- Certificates of deposit (CDs) are debt instruments that usually offer a fixed rate of return.
- CDs are issued by banks and savings and loans and are generally insured by the Federal Deposit Insurance Corporation, up to $100,000 per institution. This insurance covers the principal and accrued interest on the CD.
- Maturities range from 3 months to 7 years. Generally, CDs may not be withdrawn prior to maturity.
- Individual CDs start as low as $100, although they are generally sold in increments of $1,000, up to $100,000 maximum (including interest).
- CDs can be suitable for IRAs and Keogh plans, and can also be purchased by pension and other employee benefit plans.
Zero coupon CDs
Zero coupon CDs are purchased at a discount to their face value. They mature at par, eliminating concern over how to reinvest interest distributions.
- Interest income from zero coupon CDs is subject to taxation annually as ordinary income, even though the investor receives no income.
- The market value of zero coupon CDs fluctuates more than traditional CDs, and therefore may not be suitable for investors with liquidity needs.
Callable "step-up" CDs
These are CDs in which interest rates can increase over time on a predetermined schedule.
- After a noncallable period-typically one or two years-these CDs are callable by the issuer.
- In return for the high yields offered by CD "step-ups," you must accept the risk of your CD being called (redeemed) before maturity. This means you may have to reinvest principal at a lower interest rate.
- As with traditional CDs, if you sell your CD "step-ups" prior to maturity, you will also be subject to market risk. The market value of CDs fluctuates, so, if sold prior to maturity, your CD may be worth more or less than its original cost. Additionally, liquidity in the secondary market can be limited.
- If you invest in CD "step-ups," you should be prepared to hold the CD until it matures or is called.
