IRA Investment Strategies
A couple of days ago the market was up 140+ and a few days later down 200+. Are you tired of this roller coaster?
If your at, or nearing retirement and want to take the risk out of your retirement portfolio then consider investing in bank/credit union Certificates of Deposits (CD).
This site, and blog are designed to try and help the unsophisticated investor take advantage of a federally insured investment option. You can protect every penny that you have and earn a small return on your money. By using some of the tips in this site you can improve those earnings.
Please search through the material. I have tried to be as clear as possible, however, if you have a question please feel free to post it. I will responde as I can.
It pays to ask
I had a CD maturing last week. One of those I was Laddering over 5 years, since the fall of 1987. Wanted to put it into a 5 year CD at the best rate I could find. Had found a great rate of 3.75% at www.Mechanics-Coop.com but when maturity date came the rate had been dropped to 3.50% two days before. I asked branch manager for the higher rate, he made a call, and I was given the higher interest rate. That was a 7% improvement in the rate of return on this CD.
Lesson learned, ask and maybe you shall receive.
CD Risks
What are the Risks with a CD?
The risks associated with investing in CD's are different than the risks of most other types of investments but it is best to understand them before moving forward. The first risk is that you are committing your principle into the banks care for a specific period of time. The amount of time is selected by you, but the bank expects to have your money for the full term you have selected. If you want, or need your money sooner there is a potential penalty that you must pay. This penalty can possibly cost you some of the original amount you gave the bank or credit union (see Types of CD penalties). There are ways to minimize the possibility of loss from this situation that you should consider (see Minimize CD penalties).
There is also the risk that the interest you will earn on the CD will not be as much as you might earn in the stock market through a mutual fund or direct stock investment. When the stock market is strong the earnings potential usually exceeds the rates that banks are willing to pay for CD deposits. When you make a commitment to a CD for a specific term and amount you cannot take advantage of higher future CD rates until your current CD matures (reaches the end of the time you agreed to keep it on deposit). This means you might be kept from taking advantage of higher interest rates in the future. To give yourself greater flexibility sees "What is laddering of CD's".
Another risk of investing in a CD is that you might need some of the money for an emergency and now it is tied up at the bank/credit union. The possibility of this becoming a problem and causing you to incur penalties can be minimized by taking a few simple steps (see Minimize CD penalties).
The only other risk that you might face is that the bank/credit union in which you have made your deposit "fails" and is taken over by a government agency or another bank. If your bank is taken over by another bank they must honor the terms of your original agreement. There is little or no risk in this situation. Make sure to keep all your paperwork ready should this possibility arise. If your bank/credit union is taken over by a government agency (FDIC or NCUA) then your deposits are insured with some exceptions (see Federal Deposit Insurance and Other insurance under CD Rates & Insurance).
Callable CD’s
Someone recently asked about Callable CD's. What are they and how do they work?
For an example we will use a ficticious 2 year CD offer of 3%. During the life of the CD the bank has the option to end the CD, usually on the anniversary date. In our case that would be at the end of the first year. Thus your 2 year CD could become a 1 year CD, at the banks discretion.
Why is the bank doing this? The bank thinks that rates may go up to more than 3% at the end of the first year, but they are not 100% confident in that opinion. If rates do go up above 3% after the first year they will let you keep the CD, since it cost them less than paying the new higher rates. But, if rates don't go above 3% and stay at 2.75% (for example) they can call the CD and not have to continue paying more than the market rates.
So to summarize. With a Callable CD if rates go up you lose because you keep getting a rate that is lower than market. And if rates go down you lose if the bank calls the CD and you no longer get the higher rate. The decision by the bank to call the CD will not be made with your best interest in mind.
Suggest you consider laddering which puts the decisions and control in your court.
Again I would appreciate your feedback.
CD Penalties
Types of CD Penalties
The most common CD Early Withdrawal Penalties are the loss of a specific number of months interest if the account is closed before the end of the term (maturity date). For CD's of 1 year or less in term the penalty is most often 3 months interest. If the term is more than a year the penalty commonly is 6 months loss of interest. It is important to read and understand the early withdrawal penalty section of the disclosure provided by your financial institution.
It is important to understand how these penalties work. If for example you buy a six month CD and have to withdraw the money after only two months into the term you could face a three month interest penalty. In this case the CD has only earned two months of interest. Thus the penalty will be the two months of interest you have earned plus one month's interest is deducted from the amount you originally invested. In this example you could lose what you earned and some of what you invested.
You can minimize the possibility that you will incur these penalties by diversifying your CD holdings. Buy CD's with staggered maturities and multiple CD's of smaller amounts instead of a single large CD.
Minimize CD penalties
Penalties are incurred when a withdrawal of some, or all of the funds in the CD are withdrawn prior to maturity. These usually are the equivalent of three to six months interest that would have been earned on the deposits. It is important to clearly understand the penalties that are possible on the CD investment that you make.
Many people are concerned that they might need cash for an emergency at some point and are reluctant to make a long term commitment of their funds. One easy way to minimize this potential concern is to break the investment up into smaller pieces. If you have $6,000 to invest but are afraid you may need $800 before maturity for an emergency, consider the following. Purchase six $1,000 CD's instead of one $6,000 CD. The paperwork will take a little longer and the customer service person may not be happy, but you can now withdraw one or two of the CD's prior to maturity without paying the penalty that would have applied to the entire amount. Also, remember that six $1,000 CD's earn the exact same amount as one $6,000 CD. Look into the minimum deposit amount required for the particular CD that you are considering. Some institutions require only a $500 minimum deposit, thus in the previous example you could open twelve $500 CD's.
You can also request exception to the penalty on one of the $1,000 CD's because you are leaving the rest of your investment with the bank. They do want to keep your money, so negotiate to try and get a break on the penalty.
When Rates Are Up
When the interest rate trend is upward it is best to switch to having the interest on your CD portfolio reinvested in new CD's instead of being compounded into the existing CD's. This allows you to take advantage of higher rates each time interest is paid on your existing CD investments. A portion of you portfolio in a laddered CD structure is also always coming up for renewal. This allows you to take advantage of the higher rates without having to get out of a single CD investment whose maturity is well into the future.
CD Rates and Insurance
How Banks & Credit Unions Set CD Rates
Financial institutions set their rates base on their need for deposits and the rates set by competitors. They may anticipate that rates will be going down further and want deposits that will quickly re-price downward (i.e.; short term CD's) so the most attractive rate they offer will be of a short duration. If they think that rate might be going up they will get aggressive with longer term rates to try and lock in deposits at a fixed rate that will soon be eclipsed by the market.
Bottom line is that their motives and your motives are not always the same. Shop around for the best rates you can find and take the time to make you investments wisely. Banker's look at CD deposits as "hot money" that will leave them when the next better deal comes along. They don't expect you to be loyal to an organization. Shop rates!
Federal Deposit Insurance
Historically the Federal Deposit Insurance Corporation has insured deposits by an individual up to $100,000. The FDIC provides this insurance with the full support of the United State Government. Today those deposits have had the amount of insurance increased to $250,000 per individual. Another organization provides the same insurance for credit unions. It is the NCUA and is also a government agency.
It is important to remember that this insurance applies to all the funds you have on deposit with each financial institution. So if you have CD's, a savings account and a checking account at the same bank or credit union they are all added together to determine the insured amount.
The FDIC has an explanation of this program at
http://www2.fdic.gov/dip/index.asp
The NCUA site is
http://www.ncua.gov/default.aspx
Other Insurance
Some financial institutions provide additional insurance coverage to protect your deposits beyond the amounts covered by the federal programs. In Massachusetts the DIF provides additional coverage for banks and the MSIC provides coverage for credit unions.
When Rates Are Down
Laddered CD's do extremely well when interest rates are going down. This is also a time when the economy may not be doing to well. If you have a 5 year ladder set up in this environment only 1/5th of your investment will be re-pricing at the current lower rates and 4/5th will stay at the higher earlier rates. Thus you end up dulling the effect of falling CD interest rates. Also, if you continue the ladder strategy you will be looking to replace that maturing CD with a long term CD which should offer a higher rate of return then a short term investment.