This isn't your father's certificate of deposit.
CDs, the super-safe stalwarts of risk-averse savers, have changed -- shedding some of the stodginess that limits their use as investment vehicles. What's more, with the Federal Reserve having bumped interest rates up twice this year, CD rates have risen, too. The higher rates, coupled with an increasing flexibility, have boosted the usefulness of a certificate of deposit as a potent parking place for cash you might need to get your hands on quickly, experts say.
"My personal opinion is that there is a need for CDs in a person's portfolio," says John J. King, managing director of Provident Bank of Maryland's Community Banking Division. "You do need diversification, and we all know what can happen to the stock market."
At a time when stocks have generated several years of historically phenomenal returns, savers sometimes forget that cash is an important piece of any portfolio. Stocks are volatile, meaning that it's risky to expose the money you might need at any time to the short-term vagaries of the stock market, experts say.
CDs are technically "time deposits," so-called because they hold money invested for a fixed term -- as short as one month or as long as 10 years. But, unlike passbook accounts, where consumers can withdraw the money whenever they wish, extracting cash from a certificate of deposit typically requires notice to the bank. Indeed, there are usually penalties for "early withdrawal" -- that is, money taken out before the end of the agreed-upon term.
In return for this rigidity, CD investors get better interest rates than they would in a standard passbook or even in most money-market funds. And, unlike stocks, the money in a CD is typically guaranteed against loss, by the federal government. That's one reason many retirees like them as a long-term parking place for the retirement money they saved during decades of working to finance their "golden years."
During the past decade, increased competition in the financial-services arena has spawned all sorts of new investing and savings products, prompting banks to build some flexibility into their CD products, said Keith J. Leggett, senior economist for the American Bankers Association in Washington.
"Competition is good for the consumer," Leggett says. "It forces companies to work on products that meet consumer needs."
For instance, some CDs offer investors the opportunity to accept a slightly lower rate in return for the option of making one withdrawal from the account during its term -- penalty-free. And other types of CDs allow savers to make additional deposits -- a move once prohibited.
Experts say all these new products can make CDs a good place to stash the cache of cash you should amass as an emergency fund. Indeed, consumers should squirrel away cash equal to three to six months' salary, financial gurus say. And because the money is for emergencies -- such as an unexpected illness or the loss of a job -- that hoard should be placed in a "liquid" investment such as a money market or CD, meaning it's quickly accessible.
Just like with bonds, investors should consider staggering the maturity dates of their CDs -- mixing them so that all the money isn't locked up for 10 years or so that all the certificates aren't maturing at the same time. This sound strategy is known as "laddering" a portfolio.
Short-term CDs -- a year or so -- are useful. But they're more for capital preservation than for long-term investing, says Thomas P. Walpole, a certified public accountant and financial planner in Rochester, N.Y.
For wealthier savers who use CDs, Walpole suggests having some certificates of deposit in smaller amounts -- $10,000, for instance. Then, if an emergency arises, the saver can cash out at a smaller penalty without surrendering all of the interest on, say, a $100,000 CD.
Despite the jump in overall market interest rates, investors have yet to stampede back into CDs, said Provident Bank's King. However, consumers are drawn in when the bank introduces or promotes a CD with a higher interest rate or special features, such as a new eight-month CD with an annual percentage yield of 5.35 percent, or the higher-yielding CD investors can purchase from Provident via the Internet, bank officials said.
There's a tidy sum in CDs in U.S. banks and thrifts. At the close of the first quarter, the most recent figures available, time deposits at U.S. commercial banks totaled $3 trillion, with another $700 billion at savings and loans, according to the ABA's Leggett.
Stocks are getting the headlines, but CDs have their place, says Walpole, the CPA.
"For some people, they're appropriate," he says. "They're risk-free, but they're fairly bland -- they're not going to shoot up with the market. On the other hand, they let some people sleep at night and earn a fair rate of return. And that's what it's all about."