Step up into a new world of alternative CDs
September 07, 2011
In an attempt to generate enthusiasm from investors who have grown weary of tying up their money in plain, vanilla, low-rate products, banks are adding some incentives to their CD offerings. The latest products are designed to meet customer concerns about being locked into low CD rates when interest rates may be rising. They also offer some much-needed flexibility in the form of liquidity.
How do the new CDs work?
There are several types of these rising-rate CDs: step-up, bump-up and liquid. The step-up CD raises the interest rate at predetermined intervals during the life of the product. The increasing rates are determined by the institution and based on the term of the CD.
The bump-up, or Opt-Up, CD lets the more "hands on" investor decide when to raise the rates during the life of the product. There is a maximum number (usually one or two) of times they can bump up the rate during its term.
The liquid CD allows the buyer to move some percentage of the money invested out of the CD without penalty. This can then be used to buy a new CD with a higher rate if the investor so chooses.
Reasons to be excited?
Considering the current low interest rate climate, the word "excited" probably isn't as accurate as "optimistic." Yet, anytime you can get a better interest rate, it should be considered a plus. This is especially true for fixed-income investors and the many of us still seeking safer havens than the stock market.
"I don't see much of a downside," says Lee Hull of Hull Capital Management in Tyler, Texas, and author of the forthcoming book Less Risk, More Return. "Clearly the bump-up or step-up is an advantage to a traditional CD if all things are equal, meaning you don't have to extend for a longer time or start at a lower rate." Hull also stresses the importance of comparing apples to apples regarding rates, terms and penalties when it comes to shopping around for certificates of deposit.
"The reasoning behind the new CDs is to offer customers flexibility," says Don Vecchiarello, spokesman for Bank of America, noting the growing consumer interest in the new CD products. "People want the security of a CD, but they don't want to feel locked in during a rising interest rate environment. This gives them more options."
Are there any risks?
Of course there are some risks. First, you do not want to start out at a lower rate and simply be stepping up or bumping up to the rate you could have been getting elsewhere. Additionally, if you only have one opportunity to bump up your CD rates, and you do so, there is the risk that rates will rise again and you may miss out. So there is the risk that you act too soon.
Another concern is that some of these new CDs can be called, meaning you may never see the step-up or have the chance to bump up to a higher rate. So look for non-callable products.
As for the liquid CDs, they do allow you to have access to some of your money quickly, which is one of the most significant factors for all investors today. However, the stipulations regarding how much you can withdraw, when you can take such withdrawals and the parameters surrounding withdrawals can make or break these offerings. Don't give up too much for the luxury of liquidity.
The Bottom Line
If the initial rate is competitive (and you have read all stipulations carefully), you can benefit from these new CD offerings in a rising interest rate environment, particularly in the short term (18 months or less). This can give you potentially the highest CD rates and a chance to roll over and bump or step up again if rising rates continue. In fact, laddering such CDs can keep you in step with each rate increase. So, if you foresee rising interest rates, you may want to put these new CDs on your radar screen.
