When you buy a certificate of deposit, you lend a bank or investment firm a sum of money for a period of time in exchange for interest payments. In theory, CDs are principal protected and you often have to sacrifice yield in exchange for safety. However, you can get better than average returns on your CD investments if you are willing to do some research and expose yourself to a degree of risk.
You can find the highest yielding CDs in your local area by looking for rates in your local newspaper. You can broaden your search to the national stage by browsing rates online. Some online-only banks pay above average rates on CDs since these banks have lower operating costs than rivals with brick-and-mortar stores. The highest yielding CDs are usually found at banks that are desperately trying to raise cash in order to remain solvent. The Federal Deposit Insurance Corporation insures bank deposits up to $250,000 per account holder per bank. Your principal is protected even if you buy a CD from a struggling bank although the FDIC does not have to honor future interest payments on a CD issued by a failed bank.
Unlike banks, credit unions are not-for profit entities that do not have to pay tax. Consequently, credit unions have lower operating costs than banks and those savings are passed onto account holders. You can often find lower than average rates on loans through credit unions as well as above average rates on CDs. Credit unions are not FDIC insured but are protected by insurance provided by the National Credit Union Administration. The NCUA offers the same coverage level as the FDIC. On the downside, you can only buy a credit union CD if you qualify for membership based on factors such as where you live or work.
You can buy bank issued CDs through investment brokers. Such CDs typically have higher yields than CDs available directly through banks. Terms range from months to years and in some instances you can sell a brokered CD before it matures on the secondary investment market. Regional banks use brokered CD offerings to increase their customer base beyond their geographic footprint. On the downside, many brokered CDs have call features that enable the issuing bank to cancel the contract prior to the CD reaching maturity. Banks often utilize call features in falling rate environments so as to avoid paying above average rates of interest.
While traditional CDs pay a fixed rate of interest, the highest yielding CDs are often index rather than interest based. Brokerage firms and banks market CDs that are tied to indices such as the Standard and Poor's 500. Your returns are based on upward or downward movements in the underlying index. Unlike conventional CDs, indexed CDs do not provide you with performance guarantees. If the index moves in one direction you earn a healthy return while movement in the opposite direction may mean you get nothing back other than a return of principal.
- U.S. Securities and Exchange Commission: High-Yield CDs – Protect Your Money by Checking the Fine Print
- U.S. Securities and Exchange Commission: Equity-Linked CDs
- FDIC: Certificates of Deposit: Tips for Savers
- Bankrate.com: Credit Unions Win on CD Rates
- Bankrate.com: CD Rates may Fall After Bank Fails