High Yield CDs: The What and the Why
CDs, technically known as certificates of deposit, are special accounts issued by banks, thrift institutions and credit unions. Money placed in a CD cannot be withdrawn by the account holder until the maturation date without a substantial penalty, ranging from 0% to the entire interest (the penalty cannot be greater than the principal). Upon maturation, the principal and generated interest may either be reinvested or rolled over in another CD and may be withdrawn.
Maturation periods and interest rates vary greatly from account to account and bank to bank. Generally, the longer the maturation period and the higher the initial minimum investment are, the higher the interest rate. Interest rates are calculated to not exceed inflation. CDs, therefore, do not increase the time-adjusted value of capital, but they do prevent the destructive forces of inflation from slowly gorging on money. CDs are insured by the FDIC up to $250,000. Credit unions are insured by the NCUA.
CDs are win-win situations. The bank gets its claws on an amount of capital and it knows exactly how much time it has to play, while the account holder feels safe and happy knowing his or her money is busy reproducing.
High-Yield CDs
What exactly constitutes a high-yield CD is, to some degree, in dispute. Many agree that CD bank rates ranging from 1.5-5% count as high-yield account rates. There are several characteristics that most high-yield CDs tend to exhibit.
They require larger initial investments. Attaining a 4-5% APY interest rate typically demands a minimum principal of $50,000-$100,000. CDs in the 2-3% range may require $5,000-$25,000 upon startup.
Better be in for the long haul; high-yield CDs have long maturation periods. Most CD maturation periods range between 30 days and 10 years; anything more than a decade is usually termed an IRA retirement CD, and do not pay interest until maturation. High-yield CDs rarely ever go beneath a year and generally range between 2-10 years.
Expect beatings, not love taps for withdrawing funds prematurely. A bank will likely take back the entire generated interest for early withdrawals. Therefore, a high-yield CD should not be used as an emergency or general savings fund.
Beat the Market
How does one get the best rates? Here are some strategies to stay abreast with high-yield CD bank rates.
- Get personal. Personal CDs tend to garner more cash than business accounts.
- Some experts recommend investing in smaller institutions, as they have historically offered higher rates. They are also less stable, however, and may be more likely to call an account.
- Go to the proverbial secondhand account store: brokerage (discount) CDs. Identify who the original issuer is, as that is what truly determines the status and safety of an account.
- Online banks generally charge fewer account fees, have lower startup costs, and higher interest rates. But they may not be as secure or as versatile.
- Depending on who is winning, the bear or the bull, market-indexed CDs may be a viable option. The most popular index is the S&P 500. Market-indexed CDs may be illiquid for the first year or so.
- Laddering is a popular strategy to get the highest possible rates while still having cash relatively available. An account holder will have both long-term and short-term CDs. After each short-term CD expires, the principal and return is reinvested into the long-term CDs. This balances returns with liquidity.
- A bank may reserve the right to call or kill a CD for various reasons – namely, they are losing money. The bank may also reserve the right to sell a CD to a competitor.
- How often is the interest compounded? Daily, weekly, yearly? This can drastically affect the sum penalty for premature withdrawals, as well as the APY if funds are added intermittently throughout the year. Check if the rate is fixed or variable.
So get the work out of the way. Make money work for you – invest and relax. That is capitalism. Thank you, high-yield CDs.
Questions and Answers
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