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 $100,000.
Here's 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
now offer CDs. These brokerage firms – 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 today's markets, CDs have become more complicated. Investors
may now choose among variable rate CDs, long-term CDs, and CDs with special
redemption features in the event the owner dies.
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 you've invested in a long-term CD and
interest rates subsequently rise, you'll 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 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've tied up their
money for five, ten, or even twenty years. Before you purchase a CD, ask
to see the maturity date in writing.
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. In other words, find out where the deposit broker plans to deposit your money. Also be sure to ask what record-keeping procedures the deposit broker has in place to assure your CD will have federal deposit insurance. For more information about federal deposit insurance, call the FDIC's Central Call Center at (877) 275-3342 or (877) ASK-FDIC. For the hearing impaired call 1-800-925-4618 or 1-703-562-2289 (7:00
am to 7:00 pm Eastern time)
Investigate Any Call Features – Callable
CDs give the issuing bank the right to terminate the CD after a set period
of time, but they do not give you that same right. If the bank
calls or redeems your CD, you should receive the full amount of your original
deposit plus any unpaid accrued interest.
Understand the Difference Between Call Features
and Maturity – Don't assume that a "federally insured
one-year non-callable" CD matures in one year. If you have any
doubt, ask the sales representative at your bank or brokerage firm to
explain the CD's call features and to confirm when it matures.
Confirm the Interest Rate You'll Receive
and How You'll 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 you'll be paid – for
example, by check or by an electronic transfer of funds.
Ask Whether the Interest Rate Ever Changes – If
you're 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 Industrial Average.
Research Any Penalties for Early Withdrawal – Be
sure to find out how much you'll have to pay if you cash in your CD before
maturity.
Ask Whether Your Broker Can Sell Your CD – Some
brokered CDs are issued in the name of the "custodian" or deposit
brokers. In some cases, the deposit broker may advertise that the CD does
not have a prepayment penalty for early withdrawal. In those cases, the
deposit broker will instead try to resell the CD for you if you want to
redeem it before maturity. If interest rates have fallen since you purchased
your CD and demand is high, you may be able to sell the CD for a profit.
But if interest rates have risen, there may be less demand for your lower-yielding
CD. That means you may have to sell the CD at a discount and lose some
of your original deposit .
Find Out About Any Additional Features – For
example, some CDs offer a death benefit that allows a CD owner's heirs
to redeem the CD without penalty when the owner dies.
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 investors.
If you have a complaint
about a CD you purchased through a bank, try to resolve your complaint
directly with an officer of the bank before involving an outside agency.
Financial institutions value their customers and most will be helpful.
If you are unable to resolve the matter with the financial institution,
use the following guidelines to determine where to direct your complaint.
If your complaint is
against a salesperson who represents a third-party investment firm, call
the number below for instructions on where to write:
Financial Industry Regulatory Authority
(formerly The National Association of Securities Dealers (NASD))
(301) 590-6500
If your complaint
or inquiry is about a specific financial product or investment, contact:
Securities and
Exchange Commission (SEC)
Office of Investor Education and Assistance
450 5th Street, NW
Mail Stop 11-2
Washington, DC 20549
(202) 551-6551 or
(800) SEC-0330
If
your complaint is about a financial institution or an employee of the
financial institution, contact one of the federal
agencies listed below.
If the financial institution is a state-chartered
bank and not a member of the Federal Reserve System, contact:
Federal
Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
(877) 275-3342 or (877) ASK-FDIC
For the hearing impaired call 1-800-925-4618 or 1-703-562-2289 (7:00
am to 7:00 pm Eastern time)
If the financial
institution is a national bank, contact:
Comptroller of the Currency
Customer Assistance Group,
1301 McKinney Street, Suite 3450
Houston, TX 77010
(800) 613-6743
If the financial institution is a state-chartered
member of the Federal Reserve System, contact:
Board of Governors
of the
Federal Reserve System
Division of Consumer
and Community Affairs
20th and C Streets, NW
Washington, DC 20551
(202) 452-3693
If the financial
institution is a thrift or a savings institution, contact:
Office of Thrift
Supervision
Consumer Affairs
1700 G Street, NW
Washington, DC 20552
(202) 906-6237
(800) 842-6929
