Understanding Callable CDs
8In our continuing coverage of CDs, this article we’ll talk about callable CDs, which as with all investments, offers pros and cons if you decide to invest in one.
The first thing to understand with a callable CD is it can be returned by a financial institution before the term ends, along with whatever interest has built up during that time. Along with that, there is included what is named a call-protection provision, which guarantees you will own the CD during that period at the interest rate offered. For example, if you acquired a 3-year CD, it may be callable after you hold it for six months. At that time the bank can end the deal and pay you the principle and interest for that period, without continuing on with the contract.
I want to interject here concerning the reason in talking about CDs in all the various ways you can invest in them; it’s so you can not only discover what’s available out there, but more importantly, to understand what each one has to offer and why. This helps you become a better investor, even if you decide to go outside the relative safety of CDs into another type of more risky investment.
With that in mind, what value would it be for someone to invest in a callable CD, and why would a bank or financial institution offer one? From the point of view of the bank or financial institution, it shifts the risk concerning interest rates away from the bank to the one buying the CD. Banks are managing their loan portfolio as it applies to interest rates of their deposits, the reason a callable CD is offered.
Why would we want to do something like that? It’s all about return on investment or interest rate yields; you get a higher interest rate for bearing the risk. This isn’t risk to your money invested, but risk as to returns.
During the period of time you own the CD, if interest rates fall, you then will have the bank “call” the CD if the call-protection period is over, causing to lose the higher interest rate you originally had.
How do you determine whether to invest in a callable CD or not? It’s all related to the interest rate environment and if your research shows it’ll fall, plateau, or go up.
The downside for the investor is if the callable CD is in fact called by the bank, it would force the investor to invest at lower interest rates, receiving less on their money.
Tags: banking, cds, certificate of deposit, certificate of deposits, financial management
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