investing

What type of CD is best?

One drawback is that zero-coupon CDs are usually long-term investments and that means you're taking on considerable interest rate risk. If interest rates rise during that 10-year period, you'll be on the losing end of that deal!

Another potential problem is you're credited with phantom income each year. No money is being put in your pocket but you have to pay Uncle Sam because you owe tax on the interest. In our example, you'd owe tax the first year on $3,000 you haven't actually received. Each year you'll have a higher base than the year before -- and a bigger tax bill. Make sure you have the funds to cover the taxes.

Callable

The bank that issues the CD can "call" it away from you after the call-protection expires, but before the CD matures. For instance, if you buy a five-year CD with a six-month call-protection period, it would be callable after the first six months.

Just as with the zero-coupon CD, the bank is shifting interest rate risk onto your shoulders. If it issues the CD at 5 percent and six months later rates drop, and the bank is now paying 4 percent on five-year CDs, the bank can call, or take back, your CD and reissue it at 4 percent. Of course, you'll receive your full principal and interest earned to date. But you're now stuck trying to reinvest your money at lower rates.

Usually, banks pay investors a premium for taking on the risk that the CD may be called. They may pay a quarter- or half-percent more on a callable CD than they would on a CD without the call feature.

Brokerage

A brokerage CD is simply a CD sold through a brokerage. Some banks use brokers as sales representatives to find investors willing to purchase CDs from their banks. As you can see from Fidelity's list of CDs, it's a convenient way to buy CDs, as you only need to have an account with the brokerage. There's no need to open accounts at a variety of banks just to get the better yields. Brokered CDs often pay higher rates than CDs from your local bank because banks using brokered CDs compete in a national marketplace.

These CDs are more liquid than bank CDs because they can be traded like bonds on the secondary market, but there is no guarantee you won't take a loss. The only way to guarantee getting your full principal and interest is to hold the CD until maturity. Brokered CDs often have call options.

It's easy to say that brokered CDs are backed by the FDIC, but you as the consumer must look for it in writing on the website or any printed materials you're given.

High-yield

Banks compete for deposits by offering better than average rates, but the best route for finding the highest rates in the nation is Bankrate.com's 100 Highest Yields page.

Bankrate surveys local and national institutions to find banks offering the highest yields on CDs. All accounts are directly offered to the consumer by the institution.

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