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Rising-rate CDs: flexibility, with a price


Like kids standing around the pool on the first day of summer, investors are reluctant to jump in to what's lately been a very chilly market for certificates of deposit.

"More money now than ever is basically sitting in liquid deposits," says Dan Geller, executive vice president at Market Rates Insight in San Anselmo, Calif. "We have seen a gradual shift from term deposits to liquid deposits over the last few years."

Hoping to give CD investors a little push and get back some of the billions that have flowed out of CD accounts in the past few months, banks are introducing CDs with rates that can rise along with interest rates in the wider economy.

Exploring rising-rate CDs

As you explore rising-rate CDs as a possible investment tool, consult Bankrate's 2011 survey that outlines the rates and conditions of 15 step-up CDs, 61 bump-up CDs and 49 liquid CDs from around the country.

"In a rising-rate environment or the cusp of a rising-rate environment, investors are very reluctant to tie up their money in longer-term CDs," says Greg McBride, CFA, senior financial analyst at Bankrate. "So you start to see rising-rate products coming to market in an attempt to offset the objection consumers have about tying money up at a low fixed rate, only to see interest rates go racing past them."

Geller says rising-rate CDs can be attractive to investors for a number of reasons, one of the biggest being they can help investors fight rising inflation. Geller says there are signs that core inflation is picking up and rising-rate CDs are one way consumers can protect themselves.

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"They are designed for inflationary times," Geller says.

Rising-rate CDs come in three flavors

Most rising-rate CDs fall into three basic categories, each with its own pros and cons.

  • Bump-up CDs allow investors to raise their rates a specified number of times during the CD's term. "The bump-up can be favorable as long as you're not trading away too much on the front end, and you have to be pretty good about timing as to when you're going to increase that rate in order to make it optimal," McBride says.
  • Step-up CDs rise at predetermined intervals during the course of the CD's term. McBride says their greatest strength may be simplicity. "The step-up CD is actually the most straightforward in terms of measuring whether that's your best option versus a regular CD," he says.
  • Liquid CDs allow investors to transfer money out of a CD, usually with some conditions on how it can be done, so it can be reinvested in higher-rate CDs should interest rates rise. "Liquid CDs really can accomplish two goals," McBride says. "You're not giving up too much in yield, and you get the ability to have not only competitive returns now, but the ability to capitalize on even better returns later without penalty."

Regardless of the type of rising-rate CDs you gravitate toward, McBride stresses that there's no free lunch.

"There's one consistency and that's if you're going to have the benefit of higher rates later, you're going to have to give up something on the front end," McBride says. "There's a trade-off."


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