Retirement Income Blog

 
Thanks to the FDIC, millions of Americans are able to sleep peacefully at night, knowing that their savings are protected by government-backed insurance. Since the thirties, certificates of deposit have become synonymous with safety of principal. Bank customers who shop for CDs concern themselves only with the rates and terms that are available as CD investing is riskless within the insured amounts.  When financial planning for retirement, CD investing can be a cornerstone of those plans.

Unfortunately, the safety that comes with FDIC insurance comes with a price. Will Rogers once said, “It’s not the return on my money that concerns me, it’s the return of my money.” This famous saying exemplifies the attitude of many bank customers. While CD investments are among the safest types of investments available, their rate of return is correspondingly low. If interest rates are around 4%, then that is about what you can expect a short term CD to pay. While longer term and jumbo CDs can pay slightly more, it is very difficult to see much real growth (i.e. after inflation and taxes) from them over time. CD investing is easy and safe, but doesn’t often pay very well.

However, there is another option available for those seeking higher rates on their guaranteed CD investments. Unbeknownst to many CD buyers, many brokerage and investment firms offer CDs. While these brokered CDs do differ from their cousins in the banking system in some respects, they are still FDIC insured up to $250,000 per owner or beneficiary (through 12/31/2009). CD investing is easy through a brokerage because you can choose from among many banks or diversity amongst banks all on one statement. Furthermore, brokered CDs generally pay a higher rate than bank CDs, and they often contain other features, such as put or call options that allow either the buyer or the issuer to redeem the certificate prematurely without penalty. (Use the retirement calculator to see the impact of an additional 1% interest over time). For example, a brokered CD with a 20-year maturity could be “puttable”, after five years, if the buyer so desires. That means that five years from now, if rates have gone up and the buyer wishes to move the money in this CD to another one, then he or she can put the CD back to the issuing bank for return of their original principal.  But read the fine print.  The put feature is often subject to available of funds and is not a guaranteed feature.

Call features give the issuing bank a similar privilege as prior to maturity, the issuing bank can return the investors principal. CD investing can also get more complex and profitable if you want to take advantage of another’s misfortune as you can buy brokered CDs on the secondary market from a person who needs the money early (and will likely need to sell to you at a discount). Note that the FDIC guarantee will only apply for investors that either hold their certificates to maturity or redeem them in a put or call transaction so if you buy a CD on the secondary market, check the quality of the issuing bank. If the certificate is sold prematurely in the secondary market, then the owner may receive more or less than his original investment, depending on market conditions. But those who hold their CDs to maturity can enjoy higher rates of income.  These long term CDs should be considered illiquid investments even though there may be liquidity possibilities.

Note that brokered CDs usually are of a longer term or have features not typical of the CD from your neighborhood bank.  Brokered CD investing may not be right for you.  Just understand all of the features to decide.

Post provided by Javelin Marketing

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Your local bank likely offers among the lowest CD savings rate–not a good thing for your retirement investing.  The local bank has the expense of rent, the tellers’ salaries and highly unproductive service representatives that will waste an hour opening a checking account.  The expense of running a bank branch is enormous and therefore, the CD savings rate offered by the local bank won’t be your best bet.  What if they could avoid all of these expenses and pay you a better rate?

That’s exactly what Internet banks do.  They have no buildings in high rent retail centers (they can have their offices in the warehouse district because they don’t have customers visit) and they don’t waste time opening checking accounts.  The customers serve themselves online.  An Internet bank can offer a higher CD savings rate because their expenses are lower and that means more for you, the investor.

But it can even get better than that if you share some risk with the bank.  The rate offered by the bank is limited by the potential risk they have.  If they give you 5% locked in for 5 years, they have the risk of not being able to earn 5% each year when then lend their money out for mortgages, etc.  But, if you allow them to cancel your CD in case they cannot earn the promised rate, then you can get a higher CD savings rate.  These CDs where you share the risk are called “callable CDs.”  The bank is permitted to call your CD (pay you off) before the end of the term.  These callable CDs are usually offered in terms of 5 years and up so they are appropriate for long term investors who desire a higher CD savings rate.

Another way to get a higher CD savings rate is with an indexed CD.  Such a CD has interested tied to the stock market.  Don’t worry, the FDIC insures your investment so you can’t lose money.  But if the stock market does not rise, you wont make money either.  With such a CD, the rate is typically measured at the end of the term, e.g. 5 years.  A typical CD may pay you 50% of the increase in the stock market.  So if the market rises 80% over the 5 years term, you get 40%–equivalent to 8% simple interest on your invested principal.  Not bad.  But if the stock market stays the same or declines, you get your money back with no interest.  Like the callable CD, if you are willing to share some of the bank’s risk, you can get a higher CD savings rate.  So check your retirement planning calculators and start figuring!

If you’ve ever had the thought that it’s good to own a bank, you can participate in the two CDs just described and share the banks risk, earn a higher CD savings rate and see how you like being the banker as well as the investor.

Last, let’s not forget that the rich get richer.  Jumbo CDs ($100,000+) typically pay higher CD savings rates and for larger amounts, say $250,000 and above, the CD rate is negotiable. You simply show the best rate you find and ask your local banker to beat it.  You may be surprised that the rates are not fixed and your banker has some room to negotiate.

Post provided by Javelin Marketing

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