For conservative investors who still seek interest rates that are competitive along with security of capital, CDs are an excellent choice. The protection that is offered for investors is provided by FDIC insurance, insuring that in the event that the bank closes, the investor will have their investment returned to them.

Current Income

Many investors leverage CDs as an investment choice for current income. While CDs do not provide consistent income during the investment period, they do provide interest upon the CD’s maturity date. So, when the CD becomes mature, the investor will gain their original capital investment along with their earned interest. In order to receive regular income from CDs, a common strategy that will be used is to ladder CDs with different maturity dates and different interest rates. For example, if an investor purchases $1,000 CDs each month over 12 months, they will then have one maturing each month moving forward. This strategy can allow an investor to have regular interest income, to reinvest the capital into another CD or to withdrawal the entire investment amount when the CD becomes mautre.

How to Find the Best CD Rates

When investing into CDs, the most important factor that many investors often consider is the interest rate. While interest rates regularly change, it is important to understand where and how to find the best rates for your personal portfolio. Shopping around, using the benefit of time and working with relationships can help investors to take advantage of the best CD rates.

Shop Around for Interest Rates

The best place to start when working to locate the best CD rates is to determine what the current rates are. You can begin your CD rates search in the local paper, under the financial section. You can also visit many of the online investment websites, bank websites or general information websites for the average CD rates. Typically these resources will list the 1 year CD rates, the 3 year CD rates and the 5 year CD rates even though there are more available options to consider.

Once you have established a baseline, it is best to shop CD rates among several institutions. Banks are the best place to start and if you have an established banking relationship, begin your search there. In addition to finding out what the CD rates are at multiple banking institutions, you may also decide to search several of the more prominent brokerage houses. In addition to banks and brokerage houses, investors can also search online. With the expansion of the Internet as a search tool, there are a variety of additional banking and financial institutions that offer CD rates that are often times more competitive than what an investor can find locally.

Use the Benefit of Time

CD rates will most generally be higher for those with longer maturity dates. The primary reason for this is that the risk to the investor is higher than for shorter term CDs, and the investor is promising to leave their investment money with the financial institution for a longer period of time. The higher interest rate is a reward for taking both of these risks. If it is possible for an investor to take advantage of the higher long term interest rates, and/or to develop a CD laddering strategy, this is advised as it will increase the overall yield of the investment portfolio.

Leverage Financial Relationships

Another major factor to take into consideration when shopping for the best CD rates, is to leverage the power of relationships. If there is a pre-existing financial relationship, it is not uncommon for that relationship to offer a bonus rate for additional investment money flowing into their establishment. The reason for this is that many businesses are looking to add on products and services for existing customers, so they offer s bonus rate for the addition of a CD investment. So, next time you are looking for the best CD rates available, start by speaking with your local banking institution; you never know, you may just gain an extra portion of a percentage point or even an entire percentage point by taking this step.

The Impact of an Inverted Yield Curve and CD Rates

In a more turbulent interest rate economy, one of the most prevalent buzz words is ‘inverted yield curve’, yet many investors are not familiar with its meaning or its effects on their investment portfolio. While interest rate movements may not affect every investor directly, they can significantly impact the fixed income investor and in particular, those who are investing in CDs. Understanding what the yield curve is and how it can impact CD rates will help investors to make more educated decisions in regards to their personal investment portfolios.

What is an Inverted Yield Curve?

The yield curve describes a relationship between short and long term interest rates of US Treasury securities. But, how does this inverted yield affect CD rates and other fixed interest rate investments? An inverted yield curve occurs when the short term interest rates exceed those of long term fixed securities. This phenomenon is an important economic event that impacts corporations, debt instruments, investors and consumers. And, investors should pay particular attention to this occurrence so that they may adjust their portfolios accordingly.

One of the reasons why this economic event is so significant is that it is out of the ordinary to have short term interest rates greater than long term rates. In many cases, when interest rates change in this fashion, it can signal an upcoming recession, causing many institutional investors to refinance their debt instruments; an event that affects individual investors and consumers alike.

What Does an Inverted Yield Curve Impact?

The most significant viewpoint of an inverted yield curve is that of a possible upcoming recession. When interest rates in the short term, including CD rates rise, it is an indication that the viewpoint of the long term health of the economy is poor. In an interest rate economy such as this, many investors move to shorter term debt instruments or CD rates that are more attractive while they search for more sustainable portfolio options for the long term.

How Does an Inverted Yield Curve Affect CD Rates Directly?

While an inverted yield curve can affect every investor, it has the greatest impact on the fixed income investors. When investors select CD rates that are for the longer term, they are generally doing so for the higher interest rates. Longer term fixed investment options pay a higher rate of return to compensate the investor for taking higher risks. In the event of an inverted yield curve, the shorter term CD rates such as the 1 year CD rates become more attractive than the 5 year CD rates. In the event that an investor has a variety of CD rates in their portfolio, it can become challenging to determine whether to move money into shorter term CDs for higher interest rates, to invest new money into the higher paying CDs or to leave the money in the existing portfolio for the long term. In any of these available options, it is always advised to seek the advice of a professional before making any investment decisions.

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