Published September 19, 2011
Breaking With CD Tradition
As interest rates linger near record lows, locking your money away for years in a certificate of deposit may not sound appealing. You may need access to the money or want a chance at higher rates, so many banks have begun promoting nontraditional CDs to encourage investment.
These accounts provide increased convenience and liquidity, but they typically come with a trade-off -- lower yield potential than a traditional CD. Before you begin browsing the banking world for these alternatives, consider these five tips to better understand your options.
Penalties Can Pay Off
A no-penalty CD eliminates early-withdrawal fees -- fees that the Bankrate 2010 CD early withdrawal penalty study shows can be quite hefty.
While the prospect of a fee-free withdrawal may sound comforting, paying the penalty can work to the investor's advantage in some cases, says Greg McBride, CFA, Bankrate senior financial analyst. This strategy is known as riding the yield curve and involves investing beyond your investment horizon -- in other words, putting money in CDs for longer terms than you intend to have it locked away.
Consider McBride's comparison between a five-year CD that yields 2.5 percent and a two-year CD that yields 1.5 percent. With an investment of $10,000 in the five-year CD, paying a six-month early withdrawal penalty after two years still yields approximately $75 more than holding the 2-year CD to maturity.
While Bankrate's 2010 early withdrawal study showed that 180 days of interest was the most common penalty for CDs with multiple-year maturities, some banks levy fines as high as 24 months' worth of interest.
Don Taylor, assistant professor of finance at Pennsylvania State University in Brandywine, Pa., and Bankrate's investing adviser, says consumers can compare CD withdrawal penalties just as they compare rates to determine the cost-effectiveness of riding the yield curve.
Timing is Everything
Another common type of alternative CD is the bump-up CD. Most bump-up CDs allow account holders to request a one-time rate increase prior to maturity, but some banks allow multiple requests.
For consumers who invest in bump-up CDs, the goal is to maximize the average yield -- a goal that helps to determine when to request a rate increase from the bank, Taylor says.
"Once you get past the halfway mark, the value of the bump-up option becomes less and less valuable," Taylor says.
Aurora Vidin, deposits product manager at BECU, says that the Washington-based credit union has recently seen an increase in the popularity of its bump-up CDs -- an increase she attributes to the current low-rate environment.
"You need to look at your objectives before you consider taking advantage of the bump-up CD option," Vidin says.
Vidin says reviewing your original savings objectives is crucial before exercising the right to bump up the rate. Bankrate's savings goal calculator can help to determine your current progress and how increased interest rates can accelerate the time to reach your savings goal.
Not all Alternative CDs are Created Equal
As you compare nontraditional CDs, interest rates only tell one part of the story.
From a $5,000 minimum deposit to the requirement to open a personal savings or checking account along with your new CD, many no-penalty and bump-up CDs come with additional strings attached.
While high account balance minimums may intimidate some savers, the savers looking to actively manage their CD portfolios are likely to be able to meet these minimums and give their investment more potential to earn higher interest, Taylor says.
Not all options are restrictions for the saver. Some banks and credit unions offer the ability to contribute money to a CD during the term.
"The ability to add money to your CD is a valuable option," Taylor says.
For example, Taylor says that if a consumer adds money to a two-year, bump-up CD one year before maturity, the additional funds receive the benefit of a higher rate with a shorter term.
Keep Some Money Within Reach
While some consumers may enjoy the easy cash access that a no-penalty CD provides, there are ways to keep your money within reach without sacrificing yield.
Todd Pietzsch, manager of public relations at BECU, says that now is not the best time to invest in long-term CDs. As an alternative, he says consumers can consider laddering CDs over a certain period and extending into longer maturities when rates begin to rise.
CD laddering is a strategy that diversifies your total CD investment among varying maturity dates. McBride says that investing in shorter maturities now gives consumers a chance to study the market as they determine how to structure their CD ladders in the future.
"In the meantime, you'll get the opportunity to survey the interest rate landscape as shorter CDs mature," McBride says.
For consumers considering spreading their funds across a range of CDs, Bankrate's CD ladder calculator highlights how the strategy can help maximize your return on investment.
Find the Interest Rate Knockout Winner
Rather than comparing nontraditional CDs, consumers should explore the entire banking spectrum to find high interest rates, liquidity and convenience.
While regular CDs and nontraditional CDs can lock in above-average interest rates for a fixed term, the Bankrate 2010 high-yield checking study shows that many national banks offer account options with very competitive rates.
"High-yield checking accounts can be a slam-dunk for consumers who are comfortable with online statements, direct deposits and regular debit card usage," McBride says.
However, if you are looking for a new home for a large chunk of money, the 2010 high-yield checking study also highlights that these accounts come with maximum balance caps. After an account holder crosses a certain threshold, the surplus will not earn the above-average rate.
You can search for high-yield online savings and money market accounts, which offer above-average interest rates and convenient cash access. To understand how different interest rates can impact your yield potential, Bankrate's savings rate comparison calculator shows how a few points can make a big impact.