By: Julio Perez, Spring 2018 IAC Graduate Research Assistant
When investing in a security, an investor often looks at the underlying company offering the service or if the company’s fortunes will improve in the future. In the case of certificates of deposit, however, an investor looks at the stability of the entity (often a bank) and how likely they are to pay him the promised yield.
Specifically, a certificate of deposit (CD) is an investment that holds a fixed amount of money for a fixed period of time in exchange for a higher interest rate than a typical savings account. Said CDs can be purchased at a fixed or variable interest rate for a set number or months or years (6 months, 2 years, 5 years, and so on). CDs also tend to be protected by federal deposit insurance of up to $250,000.
If a CD is redeemed before it matures, the investor has to pay an early withdrawal penalty or otherwise forfeit a portion of the interest earned.
Of course, it would not be an investment if it did not have risk, and with CDs, there is always a risk that inflation will mitigate a large portion of an investor’s interest rate, with severe inflation shifts resulting in an effective capital loss on the investment. However, generally speaking, CDs tend to be the safest form of investment, due to its low risk/low reward nature.
Although most CDs are issued by banks, many brokerage firms and independent salespeople, known as “deposit brokers,” can negotiate a higher interest rate by bringing in investments in bulk and then offering these higher yield CDs to customers. Like any high yield investment, it brings with it a higher risk and requisite level of expertise, which itself requires the investor to double-check to make sure they know what they are doing before investing.
FINRA has put out investor alerts for ads promoting “High CD Yields!” employing the typical bait-and-switch of not selling you CDs but different high-commission products to make a profit at the investor’s expense.
Translated: “I want to keep my money in a deposit account, but I want a higher interest rate, even if I can’t withdraw it for some time.”