CD could be good idea
Is there a calculator I can access at Bankrate for the following
situation? A CD I own earns 3 percent and has one year till maturity.
Another bank has a 4 percent CD with three-year lock in. The bank
with the 3-percent CD has a three-month interest penalty. Should
I take the penalty and switch or stay pat? Thank you.
Bankrate has a host of certificate of deposit,
or CD, calculators,
but doesn't have one that tells you whether you should take the
penalty, cash in your old CD and lock into a new CD. It's not a
straightforward problem when you change the investment horizon,
like you did in your question, from one year to three years.
Let's look at the apples to apples situation first.
If you were trying to decide whether to redeem a 3 percent CD with
a year remaining until it matures, and the CD has a three-month
interest penalty on early redemption, then you're losing 3/12 x
3 percent or 0.75 percent interest on your current CD. For you to
be ahead, you need to earn more than 3.75 percent on a one-year
CD. Searching the 100 top CD rates using Bankrate's highest
yields function you can currently earn 4.58 percent annual percentage
yield on a one-year CD. That's higher than 3.75 percent, so you
can benefit from redeeming the old CD and replacing it with the
new CD without shifting your investment horizon.
When you shift your investment horizon from one year
to three, you also have to consider what interest rates will be
like a year from now when you can invest in a two-year CD without
paying the early-redemption penalty on your now-matured CD. If interest
rates have moved higher, you could be better off for having waited
the year, not paid the penalty and then invested in a two-year CD.
not technically accurate, but you can use average annual rates to approximate
where interest rates will have to be a year from now to be better off waiting
to reinvest. Bankrate reports the highest yield three-year CD at an annual percentage
yield of 4.71 percent. Here's a table that shows how you can use the sums and
the averages to help you decide:
John's early redemption
Dr. Don's early redemption
Mature & reinvest
(less 0.75% penalty)
For you to be better off waiting to reinvest when
the existing CD matures, you have to expect the two-year CD to yield
more than 5.19 percent a year from now. While I can't tell you what
two-year CD yields will be a year from now, you can currently invest
in a two-year CD at a 4.64 annual percentage yield. So the rate
on a two-year CD would have to increase by 0.55 percentage points
over the next year for you to be better off waiting.