Why Invest in a Variable-Rate CD?
A variable interest rate CD is different from the fixed rate CD in that it is tied into the movement of current interest rates – whether up or down – while the fixed CD interest rate remains the same throughout the duration of the term. So with a fixed rate CD you know what you’ll make over the term of the CD, while with a variable rate CD you won’t.
The strength of a fixed CD is its safety and predictability, while its weakness is if interest rates go up, you don’t get to participate in the better situation; thus the reason for the creation of a variable-rate CD by financial institutions to address that situation.
With a variable-rate CD, if interest rates rise, your interest rate on the CD will rise with it, and if it falls, your interest rate on the CD will fall as well, giving some downside risk. For example, if you have a fixed rate CD and interest rates fall, you will still be able to collect the higher interest rate from the CD.
What this means is we must be aware of the interest rate environment we are currently in to determine the best type of CD to buy. In our current interest rate environment the U.S. government is holding interest rates down in an attempt to stimulate exports and hopefully stimulate the creation of more jobs, or at minimum, keep them from falling even further in the manufacturing sector.
Consequently, the current low interest rates mean that have nowhere to go but up, yet there’s a lot of questions as to the political will to allow that to happen. The thing that must be considered at this time then is when interest rates will be allowed to go up; that ‘s what determines your decision on the type of CD to buy.
If you believer after looking over the overall situation that interest rates will be raised by the Federal Reserve sometime soon, a variable rate CD could be a great way to invest for your safe money. You would probably get similar rates to a fixed CD, yet with upside potential. All of this depends on what bank or financial institution you do business with or buy the CD from, so all that has to be included in your decision-making process and where the interest rates will stand when the variable-rate CD is bought.
In a rising interest rate environment, when comparing a variable-rate CD versus a fixed rate CD, the variable-rate CD will do better.
Finally, check with the institution you plan on buying a variable-rate CD from as to how the interest rates are determined or measured. Banks tie the interest rates of the CD into different instruments, so you want to know what they are. Some, for instance, may track an interest index, while others may tie the interest rates to a U.S. Treasury Note. Either way, you should ask what is the determining factor in the movement of interest rates as it relates to your variable-rate CD.
Tags: cds, certificate of deposit, certificate of deposits, money management, short term savings, variable rate CD
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