Are Liquid CDs Your Cup of Tea?

Liquid certificates of deposit sound good, but they aren't for everyone.

Yes, these CDs do offer one tempting advantage: no-penalty withdrawals. Traditional CDs typically sock you with early-withdrawal fees if you need money before the maturity date arrives.

But the "gotcha" for liquid CDs is that terms, conditions and rates for them vary widely. They have no penalties, but only if you abide by preset withdrawal limits or amounts. And their lower rates -- usually ranging from 0.2% to 0.55% -- mean that you sacrifice yield for more flexibility.

Banks determine when you can take your first penalty-free liquid CD withdrawal, says Brad Levin, president of Legacy Wealth Partners in Woodland Hills, Calif. The upshot: Be aware of the investment's features or you may trigger early, hefty withdrawal fees that wipe out earnings. The early-withdrawal period usually doesn't start for about seven days.

Money for Emergencies

The dilemma is that these days, cash is king. Having more than six months' worth of emergency funds on hand is important, says Greg McBride, CFA, senior financial analyst at Bankrate.com.

"Especially if your circumstances have changed, such as a job or relationship (change)," he says. "But cash can be a drag on returns."

That's why McBride favors other liquid, top-yielding investments such as bank savings accounts or money markets that are insured by the Federal Deposit Insurance Corp.

However, money market mutual funds offered by brokers aren't insured. "Use them for putting money into the market at a moment's notice," McBride says. "They're not a permanent parking place."

The Skinny on Liquid CDs

Consider these downsides to liquid CDs before putting your money into them.

Withdrawal limits. Liquid CDs aren't as liquid as they sound. Why? They may tie up your money for at least seven days after opening the CD. There also may be maximum and minimum withdrawal limits. "Terms vary widely," McBride says. Some liquid CDs limit you to annual withdrawals, others to once or twice during the CD's term.For example, San Francisco-based First Republic Bank's liquid CD limits withdrawals to seven calendar days apart or you're slapped with early-withdrawal fees. Washington-based Seattle Bank's 13-month liquid CD allows you only one penalty-free withdrawal per calendar month.
Larger minimum investments. Unlike plain-vanilla CDs, liquid CD versions sometimes have higher minimums. For example, at Los Angeles' CapitalSource Bank, the minimum investment for its liquid CD is $25,000. If your CD dips below that amount, you'll pay early withdrawal fees.
Lower interest rates. Liquid CDs that mature in less than one year have vastly inferior yields compared to top yields on savings or money market deposits, McBride says. And with long-term CDs, how much are you willing to give up for the flexibility?

What's Better?

While the early-withdrawal penalty does exist with traditional CDs, short-term CDs could be another investing option. As of mid-April, six-month CDs averaged 0.68% in yield, according to Bankrate.com's CD rate tool.

Liquid accounts also had appealing rates. Online interest checking accounts yielded 0.65% and money markets offered 0.64%, according to the Bankrate CD rate tool in mid-April. Some money markets offered by highly rated banks such as Ally Bank, an online bank based in Detroit, or Nationwide Bank in Columbus, Ohio, paid at least 1%.

"And, you sacrifice nothing in terms of liquidity," McBride says. That's why it pays to shop around, since there's a lot of competition for your money.

Levin adds that bank money market accounts with FDIC insurance are especially important for investors investing more than $100,000. "You need that protection," Levin says.

Many money market accounts are also easy to access and throw in check writing. For CD investments, Levin suggests using short-term traditional CDs since they pay higher rates.

"Liquid CDs are a marketing strategy," Levin says. "They're never attractive enough to recommend."