Financial Planning: A Midyear Guide 1987 : part five: Building Wealth : Banks Tailoring CDs in Splashy Stripes to Suit Every Taste

The certificate of deposit, the boring old CD, the last refuge of widows and orphans, has suddenly become one of the hottest products in banking.

There are CDs with variable interest rates, CDs you can add to, CDs with adjustable maturities that allow you to buy a time deposit that comes due in seven years, five months and three days. In New Jersey, they’re offering something called the “bump-and-run” CD that lets you gamble on interest rates by picking a new rate based on current market rates at any one time during a two-year term of the certificate.

“CD pricing has become what adjustable-rate pricing is to mortgages. It’s gotten very confusing,” said Frank Diekmann, editor of Bank Advertising News, a Miami publication that monitors developments in bank products and marketing. “It used to be you slapped your money in and that was your rate for a year. Now, CD pricing is as confusing as getting a mortgage.”

The reason that banks and savings institutions are rushing to offer new wrinkles in CDs is simple: rising interest rates. A rule of thumb followed by most investors is to use time deposits to lock in high returns when interest rates are falling. CDs generally look like a poor bet when rates are rising, and money rushes into more market-sensitive instruments like money-market accounts and mutual funds.

In August, 1984, when CD rates last peaked, a depositor could tie up a five-year CD at nearly 12% and earn that month in and month out while rates steadily fell to a bottom of less than 6% last December. Conversely, an investor who bought that 6% CD in December must be looking with dismay at today’s rates, which are once again approaching 12% for a five-year note.

But with some of these newfangled accounts, CD buyers can protect themselves against rising rates, either by buying shorter maturities or finding an adjustable-rate CD such as the “rising-rate CD” offered by Meridian Bank in Reading, Pa., which adjusts the interest rate every three months. If rates dip, you get to keep your old rate.

This account and its many imitators put into practice the key rules of CD investing. Robert K. Heady, publisher of Bank Rate Monitor, which tracks bank deposit rates weekly, offers these tips:

Go short term when rates are rising.

Move your money into CDs with terms of six months or less when interest rates are moving upward so you are in position to take advantage of the new, higher rate when your certificate matures.

Go long term when rates peak.

This is a little trickier. But if you watch the rates on Treasury auctions or even the pace of changes in bank deposit rates tracked by your newspaper, you can get an idea when the rise in interest rates has slowed.

When the Federal Reserve acts, follow. The key rate to watch is the Fed discount rate, Heady counsels. When it drops, CD rates will fall faster and it’s time to bail out. But when it rises, be prepared to lock in the new rate in your CD.

That’s all good advice for the bank depositor who has the time and inclination to monitor the discount rate and the other arcana of financial markets. But the typical CD buyer is looking for absolute security and a predictable rate of return, according to financial planner T. Kevin Denny of Glendale.

“What’s unique about CDs is the safety of principal under federal insurance. That’s the primary consideration,” said Denny, who is also a certified public accountant. “They are almost risk-free. They are not subject to interest rate risk,

and the principal is protected. It’s a traditional investment for those who like to sleep at night.”

Denny advises all of his clients to put part of their investment portfolios into certificates.

Denny said that an investor, such as a retiree, with a substantial amount of cash available and no desire to speculate on stocks, real estate or other more volatile investments, should spread his CDs around, making sure he or she is always under the federal insurance limit of $100,000 per account.

The investor should also vary the maturities of his time deposits, keeping some money in short-term certificates and some in longer-term accounts, so that he can always take advantage of favorable rates. This is exactly how a bank manages its own funds to hedge against interest rate fluctuations, Denny noted.

Until recently, the CD buyer had few choices in the length of the certificate, usually having to choose between 30-day, 90-day, six-month, one-year, two-year and five-year notes. Today however, the options are virtually limitless.

First Interstate Bank of California, for example, just began offering CDs with terms ranging from seven days to 10 years--and anything in between. First Interstate will sell a 47-day certificate or a eight-year, nine-month note. However, the interest rate options are narrower. Any term between 30 and 90 days earns a single rate, while there is no higher rate for a nine-year note than a five-year note.

Different institutions require different minimum deposits for their CD accounts, although most demand at least $500 to buy a certificate. Some, like Great Western Savings and First Interstate, pay higher yields for larger amounts, with a cutoff at $10,000 in First Interstate’s case. The highest yields are available on so-called jumbo CDs, those with deposits of $25,000 or more.

“When a customer comes into the branch to purchase a CD, the primary question is ‘What are you purchasing it for?’ ” said Guy Molde, First Interstate’s senior product manager for all interest-sensitive accounts. “Most of the money in CDs has a purpose to it. Retirees use it for income to supplement other income. Some customers will invest in CDs targeted to next year’s vacation. Some individuals buy certificates for their kids’ education.”

With the new system, Molde said, customers can more precisely tailor their accounts to their specific purposes.

CDs have long been the chosen investment for the majority of individual retirement account holders at Great Western Savings, according to Mark Lipson, executive vice president and chief financial officer. Recently, however, because of falling interest rates, IRA investors have been diversifying into stocks, bonds and real estate limited partnerships, Lipson said.

He added that he expects CDs will regain much of their popularity as investors see the stock market peaking and turn back to the safety of the insured certificates.

“It’s guaranteed, it’s federally insured, it’s a predictable investment,” Lipson said. “Earlier this year, mutual funds and money-market accounts were tremendously popular. Now they’re coming down a bit. People are beginning to look at more than just the yield; they’re conscious of the total investment. They know that with these investments their principal value may be eroded over time. This is not the case, obviously, with a certificate.”