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Why choose alternative CDs?

Investing Basics » Why Choose Alternative CDs?

Penalties can pay off
Penalties can pay off

A no-penalty CD eliminates early-withdrawal fees -- fees that the Bankrate 2010 CD early withdrawal penalty study shows can be quite hefty.

While the prospect of a fee-free withdrawal may sound comforting, paying the penalty can work to the investor's advantage in some cases, says Greg McBride, CFA, Bankrate senior financial analyst. This strategy is known as riding the yield curve and involves investing beyond your investment horizon -- in other words, putting money in CDs for longer terms than you intend to have it locked away.

Consider McBride's comparison between a five-year CD that yields 2.5 percent and a two-year CD that yields 1.5 percent. With an investment of $10,000 in the five-year CD, paying a six-month early withdrawal penalty after two years still yields approximately $75 more than holding the 2-year CD to maturity.

While Bankrate's 2010 early withdrawal study showed that 180 days of interest was the most common penalty for CDs with multiple-year maturities, some banks levy fines as high as 24 months' worth of interest.

Don Taylor, assistant professor of finance at Pennsylvania State University in Brandywine, Pa., and Bankrate's investing adviser, says consumers can compare CD withdrawal penalties just as they compare rates to determine the cost-effectiveness of riding the yield curve.

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