How to get more than safety with Certificates of Deposit
By Dennis Gregory
This may come as a surprise, but Certificates of Deposit, like those you see on that chalkboard at the bank every week, actually have the potential to yield higher than the advertised rate.
What you may already know: Certificates of Deposit come in all shapes and sizes.
You can buy CDs for as little as $1,000, all the way up to $100,000, in multiples of $1,000, and still be insured by the FDIC. This makes them one of the safest investments you could possibly find. They also have different expiration periods, such as 1 month, 6 months, 1 year, all the way up to 5 years. Naturally, the more time your money is invested, the better the certificates of deposit rate you can expect.
Traditionally, the difference in Certificates of Deposit rates between a 6-month CD and a 5 year CD was around 1.0 whole percent, but nowadays the margin is much closer, with interest rates on the rise as they are in 2006. At the time of this writing, the highest CD rate for both a 6-month and a 5-year CD is almost the same, around 5.50% APR each.
There is one other major factor that sets CDs apart. Some CDs are labeled "equity-linked," which means that they are tied to a portfolio that the issuing bank put together. Doing this offers the possibility of an even higher-yield return than advertised, but it also increases the risk in the case that the bank's portfolio goes down.
In my experience, this is almost always the case, even in growth markets. For much the same reason that I don't let brokers pick my stocks, I refuse to buy equity-linked CDs and do not encourage you to purchase one, despite the possibility of higher returns.
So how do I use non equity-linked CDs to get higher-than-advertised returns?
I build what is referred to as a laddered portfolio. This is where you can purchase a few different CDs with different expiry periods, traditionally one year apart, to combine and pay me the best rate of the day, every year. A major bonus is that you'll have access to a portion of your cash while you enjoy the longer-term rates.
That in itself was a major reason to ladder your CDs when the rates were structured the typical way. But now, as federal interest rates are going up, the tactics are a bit different.
There may not appear to be anything to gain at first by the fact that we're achieving a long-term rate while receiving cash out in shorter intervals, since the long-term and short-term rates are now so similar.
The twist is using the ladder at smaller intervals, to approximate a 1-month CD!
A closer look at laddered CDs in 2006
A couple of years ago, when Greenspan was busy and interest rates were still declining, anyone speaking about a laddered CD portfolio was describing 5 or more FIVE year CDs, bought with expiry periods one year apart. (Example: the first CD expired in October '02, the second in October 03, etc...)
This gave the traditional investor the ability to obtain the five-year rate but still have access to his money, at least a fifth of it, every October.
Today, however, you can simply buy 1-year CDs to achieve the same effect, because there is no difference in the 1-year and 5-year rate of return. (So I doubt anyone is even buying 5 year CDs right now.)
Therefore, the game has to be played differently, and it still works great on the monthly, instead of yearly cycle. Now you can walk into your bank and buy 4-month & 6-month CDs, although you may need to purchase once every other month to keep the cycle seamless. Doing so will give you access to a portion of your cash as often as monthly, but you'll be getting the 4 or 6 month rate of return instead!
I highly encourage you to read all you can about Certificates of Deposit and draw your own conclusion before making any investment in these, or any other, form of investment. In keeping with that tradition, I would like to invite you to drop by my free website for Certificate of Deposit resources. It offers a large volume of facts and figures on CDs that isn't published anywhere else on the web at all.
When was the last time someone showed you a way to beat the bank with 100% safety on your money?
About the Author
Dennis Gregory is a full-time investor with growing portfolios composed of every major type of financial asset. Learn from his experience at his free Certificates of Deposit rate and resource website; Http://www.certificates-of-deposit.info
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