While a bump-up CD is as safe as any CD, there is an included benefit, which when used right, can be a great way to take advantage of interest rates when the interest rate environment is one that is rising.

The duration of a bump-up CD can change from financial institution to financial institution, along with the interest rates offered, so you obviously need to do your homework concerning that.

What a bump-up CD is is just what it sounds like. If you buy a CD that has the bump-up option, what that does is allow you to participate in increased interest rates by telling your financial institution you want the new and higher rate as they’re offered. It’s as simple as that. If the interest rates rise, you contact who you bought the CD from and tell them you want the higher rate. It’s obvious, but you must buy a bump-up CD to get this. You can’t just buy a CD and tell the bank to bump it up, it doesn’t work that way.

The reason why, is the original bump-up CD will carry a slightly lower market rate at the time you buy it. A bank or financial institution will gamble that the interest rates won’t go higher during the time you own the CD, while you’re gambling it will, by buying the slightly lower interest rate. So in essence, both the bank and you are offering one another a carrot and a stick to make the transaction.

If interest rates don’t go up during the time you own the CD, the bank wins because they got use of your money at a better rate than they did from others, thus making more profit. If the interest rates do go up, you win, assuming they go higher than the market rate offered for regular CDs, so the bank makes less profits on your money, while you make a better return.

As a bump-up CD will be insured like any other CD, the risk isn’t in losing your money, the risk is in possibly making a smaller return.

So the obvious time to buy a bump-up CD is when it’s close to certain interest rates will start to rise, so you can essentially lock in a higher interest rate by temporarily accepting a smaller one until the higher rates kick in.

The other thing to take into consideration is the length of time it will take an interest rate to rise. You want to buy a bump-up CD when you believe there will be significant hikes in the interest rates … and soon, as the longer it takes to rise, the less chance you’ll have of making up the difference in interest rates when you first bought them, as it would have to rise fast and high the closer it gets to the end of the ownership period.
 
The strategy would be to buy them as close to the expected interest rate hike as you can, as that would give a CD the chance to move up a couple of times during the time you own it, giving you a much higher interest rate than you would have if you had bought a conventional CD.

Be sure to check with the institution as to how many bump-ups you’re allowed, as at times they’ll limit it to two or less, so you want to be sure if the interest rates rise, that you get the bump.

Also remember that just because the interest rate rises, doesn’t mean the bump automatically kicks in or you have to trigger it. The couple of bumps allowed by most banks can be taken an any time while you own the CD, and so you must keep a careful eye on when the best time will be.

One other thing to watch for is some banks require you to extend the length of the CD when you bump it up.

Keep all these factors in mind when looking into a bump-up CD. They can be great personal finance tools to use to get a better return on your money. Just understand what the bank or financial institution you’re buying it from requires, and watch the Federal Reserve and any expected announcements as to interest rate increases.

Most the times the consensus from analysts is pretty much on the money as to when interest rates will rise, the only question usually how many basis points.

Tags: Bump-UP CD, cds, certificate of deposit, financial management, money, saving strategies, short term savings

This entry was posted on Saturday, October 3rd, 2009 at 7:00 am and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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