Originally created 09/22/05

Rate increases make CDs attractive



NEW YORK - As the Federal Reserve has pushed up interest rates, certificates of deposit are looking attractive again.

The Fed this week raised its target for short-term rates for the 11th time since June 2004, making it likely that returns for small savers will continue rising, too.

"CD rates should go up again, particularly those with shorter maturities, like three months and six months," said Greg McBride, a financial analyst at Bankrate.com in North Palm Beach, Fla.

There also could be further increases, he said, because the Fed spoke again of a "measured" pace in raising rates.

The higher annual yields - which currently average 2.2 percent for a three-month maturity, 2.6 percent for six months and about 3 percent for one year - are making CDs a better place to park money that consumers might need in the near future, Mr. McBride said.

That could include money that older people might need to draw on periodically for living expenses, a family's emergency funds or a couple's nest egg for a new home, he said.

He recommends that savers "ladder" their CDs by investing in different maturities, say three months, six months, nine months and a year.

"That way you can get money when you need it without any penalty for withdrawing before maturity," he said. "And you can take better advantage of higher rates as they mature."

The penalty for early withdrawal on CDs generally is one quarter's worth of interest payments.

Ric Edelman, a financial planner in Fairfax, Va., said a major advantage of CDs issued by banks, thrifts and credit unions is safety, because they're insured by the government.

"But in exchange for knowing that your money is safe and available to you, you get a lower return" than from mutual funds or stocks, he said.

"That's why CDs are for cash reserves. Long-term investment money shouldn't be there," Mr. Edelman said.

As a result of the competition, banks and other financial institutions have tried to make their CDs more attractive by lowering minimum deposits, in some cases to as little as $250, and offering higher rates to customers who use other bank products, such as premium checking accounts.

Financial institutions also have become more creative in the structuring of CDs to reduce consumers' anxiety about interest rate changes.

Some have put provisions in so-called liquid CDs that allow consumers to make a single, partial withdrawal without penalty before the CD matures, making it easier for savers to tap the money if they really need it.

Other institutions have been putting escalators into their CDs so the interest rate can be adjusted if market rates rise. These come in two varieties: "step-up" CDs generally include a clause specifying when the rate increase will occur, and "bump-up" CDs require consumers to ask that the rate be adjusted.

Washington Mutual Inc., based in Seattle, offers a one-year CD with a bump-up provision, said Karyn Furstman, the first vice president and manager of the interest-bearing deposits group.

The CD requires a minimum deposit of $1,000, and "consumers have one opportunity to upgrade to a higher rate" before the CD matures, she said.

"It's useful when rates are rising," Ms. Furstman said.

Another option is a market-linked CD.

The online bank EverBank Direct, based in Jacksonville, Fla., offers a MarketSafe CD with a minimum $1,500 deposit that "provides the investor with principal protection and a market return," President Frank Trotter said.

The bank offers three-year and five-year CDs linked to the Standard & Poor's 500 index. The three-year certificates will earn 60 percent of the rise in the S&P index on maturity, and the five-year will pay 75 percent. If the market falls, the investors still get their entire deposit back.

CD advantages

- Higher interest rates mean higher returns on certificates of deposit: on average 2.2 percent for a three-month maturity, 2.6 percent for six months and 3 percent for one year.

- CDs are insured by the government and thus have the advantage of safety.

- Reacting to competition, banks are offering incentives such as lower minimum deposits and greater flexibility in accessing the money.

- Associated Press