What is a Certificate of Deposit (CD)?
Sold by banks, certificates of deposit (better known as CDs) are low-risk –- and relatively low-return — investments suitable for cash you don’t need for months or years. If you leave the money alone during the investment period (known as the “term” or “duration”), the bank will pay you an interest rate slightly higher than what you would have earned in a money market or checking account. All gains from CDs are taxable as income, unless they are in a tax-deferred (IRA) or tax-free (Roth IRA) account.
CDs are among the safest investment a persona can make. The interest rate is determined ahead of time, and you’re guaranteed to get back what you put in, plus interest once the CD matures. What’s more, if the bank goes belly up, your deposit is probably insured by the FDIC for up to $250,000.
Here are the most common types of CDs:
• Traditional CD: You receive a fixed interest rate over a specific period of time. When that term ends, you can withdraw your money or roll it into another CD. Withdrawing before maturity can result in a hefty penalty.
• Bump-Up CD: This kind of account allows you to swap your CD’s interest rate for a higher one if rates on new CDs of similar duration rise during your investment period. Most institutions that offer this type of CD let you bump up once during the term of your CD and keep the interest rate for the remainder of the original CDs term.
• Liquid CD — This kind of account allows you to withdraw part of your deposit without paying a penalty. The interest rate on this CD usually is a little lower than others, but the rate is still higher than the rate in a money market account.
• Zero-coupon CD — This kind of CD does not pay out annual interest, and instead re-invests the payments so you earn interest on a higher total deposit. The interest rate offered is slightly higher than other CDs, but you’ll owe taxes on the re-invested interest.
• Callable CD — A bank that issues this kind of CD can recall it after a set period, returning your deposit plus any interest owed. Banks do this when interest rates fall significantly below the rate initially offered. To make this type of CD attractive, banks typically pay a higher interest rate. These accounts are typically offered through brokerages.
• Brokered CD — This term refers to any CD offered by a brokerage. Brokerages have access to thousands of banks’ CD offerings, including online banks. Brokered CDs will generally carry a higher rate of interest from online and smaller banks because they’re competing nationally for depositors’ dollars. However, you’ll pay a fee to purchase the account.
Note: This article was reprinted from the Wall Street Journal for educational purposes.
What is a Mutual Fund?
The following is an excerpt from “The Complete Money and Investing Guidebook” by Dave Kansas.
A mutual fund pools the assets of its investors and invests the money on behalf of those investors. The companies that issue these funds, such as Fidelity or Vanguard, manage the pool of money on the investors’ behalf.
The underlying logic of mutual funds is that they provide diverse investments — in stocks, bonds and cash — without requiring investors to make separate purchases and trades. An individual would need more than $100,000 to build a similarly diversified portfolio of individual shares and bonds, but a mutual fund investor can send $1,000 to a fund company and find herself holding an ownership stake in a number of companies. For instance, a Fidelity fund manager will take in millions of dollars and buy up stock in IBM or General Motors; each investor in the mutual fund is then, by extension, an investor in those companies.
The rise of mutual funds has given individual investors the chance to participate in the stock market in a way not previously possible. Even after the burst of the stock market bubble in 2000, more than half of U.S. the households owned stocks, mainly through mutual funds. At the end of 2004, nearly $8 trillion was held in more than 8,000 mutual funds that invest in stocks, bonds and other investments.
The largest segment of the fund industry focuses on stocks, and just under half of the assets held by the industry are stocks. Within that universe, investors have an eye-popping number of options: index funds, growth funds, sector funds and many more. Fidelity Investments, one of the biggest mutual fund companies in the world, has about forty-five different kinds of stock mutual funds focused on the United States alone. Fidelity gives investors mutual funds that focus on small stocks, mid-sized stocks, dividend-paying stocks, growth funds and value funds. If you’ve got an investment notion, chances are that Fidelity has a fund that would fit. And it’s not just Fidelity. Other big fund companies, such as Putnam Investments and Janus Investment Professionals, also offer a range of investing choices.
Many investors have become familiar with mutual funds via their 401(k) or other retirement programs. Most such programs provide employees with a menu of fund options the employee can choose among to build his or her investment plan. It’s always smart to check with a financial adviser or an in-house retirement adviser before deciding how to deploy your retirement savings. Factors such as your age, your anticipated date of retirement and the amount of corporate matching all play a role in mapping out the proper investment strategy.
Mutual funds have costs, not just in terms of investment risk, but also in terms of fees. Like any investment, these funds have operating costs. Fees are disclosed in a fund’s prospectus under the heading “Shareholder fees”. The SEC does not limit the fees that a mutual fund can charge, but although the SEC limits redemption fees to 2%. To read more about what kind of fees you can expect with mutual funds, check out the SEC’s guide.
If you’re looking to research or track specific mutual funds, Morningstar aggregates data and content on specific funds and publishes commentary on the mutual fund world.