Joe Marullo Insurance & Retirement Services
16818 Doverwood Way
Houston, Texas 77058
The average consumer may not be aware of some more attractive CD terms as they are typically reserved for large investors and therefore offered to the bank’s wealthiest clients. Some CDs are not provided directly by an issuing bank but are made available through Financial Professionals licensed to sell the specific CD instrument in question. That is why investigating the Certificate of Deposit alternatives with a Financial Professional is one of the essential fact-finding missions in which a conservative investor can engage.
Traditional CDs: Banks sell traditional certificates of deposit directly to the general public. The purchaser agrees to hold their funds for a specified period with the bank to attain a fixed return on their investment when the period ends, usually referred to as the Certificate’s “Maturity Date.” Periods vary from 3, 6, or 9 months to 1, 3, 5, and even 7 years, and higher interest rates from the bank will typically reward longer time commitments on the part of the investor. These interest rates are generally higher than a savings account rate, but they tend to be lower compared to non-FDIC insured investments.
Suppose the depositor wants to withdraw funds before the maturity date. In that case, penalties are generally applied, and this is pretty much the only way you can lose principal with a traditional CD investment.
Brokered CDs: Brokered Certificates of Deposit are sold through Securities Broker-Dealers and Deposit Brokers rather than directly through the issuing bank. Brokers purchase the CD from the issuing bank on the investor’s behalf.
Brokered CDS will generally payout at a higher rate and are more liquid; however, even though they can quickly be sold to another buyer before maturity, the total return on the principal is only guaranteed if the brokered CD is held to maturity. Suppose an investor needs to sell before the maturity date. Rather than penalties, they will worry about the product's value on the open market, so premature sales could still eat into the principal.
The current market values of Brokered Certificates of Deposit are published monthly, so investors can easily compare their principal to the market value and calculate the effect of an early sale on their principal investment.
Typically, there is no certificate issued for Brokered CDs. They are bought and sold on a “book-entry” basis, meaning that the broker holds the CD in a custodial account for the depositor, which is standard practice in the securities industry. Many banks are moving into this process with their traditional CDs as well.
Market Linked, or Structured CDs: Market-Linked Certificates of Deposit, also referred to as Structured Certificates of Deposit, are a Brokered type of CD offering the safety of FDIC insurance with more attractive interest rates than traditional CDs. They usually pay a guaranteed interest rate and a variable interest rate tied to a market vehicle such as stocks, bonds, commodities, or indices. Conservative investors find these desirable investments as the FDIC insurance minimizes risk to principal, and the higher interest potential dramatically reduces risk to losses due to inflation.
Deposit Brokers have been selling Market Linked CDs (MLCDs) in the United States since Chase Bank introduced them in 1987, but they were designed for wealthier investors and were out of reach to average investors. While today’s MLCDs are available for a minimum deposit of $1000.00, many brokers may require a larger account size.
In today’s low-interest-rate environment, Market Linked CDs have increased in popularity as they are designed to return 3 to 4 percent more than a Traditional Certificate of Deposit.
Bump-Up CDs: Bump-Up Certificates of Deposit offer a lower initial interest rate than traditional CDs to investors but provide them with a one-time option to “bump up” their rate if interest rates rise during the CD term.
Bump-Up Certificates of Deposit are great for when interest rates are rising, and rates for CD investment could increase dramatically over the maturity period. The longer a maturity period is, even in a low-interest rate climate like we are currently experiencing, the more attractive this type of CD becomes.
Step-Rate CDs: Step-Rate Certificates of Deposit are designed to “step” up or down to a predetermined rate at a certain point in the term of the CD based on specific circumstances.
There may be multiple step points established within the term of the CD, so the overall interest earned is an average of all the rates throughout the CD. This system is a good compromise for banks and investors navigating extreme interest rate volatility – not appropriate in a stable or flat environment.
Callable CDs: Callable Certificates of Deposit are offered at higher than traditional rates to investors, with the bank retaining the option to “call” the CD after a specified period.
If interest rates drop, banks will “call” the CD, so they do not lose money on the deal but offer investors a premium interest rate for the privilege.
Zero-Coupon CDs: Zero Coupon Certificates of Deposit, like a Zero Coupon Bond, makes no interest payments until the maturity date and are sold for a discount on their face value maturity date. For example, a $75,000 Certificate over a 7-year maturity rate may be purchased at a deeply discounted rate of $50,000 on the face value. These Certificates are usually brokered, so you will have to find a licensed professional to assist you.
And beware: your income may be taxed annually as it is earned even though you will not receive it until your maturity date. Also, these Certificates are often callable.
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