CDs look more attractive, less stodgy

If uncertainty over oil prices and the stock market has you looking for a safer alternative, it's time to reconsider certificates of deposit.

Until recently, CDs offered such low rates of return that they hardly seemed worth the bother. But as the Federal Reserve has pushed up short-term rates, yields on CDs are approaching levels not seen since 2001.

There's a catch: Long-term interest rates are not rising at the same pace. So analysts suggest that investors stick with CDs that mature in less than two years. A portfolio of these federally insured investments can be a safe harbor in uncertain times.

"There has been a substantial improvement in the yields of shorter maturity CDs," says Greg McBride, senior financial analyst with Bankrate.com, a research firm in North Palm Beach, Fla. For those who are deciding whether to invest in CDs or stocks, "it all depends on your horizon and what kind of risk you're willing to take."

The average six-month CD now pays about 2.7 percent, according to Bankrate.com. A deposit of $100,000 at that rate would increase to $101,359 after six months, generating an average $226.50 a month.

A five-year CD pays a little more - just over 4 percent. But if short-term interest rates continue to climb, as expected, then it usually doesn't make sense to tie up money for long periods of time, analysts say.

This difference between short- and long-term rates - called the yield curve - is also a key indicator for the economy. Normally, it slopes upward from short-term to long-term rates. After all, the longer you allow a bank to hold your money, the higher the interest rate you expect to receive.

But with the curve nearly flat right now and the Federal Reserve poised to boost short-term rates even more this week, one of two things has to happen. Either long-term rates go up, too, or the yield curve becomes inverted.

If it does become inverted, then inflation is almost inevitable, says James Barth, senior fellow at the Milken Institute, a nonprofit economic think tank in Santa Monica, Calif. "That's what we saw during the savings-and-loan crisis two decades ago. It was devastating."

So it's probably a safer bet to invest in short-term CDs should the yield curve continue to flatten. That way if long-term rates suddenly jump, then you won't be stuck with a low interest rate for years on end, Mr. McBride says.

"Laddering'' is another technique used to reduce risk when investing in CDs. The strategy is designed to smooth out the peaks and valleys of interest rates by investing in CDs with different maturities. "But if you're thinking about setting up a ladder right now, investors should focus on shorter rungs," says McBride.

Of course, the inability to pull money out of a CD before it matures raises other concerns. Depending on an investor's financial situation, it might make more sense to simply invest in a money-market account, says Deborah Lucas, professor of finance at Northwestern University's Kellogg School of Management. "Money-market accounts are low-risk, and fully liquid, so you don't get penalized for cashing out.''

Some money-market accounts require minimum balances, and check-writing isn't always an option. But the rates are often comparable to CD rates, with nearly two dozen money-market accounts ranging between 2.76 percent and 3.44 percent, according to Bankrate.com.

Other products gaining popularity with rising short-term interest rates are bump-rate CDs, says Ray Montague, manager of deposit products at Informa Research Services in Calabasas, Calif. A bump rate allows the investor to "bump" a CD to a higher rate should interest rates rise. But Mr. Montague warns it's only a one-time option.

Another relatively safe investment are savings accounts offered online through companies like ING Direct. The investment company is offering an account with a 3 percent annual yield, no fees, and no required minimum balances. The rub: There is no brick and mortar bank, and investors must be comfortable banking online, Montague says.

If Internet banking doesn't bother you, EmigrantDirect.com also offers a savings account with an annual percentage yield of 3.25 percent. "What's good about these products is that they are totally liquid," says Montague of the federally insured accounts. "The true challenge for the consumer right now will be finding the best rates out there."

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