The attraction of a certificate of deposit (CD) is its higher interest rate over your bank's regular savings account rate. Also, federal deposit insurance secures it up to $100,000 per institution ($250,000 if an IRA). CD returns today offer new options that seniors who seek short term secure investments should be aware of. CDs can play an important part of the conservative porion of your retirement investing portfolio.
Traditionally when you purchase a CD, you invest a fixed sum of money for a fixed term – six months, one year, five years, or more for a fixed CD return. The bank pays you a fixed interest rate and you receive your investment back when the CD matures. If you redeem it earlier, you pay an "early withdrawal" penalty or forfeit a portion of the interest. So you need to plan your cash needs accordingly to not be penalized.
Today, CDs offer more options perfect for retirement investing . You can choose among variable rate CDs and long-term and callable CDs. You can even buy them through your broker. But not understanding each type's exact features can leave you with an investment you didn't mean to buy.
Some long-term, high-yield CDs have "call" features. The issuing bank may call (i.e. terminate) a CD after only one year or some other fixed period of time, perhaps because interest rates are falling. You'll receive your full investment back plus accrued interest, but you lose out on your high interest payments in the future.
On the other hand, if you've invested in a long-term CD and interest rates subsequently rise, you'll be locked in at the lower rate unless of course you pay the early withdrawal penalty.
Before you consider purchasing a CD, make sure you fully understand its terms. Know its maturity date and don't confuse it with the call date.
As an example, don't assume that a "federally insured one-year non-callable" CD matures in one year. It doesn't! These words mean the bank cannot redeem the CD during the first year, but have nothing to do with the CD's maturity date. A "one-year non-callable" CD may still have a maturity date 15 or 20 years in the future! In other words, when you see a high CD return make sure you understand why the return is so high.
Investors have accidentally bought 10 year CDs when they only wanted to tie up their money for 1 year. If you have any doubt about your CD's maturity date, ASK. Fully understand the CD's call features confirm when it matures.
Always remember that you're insured only up to $100,000 per institution under federal deposit insurance rules ($250,000 throuigh 12/31/09). So, if you buy CDs through a broker, make sure that your CDs are held among institutions so that you don't exceed $100,000 at any one or use different titling to increase your FDIC coverage.
How much should you invest in CDs for sensible retirement investing? That depends on the results from your retirement planning calculators and you asset allocation among insured investments and those with greater risk yet higher return.