How to Invest Wisely into Bank CDs

Before providing info on how to invest into CDs, maybe some quick explanations of a CD would be helpful. Bank CDs (certificates of deposit) are basically a loan you are making to the bank. Sounds a little better than them making you a loan, doesn't it. The bank agrees to pay you a certain interest rate for the duration of the term. Usually, the longer the CD, the higher the rate. [Side Note: In most cases when short-term rates are higher than long-term rates, you might want to start taking the longer-term CDs. Rates will most likely be falling in 6-months]

Certificates of Deposit can be invested in for as little as 30-days or as long as 30-years. The most common term is probably 1-year. The longest most people go is 5-years. Unlike a savings account, the bank can't lower your rate on the CD. [Side Note: This is true unless a bank is closed by the FDIC or taken over by another bank to avoid closure.]

Certificates of Deposit are considered one of the safest investments. Currently they are insured up to $250,000 at each bank. This was a temporary increase over the previous limit of $100,000 that is set to expire after 12/31/09. What is nice about CDs is you know what your return is going to be. Where as when your funds are in the stock market, your return can go up or down drastically. Generally, given a long time frame, stocks and mutual funds will outperform CDs, but CDs should be a part of a wise portfolio to protect principal and provide some stable earnings.

Okay, now for some nitty-gritty. How do you invest wisely into CDs? First, goto your favorite search engine. The three most popular are Google, MSN, and Yahoo. I would enter some searches for phrases like "jumbo cd rates", "best cd rates", "ira cd rates",etc. Visit a few pages and see what they are offering. Some pages will have direct links, some may just provide bank names. Print out the top offers. Next, try search for a rate. At this point, a 4% APY would be an amazing rate. If you find one, print out the offer and leave me a comment below. LOL. Since most people prefer to bank locally, I would take those offers and see what your local bank can do. If they can't match it, you know where to go.

I know I've been talking a lot about banks. Don't forget credit unions. Credit unions often have higher rates because they aren't trying to return a profit to a smaller set of stockholders. At a credit union, everyone that has a deposit is an owner. Each owner has one vote and you elect your board. Okay, sorry for the rabbit trail.

So before you go making a deposit though, check out the bank or credit union. FDIC insured banks and NCUA insured credit unions have to publish financial data and it is all available for free on the Internet. For banks visit, www.fdic.gov and for credit unions visit www.ncua.gov.

First, you want to look at the size of the bank and/or credit union. If they aren't very big (less than $20 Million in assets) and they have been around for 10 or more years, they probably aren't trying to become a mega-bank or be gobbled up by one. Usually, the bigger they are and the faster they have grown gives an indication of what they are trying to become. My personal experience with mega-banks is their service tends to be quite lacking. Yes, an ATM on every corner may be convenient, but when something goes wrong you want to be able to talk to a real person.

Second, look at the capital (or equity) to asset ratio. 7% and above is good. 8% and above is even better. This is a ratio of how much liquidty they have to meet needs. If it isn't very high, the bank could have to start selling off hard assets (like all of those ATM machines.)

Third, are they profitable. If not, are they a new bank? New Banks often carry a loss for three years or so as they are getting established. If they have been around for awhile, look at their history. Were they profitable last year and the year before? Check out their loan losses. Are they rising or decreasing?

Finally, check out their total risk based capital ratio. 10% or better is considered welll capitalized. These factors will give you a good basic snap-shot of the bank.

Bankrate.com which is linked below has a star rating system. 3-stars or betters are for banks in average to excellent health. One thing to keep in mind is the FDIC data and rating systems are based on lagging data. For instance we are in the 1st quarter now, but 4th quarter data was just posted. Sadly, these days, the health of an institution can change quickly.  Also try TX CD Rates

The health of a bank or credit union is important for the long-term health of your certificate of deposit. If the bank fails, you will get your funds back, but at least in this environment, you will most likely be looking at reinvesting at lower rates. In a rising rate environment, you may welcome the bank failing if you had opened with lower than the best CD rates than the current market.

Good luck. May your bank stars shine upon you.