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We used
to say savings accounts were suitable as a learning
tool to teach children about banks and saving, but
grownups were too big for this ride. However, linked
savings accounts are a different story.
Linked Savings Accounts
are linked to a personal checking account, and money
to or from the saving account is electronically
transferred at customer request. These often pay
much high interest than old style account.
Money Market Accounts - Passbook Replacement
A bank money market account protects principal, is
very liquid, and earns taxable interest.
Money market accounts may often be opened for as
little as $100 (although some banks require $500 or
$1000). Yields are typically higher than those paid
on bank savings accounts and lower than rates
realized on certificates of deposit, but at times,
money market rates have been higher than short-term
CD rates.
They
are extremely
liquid; you can make up to six withdrawals and write
up to three checks a months (a penalty is usually
charged when you write too many checks). Bank
money market accounts are FDIC insured and subject
to their limits.
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This discussion is limited to bank money
market accounts. Mutual funds also offer
money market accounts called money market
funds and they have an excellent record of
safety, but this site does not discuss the
merits of securities, which would include
mutual fund money markets.
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Mom, Apple Pie and Certificates of Deposit
A CD is a bank savings instrument
with a specified maturity. Maturities can
be for any term length, but most range from
three months to five years. Interest may be credited
daily, weekly, monthly, quarterly or yearly, and
compounds and accrues until the CD is cashed in or
matures.
Over the last twenty
years the average interest paid on certificates of
deposit has ranged from around 1% to almost 18%, and
these yields may swing violently between one period
and the next. As an example, CD rates dropped 69%
from the fall of 2000 to the fall of 2001. CD rate
increases tend to be slower - a typical 1-year CD
yielded 1% at the end of 2003 and didn't reach 4%
until the end of 2006.
Certificate of deposit yields are
usually higher than money market accounts and, based
on our research, yields earned on 5-year CDs might
well exceed average rates earned on Series EE
Savings Bonds. Interest is fully taxable, even when
money is compounding inside the CD. Over the past
thirty years, taking into account the rate of
inflation and assuming the effects of a top marginal
income tax rate, real CD returns after taxes and
inflation have been negative half of the time.
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The
typical CD penalty for early withdrawal is usually
six month’s interest, but could be one year's
interest if the CD term is two years or longer; the
penalty for maturities of less than a year is often
only the loss of one month’s interest. Certificates
of deposit are
FDIC insured and subject to FDIC limits.
You
can buy CDs where the interest rate paid may
increase or decrease over time based on a set
schedule, or where the interest you earned is linked
to the performance of an equity index, or even where
it is denominated in a foreign currency.
Your
CD may be “callable”
whereby the bank can pay you off prior to maturity
at their whim (usually when new CD rates are lower
than your current rate). However, “callable” is a
one way street, a depositor cannot “call” the bank
(if rates go up) and tell them to send you your
money without penalty.
You
can redeem a traditional CD by going to the bank,
surrendering the CD and paying the penalty, but some
of these newer CDs cannot be cashed in before the
end of the term. It is possible you may be able to
sell the CD – like you would a stock – but as with a
stock the price may be more or less than you
originally paid.
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And
you may not hear what you thought you heard. If
someone told you about a “penalty free, five year
non-callable CD” you might think you heard about a
CD with a five year maturity having no penalties for
early withdrawal. However, the reality could be a CD
that does not mature for 10 years, but that the bank
cannot take it away for at least 5 five years, and
the reason there are no penalties for early
withdrawal is because the CD cannot be withdrawn
until the end of the term.
Market-Linked, Indexed, Structured CDs
Although they use different names they all refer to
a certificate of deposit where the interest earned
is based on the movement of an external index, that
could be the S&P 500 or foreign currencies or
inflation or almost anything else. These CDs are
typically FDIC insured and may even guarantee a
minimum return or place a cap on the amount of
interest you can own. The ones I have seen usually
do not lock in the interest until the end of the 3-5
year term, so if the index was up for 4 years and
then plunged in the last year you could wind up
earning zero interest (this is different from almost
all of the
index annuities on the market because they
usually credit any index-linked interest earned
annually, but there are a few index annuities that
do not lock in interest annually and wait until the
end of the term). However, even in the worst case
the CD still gives you your principal back at the
end of the term.
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Brokered and Callable CDs
Another type of CD is a “brokered” CD. These
CDs may pay higher interest than the local
bank and they are covered by FDIC insurance
limits, but with some if you surrender
before maturity you may get the “market
value” of the CD, which could be more or
less than you initially paid. In addition,
some CDs are "callable" – meaning the bank
can stop paying interest and send you back
your money at their discretion – and this
usually happens when current rates have
dropped lower than what your callable CD is
paying. Depending upon how they are offered
a "brokered" CD could be viewed as a
security and is not discussed on this site.
If it is a “brokered” CD
you also need to know the bank behind it.
The reason is if you are already maxed out
on FDIC coverage at one bank, and the same
bank issues the brokered CD, you might find
part of your money would not be FDIC
insured. And as long as we are talking about
“brokered”, since CD brokers may not have a
license or be state registered, check them
out very carefully.
The SEC has CD tips
available on their web site at
http://www.sec.gov/investor/pubs/certific.htm
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Who is in Charge?
If you would like to learn more
about the regulatory world surrounding your bank
visit the following web sites:
Federal Reserve Board
http://www.federalreserve.gov/
FDIC
www.fdic.gov
OCC (National Banks)
http://www.occ.treas.gov/index.htm
OTS (savings Banks)
http://www.ots.treas.gov/
Credit Unions
Although they might object to be included
in the bank section, credit unions offer the same
safe money places as banks and the covered account
values are also federally insured. Credit Unions are
owned by their members - the people in the community
that use their services. They are non-profit
entities (a tax status that banks do not have) with
a history dating back almost a hundred years.
The National Credit Union
Association (NCUA)
charters and supervises
federal chartered credit unions, and savers in all
federal and most state chartered credit unions are
insured by National Credit Union Share Insurance
Fund (NCUSIF), a federal fund backed by the full
faith and credit of the United States government.
Credit Unions are a safe money place.
If you would like to learn more
about credit unions visit the following web sites:
America's Credit Unions
http://www.creditunion.coop
Credit Union National Association
http://www.cuna.org
National Credit Union Administration
http://www.ncua.gov/
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