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Strategizing with bank CDs
The Federal Reserve has raised its benchmark interest rate four times since the 2008 financial crisis, but rates on certificates of deposit, or CDs, remain super low.
Savers have waited — and perhaps prayed. Investors have looked for ways to bump up their returns without taking on more risk than they can sleep with at night.
CDs, which return all of your principal, plus a certain rate of interest at the end of a specified term, can make sense in some situations even if rates are on the rise.
Should you buy a CD before the Fed raises rates again?
The answer isn’t obvious because it depends on more than the uncertain rates climate.
You also should consider your personal financial objectives, time horizon and risk tolerance, says Dana Twight, founder and principal of Twight Financial Education in Seattle.
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When to ladder CDs with shorter maturities
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If your main objective is to add to your wealth over a long time horizon and you want to plan for higher rates, “the conventional wisdom is to shorten your maturities,” Twight says.
That might mean buying a so-called ladder of CDs with varying maturities measured more in months than years. If rates rise, this ladder could allow you to roll over your funds at higher rates as your CDs mature. If rates don’t rise, you’ll have sacrificed the higher return you might have received with longer maturities. A CD ladder calculator can help you maximize your returns.
Either way, Twight says, investors need to lower their expectations, understanding that a slightly better return for an online bank CD instead of that for a money market account makes a substantial difference.
“If you ratchet those expectations down, half a percent increase is pretty darn exciting,” she says.
One way to attempt to improve your return is to direct the interest from your CDs to a mutual fund instead of spending or re-depositing it.
As Twight says, “This strategy preserves the principal and allows unneeded income to go into the stock market periodically and automatically.”
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If your main financial objective is to protect wealth you’ve accumulated, yet you’re sorely tempted to dip into your principal, a ladder of CDs with longer maturities might be helpful, in part for psychological reasons.
“The CD strategy works for people who want preservation of capital and really, really, really want to make it a little harder to get to,” Twight says.
The risk is that if rates rise, you’ll have to pay a penalty to break out of your CDs or you’ll miss out on the chance to capture those higher returns.
If you have a long time horizon for wealth preservation, CDs with long maturities might be too conservative as an investing strategy due to the effect of inflation.
“If you retired at 45, 55 or 65, you could need that money for another 30 years,” Twight says. “Because of that time horizon, you may need to be more aggressive.”
One tactic to attempt to boost your return is to invest in mutual funds and stash your capital gains in bank CDs.
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When to review your investment portfolio
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Regardless of your objectives, you should think of your CDs in a relative, rather than absolute, way. Don’t make decisions about a CD or any other one part of your portfolio without weighing its place in your whole financial picture.
“You have to evaluate all your investments relative to everything else,” Twight says.
That “everything else” should include your employer-based retirement plan and income stability.
If your job’s secure, you might want to take more risk with your investments. If you could lose your job and income at any moment, a safer option like CDs might be sensible — whether or not the Fed raises rates.
The balancing act is to look at your portfolio “often enough, but not every day,” Twight says.
Uncertainty about interest rate hikes makes this periodic re-evaluation of your CDs and how they fit into your portfolio even more critical.
“Look at it now, then be prepared to look at it again in six months,” Twight advises. If you need help making investment decisions, consider finding a financial adviser in your area.
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Never try to ‘time’ interest rates
Perhaps the biggest potential pitfall for CD savers is trying to predict interest rates and making investment decisions based on those predictions.
Because the fact is that no one can predict the future — not even when the Fed’s market signals seem clear as the proverbial crystal.
Cheryl Krueger, president of Growing Fortunes Financial Partners in Schaumburg, Illinois, explains:
“The same way that I don’t try to time the stock market, I don’t try to time interest rates.”
What’s more, a rate hike by the Fed might not translate into higher rates for CDs or other bank deposits as long as rates are near zero or even negative in some other countries, says Ronald D. Weiner, managing director of RDM Financial Group at HighTower in Boca Raton, Florida.
“Money may still be pouring in to the U.S.,” Weiner says.
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Shop around for best CD rates
Weiner advises savers to shop around for CDs and compare different banks’ rates for desired maturities.
“Some banks may offer better short-term, others better long-term,” he says.
Rather than buy your entire CD ladder from one bank, you might want to buy CDs from multiple banks, mixing and matching the highest rates you can find for different maturities.
“To maximize the yields,” Weiner says, “you probably have to do a bit more homework because banks have different strategies.”
If you decide to shop for so-called brokered CDs, which are sold through investment advisers or stock brokerages, ask about and compare fees you may be charged as well as rates you’ll be offered.