CDs are not typically a major holding for the younger people of generation x, but with higher interest rates and many bank specials being offered this summer, I have seen a lot of people adding CDs to their portfolios. They can be a great short-term savings instrument, but if you aren’t careful or don’t understand the terms of your CD it may end up a costly mistake.
One of the most important times is when your CD matures and what happens to it. Typically the bank or institution where it is held will send you a letter shortly before maturity as a reminder. We are all busy and receive a ton of mail everyday so it can be easy to see how this reminder can be overlooked. This is bad news because a CD usually only has a short period of time at maturity for you to decide what to do. Some grace periods are as short as 5 days, others give you 10.
If you do not make a decision in this time frame and the CD rolls over, this is where it can become a costly mistake. For example, let’s say a 5-year CD matures and it just rolls over. You will then enter another 5-year term whether you like it or not. If that happened right now, it could be a problem because in many places a CD with even a 9-month term is paying the same APY as a 5-year CD. So you could be locking your money up for 5 years when you could have received the same rate with a 1-year or even shorter term.
The next potential problem comes with the CD specials that are often offered. Many banks will not automatically renew your CD for the special rate, even if a special rate still exists. In some cases, the special rate may be over 1% higher than the standard rate. Generally all you need to do is stop into your bank or give them a call once your CD matures and they can renegotiate the CD for the special. If you do not do this and just let the CD renew automatically, you could find yourself missing out on interest.
The bottom line is that when it comes time to renew your CD, even if you plan on keeping the money in the CD, make sure you review your options. You don’t want to find yourself stuck with an unnecessary term or miss out on interest. CDs can be a great savings tool, but make sure you keep up on them so you don’t cost yourself money by missed opportunities.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
That is exactly right. If we were in a decreasing rate environment, then locking up money for a longer term could be helpful, but like you said, guessing on rate movement outside of about 6 months is anyone's guess.
As an advisor that spent some time at a retail bank, I had many clients who were older, and simply let their CDs just roll forever, and have been doing it for years. Well, anyone who was doing this with long-term CDs in the past 5 years have been losing a lot of money.
Some of these people were holding 5 year CDs earning just barely 1% since about 2000. When you look at how much they missed out on over the past couple years in rates it is a shame.
Of course that is another topic for a later date I'll tackle, interest rate risk and how that can affect so-called "safe" investments.
Good point....normally, I WOULD like to keep my money
tied up for as short a time as possible, assuming equal
rates. However, if we are heading for a long period of
lower rates (no one knows for sure, of course) it would be
nice to have SOME money 'locked up' for a longer term.