More ABCs about CDs

Last week's column offered some basic explanations about how certificates of deposits work. To follow up on that, this week's column presents tips can help you assess what features make sense for you:

{bold} Find Out When the CD Matures

As simple as this sounds, many investors fail to confirm the maturity dates for their CDs and are later shocked to learn that they've tied up their money for five, 10 or even 20 years. Before you buy a CD, ask to see the maturity date in writing.

{bold} Investigate Any Call Features

Callable CDs give the issuing bank the right to terminate — or "call" — the CD after a set period. But they do not give you that same right. If interest rates fall, the issuing bank might call the CD. In that case, you should receive the full amount of your original deposit plus any unpaid accrued interest, but you'll have to shop for a new one with a lower rate of return.

Unlike the bank, you can never "call" the CD and get your principal back. So if interest rates rise, you'll be stuck in a long-term CD paying below-market rates. In that case, if you want to cash out, you will lose some of your principal. That's because your broker will have to sell your CD at a discount to attract a buyer. Few buyers would be willing to pay full price for a CD with a below-market interest rate.

{bold} Understand the Difference Between Call Features and Maturity

Don't assume that a "federally insured one-year non-callable" CD matures in one year. It doesn't. These words mean the bank cannot redeem the CD during the first year, but they have nothing to do with the CD's maturity date. A "one-year non-callable" CD may still have a maturity date 15 or 20 years in the future. If you have any doubt, ask the sales representative at your bank or brokerage firm to explain the CD's call features and to confirm when it matures.

{bold} For Brokered CDs, Identify the Issuer

Because federal deposit insurance is limited to a total aggregate amount of $100,000 for each depositor in each bank or thrift institution, it is very important that you know which bank or thrift issued your CD. Your broker may plan to put your money in a bank or thrift where you already have other CDs or deposits. You risk not being fully insured if the brokered CD would push your total deposits at the institution over the $100,000 insurance limit. (If you think that might happen, contact the institution to explore potential options for remaining fully insured, or call the FDIC.)

{bold} Find Out How the CD Is Held

Unlike traditional bank CDs, brokered CDs are sometimes held by a group of unrelated investors. Instead of owning the entire CD, each investor owns a piece. Confirm with your broker how your CD is held, and be sure to ask for a copy of the exact title of the CD.

If several investors own the CD, the deposit broker probably will not list each person's name in the title. But you should make sure that the account records reflect that the broker is merely acting as an agent for you and the other owners (for example, "XYZ Brokerage as Custodian for Customers"). This will ensure that your portion of the CD qualifies for up to $100,000 of FDIC coverage.

{bold} Research Any Penalties for Early Withdrawal

Deposit brokers often tout the fact that their CDs have no penalty for early withdrawal. While technically true, these claims can be misleading. Be sure to learn how much you'll have to pay if you cash in your CD before maturity and whether you risk losing any portion of your principal.

If you are the sole owner of a brokered CD, you may be able to pay an early withdrawal penalty to the bank that issued the CD to get your money back. But if you share the CD with other customers, your broker will have to find a buyer for your portion. If interest rates have fallen since you bought your CD and the bank hasn't called it, your broker may be able to sell your portion for a profit. But if interest rates have risen, there may be less demand for your lower-yielding CD. That means you would have to sell the CD at a discount and lose some of your original deposit — despite no "penalty" for early withdrawal.

{bold} Thoroughly Check Out the Broker

Deposit brokers do not have to go through any licensing or certification procedures, and no state or federal agency licenses, examines or approves them. Since anyone can claim to be a deposit broker, you should always check whether your broker or the company he or she works for has a history of complaints or fraud. You can do this by calling your state securities regulator or by checking with the National Association of Securities Dealers' Central Registration Depository at (800) 289-9999.

{bold} Confirm the Interest Rate You'll Receive and How You'll Be Paid

You should receive a disclosure document that tells you the interest rate on your CD and whether the rate is fixed or variable. Be sure to ask how often the bank pays interest — for example, monthly or semi-annually. And confirm how you'll be paid — for example, by check or by an electronic transfer of funds.

{bold} Ask Whether the Interest Rate Ever Changes

If you're considering investing in a variable-rate CD, make sure you understand when and how the rate can change. Some variable-rate CDs feature a "multi-step" or "bonus rate" structure in which interest rates increase or decrease over time according to a pre-set schedule. Other variable-rate CDs pay interest rates that track the performance of a specified market index, such as the S&P 500 or the Dow Jones Industrial Averag

{bold} The Bottom Line

The bottom-line question you should always ask yourself is: Does this investment make sense for me? A high-yield, long-term CD with a maturity date of 15 to 20 years may make sense for many younger investors who want to diversify their financial holdings. But it might not make sense for elderly investors.

Don't be embarrassed if you invested in a long-term, brokered CD in the mistaken belief that it was a shorter-term instrument. You are not alone. Instead, you should complain promptly to the broker who sold you the CD. By complaining early you may improve your chances of getting your money back.

Here are the steps you should take: Talk to the broker who sold you the CD, and explain the problem fully, especially if you misunderstood any of the CD's terms. Tell your broker how you want the problem resolved.

If your broker can't resolve your problem, then talk to his or her branch manager. If that doesn't work, then write a letter to the compliance department at the firm's main office. The branch manager should be able to provide you with contact information for that department. Explain your problem clearly, and tell the firm how you want it resolved. Ask the compliance office to respond to you in writing within 30 days.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at milt.zall@verizon.net.

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