Certificates of deposit are an important financial planning tool because they represent the safest investment you can make. You deposit funds, you get a guaranteed interest rate until the CD matures. You have to deal with inflation risk, that the rate of inflation could outpace your return, and the risk that you may need the funds. If you close a CD early, you will usually have to pay an interest penalty unless it’s a no penalty CD.

Personally, I don’t deposit funds into a long term certificate of deposit because I’m at an age where it doesn’t make sense from a financial planning perspective. We’re in our twenties so we’re thinking about things like starting a family and buying a home so a three-plus year CD wouldn’t make sense because our situation is changing so quickly. However, once it stabilizes, I see the value in saving money in longer term CDs as a way of planning for the future.

What I do use long term CD rates for is when I make investment decisions. CDs represent a 100% safe “investment” opportunity, so any potential investment is compared against a three or five year CD. If I can get a guaranteed 3% for a 5 year CD, why would I want to invest in something that has risk and only returns 3%?

Top Long-Term CD Rates

The following table lists the top CD rates for maturities of more than 24 months. In general, most will be 5 or 6 year CDs since the longer the maturity the higher the rate.

All of the banks on this list are FDIC insured up to $250,000.

We put our emergency fund into a CD ladder and every month one of those certificates of deposit matures and is automatically renewed. As an added bonus, ING Direct, where our CDs live, gives us a CD rollover bonus whenever we renew (currently the bonus is 0.15% on CDs of at least 12-months long). For us, the decision is simple. It’s a CD ladder and you simply renew the CD each month for the 12 month term.

What if you’re money isn’t in a CD because it’s part of a CD ladder, what should you do?

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One of the most annoying things in personal finance is opening a bank account and then seeing the interest rate drop. This happened very often in the falling interest rate environment of the last year and a half. I remember opening an online savings account only to see the rate fall the next day! It’s not bait and switch, it’s not sneaky, and banks don’t do it on purpose because nothing stops you from leaving. Interest rates aren’t guaranteed. It’s just how it is.

There is only one thing more annoying than falling interest rates, it’s rising interest rates after you’ve opened a new certificate of deposit! With CDs, if you close one before it matures, you will pay a penalty of three to six months’ interest. Again, it’s not bait and switch, it’s just the nature of fluctuating interest rates.

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Yesterday, ING Direct announced a clever new take on CDs – it’s the Added Value CD. The idea is very simple, you can get a 12 month CD with a rate of 2.25% if you open it and fund it with “new money” from a non ING Direct account. According to their terms and conditions, the new money must increase your total deposit balance as of yesterday, October 7th, 2009. Withdrawing money and then contributing it again will not work.

The 2.25% APY rate is a 0.15% premium on ING Direct’s current CD rates and it beats the best CD rates in that maturity range. With inflation at a scant 0.19%, getting 2.25% looks pretty good.

The Added Value CD [ING Direct]

When I read a Bank Deals’s article about a “triple option CD” from Southern State Bank in Arkansas, I was perplexed. I thought I knew what all the various certificate of deposit types were whenever I wrote that Certificate of Deposit Zoo post… but I was wrong.

What is a triple option CD? A triple option CD is a CD that combines the features of a bump up CD with a no-penalty CD. For those enjoying the zoo analogy, the triple option CD is a modern day Chimera. With a triple option you can usually:

1. Make another deposit into the CD,
2. Increase your rate once during the original CD’s term,
3. Withdraw part of the CD under certain circumstances.

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When Washington Mutual collapsed about a year ago, it was offering an eye-popping 5% interest rate on certificate of deposits when its competitors were offering half that. Everyone knew that WaMu was in trouble and we all ran into the open arms of the 5% CD because it was FDIC insured. Were we right in thinking the higher rate a good indicator of a bank’s weakness?

Perhaps.

But I can say, with a little data to back me up, that a bank on the verge of failure may not show it in its CD interest rates. Corus Bank, one of the banks that failed on Friday, was on my list of best CD rates. Since June, I’ve been populating that table with the help of a database on the back end. That also means that I have historical rate information, which will come in handy to see if we could’ve predicted a bank failure based on CD interest rates.

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Every week I get an email from Ally Bank informing me of how the rates will be changing (Ally Bank rates are adjusted on Fridays) and their rate structure has been confusing me as long as I’ve been getting these emails.

Ally Bank’s Savings & CD Rates

• As of August 28th 2009, their current online savings account interest rate is 1.75% APY.
• As of August 28th 2009, their current 9 month CD rate is 1.55% APY.
• As of August 28th 2009, their current 9 month no-penalty CD rate is 1.85% APY.

Rates are subject to change, here are the current Ally Bank CD rates.

Why Is This Weird?

Typically, your online savings account interest rate should be the lowest of the three. Next would be the 9 month no-penalty CD rate followed by the regular CD rate. You should get a lower interest rate on the account with the most flexibility. Since you withdraw money from a savings account at any time, you should be paid the least amount of interest in that account. Since you can withdraw your money from a no-penalty CD at any time without penalty, it should have a lower interest rate than a regular CD, where you would have to pay a penalty to access your funds.

Ally Bank has had this interest rate irregularity for a while now but recently it’s come back in line.

So What?

If you have money in Ally Bank’s online savings account, you should open a 9 month no-penalty CD immediately and transfer all your funds into that CD. Should the online savings account interest rate ever increase past the no-penalty CD, then you could liquidate the no-penalty CD without penalty. If you need the money, you can liquidate the no-penalty CD.

In fact, the best strategy would be to open up multiple no-penalty CDs so that if you do need the cash you don’t have to close out one big CD. Ally Bank does not have a minimum for CDs. For example, if you have $5,000 to save and you aren’t sure if you need the money. Open up five $1,000 no-penalty CDs. If you need $500, you can just close one of the CDs. If you opened up one single $5,000 CD, then you’d have to liquidate the whole to get access to just $500.

Am I missing something?

Every once and a while I get an email from a reader that asks where he or she should invest $1,000.

My answer? An online savings account or a certificate of deposit.

Unfortunately, $1,000 just simply isn’t enough for you to invest in the stock market. It’s certainly not enough for real estate and it’s usually not enough for investing in any asset class.

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How much money do you have sitting in a savings account? $500? $1,000?

Do you have plans for that money? If not, it should be in a certificate of deposit at your bank. If your bank doesn’t offer good CD rates, then you should open a CD with an online bank and take advantage of their better interest rates. If you don’t think you have enough money, you’re wrong. You can open a CD at an online bank with a single dollar.

One dollar.

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Ally Bank was the first online bank to offer a no-penalty certificate of deposit and now it appears that the idea is catching on. Discover Bank will announce tomorrow that they are making their 12 month CD a no-penalty CD, where you can withdraw your funds should you involuntarily lose your job. All new and renewing account holders will get this benefit (existing account holders won’t, I assume because neither party can change the terms before maturity).

What is a No-Penalty CD? If you read my Certificate of Deposit Zoo post last week, then you’ll know that no-penalty CDs are ones where you can withdraw your deposit before the CD’s maturity date without any interest penalty. Normally a CD will charge you 3-6 months worth of interest to close it early, no-penalty CDs let you close your account.

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