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The Honolulu Advertiser
Posted on: Thursday, July 20, 2006

For some, callable CDs worth risk

By Greg Wiles
Advertiser Columnist


Have a question about money matters? Akamai Money columnist Greg Wiles can try to answer it in The Advertiser. Reach him at gwiles @honoluluadvertiser.com or 525-8088.

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Q. Someone said I should look into getting a "callable CD" as an investment. What are they?

A. You'll want to study and consider your options on this one. Depending on your particular situation, a financial adviser may or may not recommend you get one.

You probably have heard of the family from which callable CDs originate certificates of deposit. They're the so-called time deposit accounts that banks and other financial institutions sell, dangling higher interest rates in front of customers if they agree to park their money with them for six months or more.

In recent years there's been an increase in the types of CDs that typically feature a different twist to traditional offerings. The additions include CDs with variable rates, zero-coupon, fixed-coupon and even those with variations that are coupled, such as step-rate callable CDs.

Locally, Finance Factors has offered callable CDs in the past and may offer them again in the future. The callables are also offered from some investment brokerages.

The allure of the callable is in the interest rates. They are typically higher than what you'd get on a plain vanilla CD. This may be attractive to people who think interest rates will remain steady or go higher over time, according to investment brokerage Smith Barney's Web site.

The callable aspect provides a potential downside, though. The bank or issuer may "call" or redeem the CD after a certain period of time, in which case you'll get back your principal plus the interest accrued to that point.

This most likely would happen if interest rates start heading south. As of yesterday, there were indications that the Federal Reserve may go into a holding pattern on interest rate increases while it studies whether 17 rate hikes in two years has collared inflation.

If interest rates were to start declining, banks and thrifts may start redeeming callable CDs. Instead of continuing to pay you the higher rate, they'd call the certificate and ask if you'd like to roll the money into a new CD with a lower rate.

In general, the issuer is willing to pay you a higher interest rate if you give them the leeway of redeeming it should rates fall. Your risk comes in possibly having to re-invest your money at a lower return.

Some steps that the U.S. Securities and Exchange Commission advises you take before you buy a CD include:

  • Investigating call features. Make sure you understand the difference between when the CD can be called and its maturity date. Some people get confused about this;

  • Asking about early withdrawal penalties;

  • Confirming the maturation date in writing;

  • If buying a variable-rate CD, check out when and how often the rate can change.

    You also should be aware that some people advise against tying your money up in CDs at this time. Alan Matsuda, a Ho-nolulu financial planner, said he suggests clients look at money market mutual funds instead. They allow you to withdraw money while paying a high interest rate, he said.

    "The better deal is money market mutual funds," Matsuda said. "I don't even look at CDs."

    His recommendations include Vanguard's Prime Money Market fund and another from TIAA-CREF. Vanguard's seven-day average yield net of expenses was 5 percent as of yesterday. TIAA-CREF's Money Market fund had a seven-day effective annual yield of 4.94 percent.

    Those compare with the 5.06 percent average yield for one-year CDs as calculated yesterday by Bankrate.com. CDs are covered by up to $100,000 of protection from the Federal Deposit Insurance Corporation; money market mutual funds aren't.

    Matsuda said there's very little danger money market mutual funds will ever have the financial problems that would require FDIC protection. Moreover, he said, the funds also are faster to increase interest rates than CD issuers.

    See Akamai Money spots on KHNL News 8 on Thursday mornings.

    Do you have a question about personal finance, taxes or other money matters? Reach Akamai Money columnist Greg Wiles at 525-8088 or gwiles@honoluluadvertiser.com