Simple Facts About Saving With Certificates of Deposit Accounts

A certificate of deposit, more generally referred to as a CD, is categorized as a time deposit. It is a promissory note provided by financial institutions in exchange for depositing funds during a specified term the course of which they cannot be accessed. CDs accrue interest during this term, generally at a higher rate than an average savings account, and are paid upon maturity. Money withdrawn from a CD before its maturity date usually incurs a penalty. The fixed terms offered vary from 3 months, 6 months, 12 months, up to 5 years.

Certificates of deposit are considered a relatively risk free investment as they are FDIC insured,

Currently the higher 1 year CD rates (one year CD rates) are averaging 1.55%, however these numbers vary based on different factors, including location and the amount of deposit. Generally these fluctuations have a bigger effect on CDs with longer maturity dates versus those that are considered short term, which tend to be less disposed to shifts in interest rates. CD interest rates are calculated based on the term of the CD and the current interest rate environment. The rate is usually higher the longer the term or the larger the sum deposited. However, once the CD is purchased and the money deposited, the return is not subject to stock market fluctuations, the earnings on the funds are guaranteed.

Withdrawals made before a CD reaches maturity generally incur a substantial penalty. For example, a five year CD might suffer a loss of 6 months worth of interest. The penalties are in place to ensure the investor keeps the funds in deposit until maturity. The penalties may or may not affect the principal deposit, if for example it is withdrawn after three months of opening with an established six month penalty. Sometimes withdrawal of the principal may require that the entire CD be closed.

Deposit brokers also offer certificates of deposit, often these brokerage firms can negotiate higher 1 year CD rates (one year CD rates) by promising to bring a certain amount of deposits to the financial institution it represents. These CDs are usually issued in large denominations and are then split up in to smaller values and resold to customers. For this reason, brokered CDs are often advertised as having no prepayment penalty associated. In the event an investor wishes to redeem the CD before maturity, the broker can attempt to resell the CD, at times even for a profit. These certificates of deposit are also insured by the FDIC however in the event the bank fails, brokered claims take a little longer to pay than the traditional direct deposit CD.

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Are Your Bank Deposits Safe? Financial Facts - What You Need to Know About Your Savings

If your bank deposits are covered by the Federal Deposit Insurance Corporation (FDIC), your money is safe up to $100,000 personally and $250,000 in eligible retirement plans. In fact, depending on how you have structured your accounts, coverage can significantly exceed $100,000 per bank. We have been negative on the outlook for U.S. Bank stocks since early last summer, but FDIC insurance has added a level of safety since its inception shortly after the Great Depression. Social Security and greater flexibility by the Federal Reserve to inject liquidity into the financial system are two other key safety measures helping to prevent another 1929-type collapse.

One of the biggest risks regarding this country's current financial malaise is more from a "crisis of confidence" in which worries about the banking system creates a run on certain banks, forcing otherwise solvent banks into insolvency.

This is one reason the Fed acted so swiftly when problems erupted with Bear Stearns in March, and more recently, took measures to instill confidence in both Fannie Mae and Freddie Mac with promises of financial backing. Only a year and a half ago, the number of troubled banks on the FDIC list were at record lows, as most banks were enjoying record earnings and soaring stock market valuations. Excess liquidity brought on by historically low interest rates coupled with relaxed, or non-existent, loan covenants created a massive bubble in real estate that has pushed a growing number of banks to the edge. This problem was many years in the making and with real estate representing approximately 60% of all bank assets, investors should not expect a dramatic turn around anytime soon. It is important to keep in mind that the plight of many bank stocks, with many down 70% or more over the past year, does not necessarily correlate with the safety of your deposits in these banks. As long as you make sure all of your bank accounts are FDIC insured you will be fine, and there is definitely no reason to panic. But what are the rules and stipulations of FDIC insurance?

FDIC insurance was started in 1933 after thousands of banks failed following the stock market crash of 1929. The deposit insurance coverage was initially set at $2,500 and steadily increased until it was raised to the current amount of $100,000 in 1980. The FDIC has the power to increase the insurance limits on all deposits every five years, based on inflation, but has demonstrated a very conservative stance by electing not to do so.

In April of 2006, the FDIC established $250,000 of insurance coverage for deposits that are held in IRA and select other retirement accounts. It should be noted that accounts not covered by FDIC include mutual funds, annuities, life insurance policies, stocks and bonds. In addition, an uninsured money market mutual fund should not be confused with an FDIC-insured money market deposit account.

After the first quarter of 2008, the FDIC released its list of 90 troubled banks, up from 53 in the first quarter of 2007 and 76 in the fourth quarter. Very few banks that make the list are destined for failure. Among all the troubled banks listed last year, only three actually failed. The recent collapse of IndyMac was a shocker to many, as the bank wasn't even on the FDIC's watch list. After its failure, it was reported that IndyMac received 100% of FDIC insured funds, and 50% of non-insured funds. Many times in the past, uninsured deposits have been partially insured, but there is no guarantee that trend will continue. For trust account holders, depositors have to wait to get their deposits until the beneficiaries of trusts can be verified.

It is important that you take the necessary steps to help navigate through this crisis:

1. Don't panic. Confirm that all of your assets in banks (savings accounts, checking accounts, money market deposit accounts and certificates of deposits) are insured up to the $100,000 per account and $250,000 per retirement account. For example, make sure if you have a joint account with over $100,000 that it is structured properly to receive up to $200,000 of coverage.

2. Establish a secondary banking relationship to have liquid assets (emergency money) available from two separate sources, should your bank become insolvent. This can also be helpful to compare yields and fees to make sure you're getting the most from your bank for every dollar of savings. Remember that insured deposits in trust accounts may not be immediately accessible and recovery of broker CDs may also experience delays.

3. If you have considerable assets, consider the Certificate of Deposit Account Registry Service (CDARS), a program designed to accept deposits of more than $100,000 and still receive FDIC coverage by spreading funds among many FDIC insured institutions. Your deposits can be insured for up to $50M with CDARS without having to set up accounts at multiple banks.

One final point - as with all banking relationships, yields are negotiable. The current credit crisis has created strong demand for loyal "credit worthy" clients so investors have never been in a better position to negotiate the best rates, and lowest fees, for each banking deposit or service.

Article presented by LanczGlobal.com

Alan B. Lancz is a nationally recognized authority on investing and financial analysis. He is the president of Alan B. Lancz & Associates, Inc. (http://www.ABLonline.com), a registered investment advisory firm and Director of Research at LanczGlobal.com (http://www.LanczGlobal.com).

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