Certificates of Deposit: Tips for Investors
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 and independent salespeople now offer CDs.
These individuals and entities – 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 other special features.
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:
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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.
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Investigate Any Call Features – Callable CDs give the issuing
bank the right to terminate-or "call"-the CD after a set period of time.
But they do not give you that same right. If interest rates fall, the
issuing bank might call the CD. In that case, you should receive the
full amount of your original deposit plus any unpaid accrued interest.
But you'll have to shop for a new one with a lower rate of return.
Unlike the bank, you can never "call" the CD and get your principal
back. So if interest rates rise, you'll be stuck in a long-term CD
paying below-market rates. In that case, if you want to cash out, you
will lose some of your principal. That's because your broker will have
to sell your CD at a discount to attract a buyer. Few buyers would be
willing to pay full price for a CD with a below-market interest rate.
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Understand the Difference Between Call Features and Maturity –
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 they 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. 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.
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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. Your broker may plan
to put your money in a bank or thrift where you already have other CDs
or deposits. You risk not being fully insured if the brokered CD would
push your total deposits at the institution over the $100,000 insurance
limit. (If you think that might happen, contact the institution to
explore potential options for remaining fully insured, or call the
FDIC.) For more information about federal deposit insurance, visit the
Federal Deposit Insurance Corporation’s web
site and read its publication Your
Insured Deposit or call the FDIC's Consumer Information Center
at 1-877-275-3342. The phone numbers for the hearing impaired are
1-800-925-4618 or (202) 942-3147
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Find Out How the CD Is Held – Unlike traditional bank CDs,
brokered CDs are sometimes held by a group of unrelated investors.
Instead of owning the entire CD, each investor owns a piece. Confirm
with your broker how your CD is held, and be sure to ask for a copy of
the exact title of the CD. If several investors own the CD, the deposit
broker will probably not list each person's name in the title. But you
should make sure that the account records reflect that the broker is
merely acting as an agent for you and the other owners (for example,
"XYZ Brokerage as Custodian for Customers"). This will ensure that your
portion of the CD qualifies for up to $100,000 of FDIC coverage.
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Research Any Penalties for Early Withdrawal – Deposit brokers
often tout the fact that their CDs have no penalty for early withdrawal.
While technically true, these claims can be misleading. Be sure to find
out how much you'll have to pay if you cash in your CD before maturity
and whether you risk losing any portion of your principal. If you are
the sole owner of a brokered CD, you may be able to pay an early
withdrawal penalty to the bank that issued the CD to get your money
back. But if you share the CD with other customers, your broker will
have to find a buyer for your portion. If interest rates have fallen
since you purchased your CD and the bank hasn't called it, your broker
may be able to sell your portion for a profit. But if interest rates
have risen, there may be less demand for your lower-yielding CD. That
means you would have to sell the CD at a discount and lose some of
your original deposit –despite no "penalty" for early withdrawal.
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Thoroughly Check Out the Broker – Deposit brokers do not have
to go through any licensing or certification procedures, and no state or
federal agency licenses, examines, or approves them. Since anyone can
claim to be a deposit broker, you should always check whether your
broker or the company he or she works for has a history of complaints or
fraud. You can do this by calling your state securities regulator or by
checking with the National Association of Securities Dealers' "Central
Registration Depository" at 1-800-289-9999.
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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.
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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.
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.
Don't be embarrassed if you invested in a long-term, brokered CD in the
mistaken belief that it was a shorter-term instrument-you are not alone.
Instead, you should complain promptly to the broker who sold you the CD.
By complaining early you may improve your chances of getting your money
back. Here are the steps you should take:
- Talk to the broker who sold you the CD, and explain the problem
fully, especially if you misunderstood any of the CD's terms. Tell your
broker how you want the problem resolved.
- If your broker can't resolve your problem, then talk to his or her
branch manager.
- If that doesn't work, then write a letter to the compliance
department at the firm's main office. The branch manager should be able
to provide with contact information for that department. Explain your
problem clearly, and tell the firm how you want it resolved. Ask the
compliance office to respond to you in writing within 30 days.
- If you're still not satisfied, then send us your complaint using our
online complaint form.
Be sure to attach copies of any letters you've sent already to the firm.
If you don't have access to the Internet, please write to us at the
address below:
Office of Investor Education and Advocacy
U.S.
Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-0213
We will forward your complaint to the firm's compliance department and
ask that they look into the problem and respond to you in writing.
Please note that sometimes a complaint can be successfully resolved.
But in many cases, the firm denies wrongdoing, and it comes down to one
person's word against another's. In that case, we cannot do anything more
to help resolve the complaint. We cannot act as a judge or an arbitrator
to establish wrongdoing and force the firm to satisfy your claim. And we
cannot act as your lawyer.
You should also contact the banking regulator that oversees the bank
that issued the CD:
http://www.sec.gov/investor/pubs/certific.htm
