What is a CD?
A CD (Certificate of Deposit) is a savings account which is characterized by fixed term borrowing, fixed interest rates and a relatively high interest rate. Insured by the FDIC (or NCUA for credit unions), CDs are often the investment choice for savers who are risk averse and like to plan carefully for their futures.
Are CDs really risk-free?
Although it would be misleading to use the term ‘risk-free’, CDs are comparatively low risk investment options. Institutions under the FDIC insure CDs to the tune of $250,000 per owner/co-owner and sometimes take out private cover as well. Offshore banks normally have even stronger insurance coverage.
How is interest accrued?
It is important to research the features of different options carefully. With plenty of variation between institutions you want to make sure you choose the CD that fits in with your offshore investment plans. Investment terms are usually in increments of three months, six months or one to five years, with longer terms often providing higher interest rates.
Some offshore banks offer higher interest rates to savers who deposit large principals; so-called ‘jumbo CDs’ might require an initial principal of $100,000 or more.
As with standard savings accounts, interest might be accrued daily, monthly or quarterly. Some CDs allow interest to be withdrawn while many accrue interest as they mature.
Can I withdraw before maturity?
It’s not in the bank’s interest to encourage early withdrawal and doing so will incur stiff penalty fees. For example, you could expect to pay a penalty of six month’s interest for withdrawing early from a five year fixed term CD.
Be aware that even when matured, some institutions automatically roll over funds into a new CD. You may face penalties if you try to withdraw after the window between maturity and re-investment has closed.
What is a ‘ladder strategy’?
In order to avoid the opportunity cost of long-term investment, some savers employ a ‘ladder strategy’. This involves dividing deposits between CDs within or across institutions, and choosing different terms for each amount. For example, you might share your deposit between a one, two and three year CD. After the one year CD matures, you withdraw the principle and accrued interest of the best CD rates and invest in another three year CD.
T’s &C’s: what to look out for.
If you are considering investing in a CD, you should look carefully at the T’s and C’s, in particular:
• Can the bank call in the CD before maturity?
• Is interest paid out or accrued?
• Is interest calculated daily, monthly or per quarter?
• What are the penalties for early withdrawal?
• Is there a delay period for withdrawal?
• When matured, will funds automatically be rolled over into a new CD?