Mapgirl’s Fiscal Challenge

I dip wayyy too much. I like the idea of th CDs. I don’t know much about CDs. Anything I need to know when looking for one?
Thanks!
LadyDoughGirl at Finance Psychology

I don’t have a lot of fancy advice for LadyDoughGirl. There’s good stuff on CD laddering by Nickel and also by Jonathan. I highly recommend their posts, but the basics of buying a CD are these:

1) When you buy a certificate of deposit, you are entering a contract to hold your money at the bank for a fixed period of time.

2) The bank agrees to pay you a specific annual percentage rate (APR), which will be slightly different than your annual percentage yield (APY). Because they can be advertised by either one, make sure you read the fine print carefully to compare apples to apples.

3) There are fixed rates and variable rates. For simplicity’s sake, I’m only going to write about fixed rates because those are easiest to understand. My mantra is don’t buy something you don’t understand, and frankly, I don’t understand some of the CD products out there, e.g. “step rates”.

4) Online banks are competitive with brick and mortar places, so don’t limit yourself and shop around.

5) When it’s time for a CD to expire, the bank will usually send you a letter or if you are a high net worth individual, they will call you and tell you when it is expiring. You will have the choice of renewing it or taking out your money.

6) Because these are fixed term contracts, if you want to withdraw your money early, there is usually a penalty of about 3 months worth of interest. ING Direct used to charge 6, but they now conform to 3 months. Keep in mind, this is why most people don’t put their emergency funds into CDs. But I have a way around this, so keep reading.

7) Shop around. I know I said this before, but shop around. It’s worth it. I saw a Wall Street Journal article which told me that Millennium Bank in VA had great rates on 180-day (6 months or so) CD’s. I had never heard of them, but realized that they were close to my office and I could open one at lunch time, so I did! It was very easy. Shop for the best rate.

CD’s usually have minimum amounts. If you go to a traditional bank, this is true. But ING Direct does not. Most CD’s are for $1000.00 minimum, some are jumbo CD’s for much, much more. Keep that in mind, because it segues into my next bullet item.

9) CD Laddering. Read the links above first. Like I said, a lot of people do not like CD’s because it freezes their assets. Locking up your entire emergency fund sounds like a horrible idea. However, to combat long terms, you can ladder CD’s. The examples Nickel and Jonathan use are for 5 year terms, but think shorter. MUCH SHORTER. I have 4 1-year CD’s laddered. It means I have a CD expiring every few months if I really need the money. (Which invariably, I do not. I just make do with what’s available.)

10) One last piece of advice. In a time of rising interest rates, take your interest disbursements monthly so you can use it to buy a new CD at a higher rate. At a time of falling rates, don’t take disbursements. I have noticed with ING, you can’t change this from one to the other, so with some early CD’s, I took the monthly disbursement. On later CD’s, I did not. It’s your choice in terms of management and leveraging interest rates.

Good luck and let me know if this advice was useful!