Three CDs That Break With Investing Tradition

Banks want to sell you their certificates of deposit and are pulling out the stops.

Why? Interest rates on CDs are at their lowest point in nearly 30 years, and investors are fleeing. CD balances dropped $130 billion in the first nine months of 2011, according to tracking firm Market Rates Insight in San Anselmo, Calif. Instead, investors shifted $762 billion into liquid accounts during that time span.

To woo investors back, banks have reimagined -- and even recycled -- CDs. Last year, they ran more promotions, and added more withdrawal flexibility and slightly higher rates on some CDs.

For example, some banks are offering nine-month risk-free CDs, in which you can withdrawal money penalty-free. And others are offering two-year CDs that allow you to bump up your rate once.

Rates Aren't Rising

To be sure, wading through CD details takes financial savvy and a magnifying glass for reading fine print. That's because some nontraditional CDs require high minimum deposits, have limited liquidation windows and/or sport puny interest rates.

The biggest dilemma is that we're not in a rising rate environment, says Greg McBride, CFA, senior financial analyst for Bankate.com. The Federal Reserve has put interest rate hikes on hold until 2014. This is troubling news for retirees who depend on the stable income CDs can provide.

Additionally, risk-free investments don't outpace inflation, which is currently at 2.9%.

Yet wringing fractionally higher rates from safe investments is fruitless, says Dan Geller, an executive vice president at Market Rates Insight. A 10 basis-point rate difference between money market and CD yields only amounts to $10 on a $10,000 investment. A basis point is one-hundredth of 1 percentage point.

The lesson? Look before leaping into a slightly higher yielding CD or a more flexible CD. The devil is in the details, since all three CDs featured in this story offer flexibility but in slightly different ways. Here's a rundown of the latest CDs.

Liquid CDs. Also known as no-penalty CDs, these investments are a hybrid, marrying liquid savings and money market accounts with CDs. You can withdraw some or all of your money penalty-free once or twice per term, allowing the investor some flexibility to chase yield if rates rise.

Liquid CDs with longer maturities have an advantage, McBride says. But in the short term, these CDs can't match top-yielding savings accounts, he says. Still, liquid CDs are the best of the bunch because they let investors park their money in higher yield instruments elsewhere, he says.

However, these CDs may have high minimum investments or strict withdrawal guidelines. For example, one bank offers a liquid CD, but there's a $10,000 minimum and withdrawals must be seven days apart.

Bump-up CDs. With this CD, you can raise your rate once or twice during its term. McBride doesn't find them appealing as an investment. The reason is that you get lower rates at the front end. Yet, 78% of the bump-up CDs surveyed mature in two years or less, according to Bankrate, leaving little time to reap higher rates, he says.

Also, you, not the bank, must decide when to pull the rate trigger.

"The million-dollar question is: When do you bump up your rate?" Geller adds. "Typically, it's only on opportunity."

Step-up CDs. These CDs get their interest rates hiked at predetermined intervals, usually once or twice during the life of the CD. Step-up CDs have a key advantage over bump-up CDs. Investors know exactly when and by how much their rates will rise, McBride says. This makes it easier to shop around and compare rates against traditional CD rates.

Be Wary of Promotions

Also, beware of promotions. One bank pays you a bonus when you withdraw your money if interest rates fall after you purchase the CD. "This is a marketing gimmick," says Robert Laura, president of Synergos Financial Group in Howell, Mich. They're even willing to lose money to attract assets, he says.

"Promotions don't negate shopping around," McBride says. "Compare rates to what's already out there."

There are also other investment alternatives, such as money market accounts or laddered CDs, which are investments in several CDs at varying maturities.

Laura has another option -- a "dividend paycheck." He ladders three dividend-paying stocks, yielding 2.5% or more. They're typically well-known, highly rated companies with low volatility. These three stocks also may have different dividend payout dates, creating a steady income. "It's an emerging trend," Laura says.

Are more newfangled CDs on the way? Not as of now. "There are no more twists banks can come up with," Geller says.