If you’re a savvy investor, you’re likely looking for ways to diversify your investment portfolio. Callable certificates of deposit (CD) are a way to invest your money for several years with a guaranteed interest rate in an FDIC-insured account. However, the issuer of your callable CD has the option of closing the account before it matures, stunting the earnings you planned on receiving for a set amount of years. Like every other investment, a callable CD has advantages and disadvantages that determine how well it will fit into your financial plan. Working with a financial advisor can give you the guidance you may need to choose the right portfolio diversification.
What Is a Callable Certificate of Deposit (CD)?
A callable certificate of deposit (CD) is an investment that pays more interest and presents more risk than a traditional CD. When you purchase a callable CD, the CD’s issuer (usually a bank or other financial institution) guarantees the investor a higher interest rate in exchange for the option to return the principal and interest to you or “call” the CD before it matures. The call option exists in case market interest rates decrease, allowing the bank to close the CD early and avoid paying investors as high an interest rate.
You can open a callable CD at a bank or credit union. Like other CDs, the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA) insure callable CDs for up to $250,000, protecting your money if the financial institution you invest with fails.
How a Callable CD Works
Callable CDs earn investors more interest than standard CDs but also have the chance of ending before their maturity date (anywhere from a couple of years to a few decades). The CD issuer can call a CD on its call dates, which usually occur every six months from the day the investor opens the CD.
Thus, every six months, the bank decides whether to return the principal and interest of your CD to you or allow it to stay for another six months and earn you more interest. If your CD’s issuer thinks it can offer CDs with lower interest rates, it will likely return your callable CD. After you receive your principal and earned interest, you can decide how to reinvest your money.
Callable CD Example
Let’s say you open a callable CD with a bank at a 5% interest rate. The CD will mature in three years, and the call date occurs every six months. As a result, you will not have access to your money for three years unless the bank calls the CD before that.
Six months pass and interest rates don’t change significantly, so the bank decides to continue holding your CD. After nine months, interest rates have fallen 2%, but the next call date is still three months away, so the bank has to wait to call your CD. At the twelve-month mark, interest rates remain lower, so the bank returns the principal and interest of your CD.
In this example, your callable CD earned you 5% interest for a year before the issuer closed the CD. The higher risk earned you more interest than a regular CD, but the account closed before reaching maturity, meaning you have to decide how to reinvest your money sooner than you may have expected.
Key Considerations for Callable CDs
Callable CDs contain call premiums, which benefit the investor. A call premium is an additional fee that the CD issuer pays you if they return your CD before it matures. The call premium is a percentage of the CD’s face value, and the bank will pay you this percentage as well as the interest your investment has earned thus far.
Your CD’s call premium decreases as it nears maturity. Therefore, a callable CD that the issuer closes after six months will pay a higher call premium than a CD that the issuer closes after two or three years. When you shop for callable CDs, ask about the call premium, as it adds to the revenue your CD will earn.
The callable feature makes for a slightly more volatile investment. Although your callable CD is insured, your possible future earnings aren’t, meaning that a five-year CD that your bank calls after one year will not sit for the remaining four years and earn you interest. Therefore, a returned CD might impact your ability to stick to your financial plan and hit financial goals. Consequently, if you open a callable CD, it’s a good idea to plan how to reinvest the money to give you a similar return in case the bank closes the account early.
Pros of a Callable CD
The biggest advantages of investing in a callable certificate of deposit are:
Cons of a Callable CD
The top cons of investing in a callable certificate of deposit are:
The Bottom Line
A callable CD might be ideal for your portfolio if you’re looking for an FDIC-insured investment with more earning potential. Although the bank could close the account early, this investment vehicle offers higher interest rates than regular CDs and a call premium to accommodate the higher risk. If you think that interest rates are not likely to drop in the foreseeable future, a callable CD could be a solid investment option.
Tips For Investing in Certificates of Deposit
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