Traditional Certificates of Deposit (CDs) typically pay more interest than savings accounts at the same bank because you’re locking your deposit for a specified time period.
But did you know there’s a way to earn more interest than a traditional CD by adding a bit of risk and essentially speculating on the future direction of interest rates?
Callable CDs usually pay a premium in order to retain a “call date.” A “call date” stipulates when the bank can “call back” the CD. If that happens, the bank hands back your principal and any interest you’ve earned to date. That’s despite there being time remaining on the CD.
For example, let’s say you invest $10,000 into a two-year callable CD at a 5% annual interest rate. But the Fed starts cutting interest rates soon after. And six months into your deposit, with rates declining, your bank decides to call back the CD.
It hands you the original $10,000, plus the $250 you’ve earned in interest. And the final 18 months of the two-year CD vanish.
Are callable CDs worth the extra interest in exchange for a non-guaranteed term?
Should I Avoid Callable CDs?
I should ignore callable CDs despite the better interest rate they offer vs. traditional CDs, right?
That’s what a listener recently asked Clark.
Asked Kristin in Michigan: “You mentioned the benefits of laddering CDs on Schwab and how great the rates are. Do you include callable CDs in the ones you are purchasing?
“I find that if I put in ‘non-callable’ in my search the rates go down significantly. Should I not be avoiding callable CDs?”
Clark is a big fan of buying CDs through his favorite discount brokers Fidelity, Schwab and Vanguard.
You can often get better rates on CDs going through those investment companies than you can find directly from banks on your own. Plus, if you’re already a customer at one or more of those three, it’s convenient.
Still, callable CDs specifically come with reinvestment risk. You may earn less over the stated time period for the CD even though you accepted a higher rate.
If interest rates drop and the bank hands you money back, you may have to invest again at a much lower rate, offsetting the initial advantage.
“I hate callable CDs because it’s like, ‘We promise we’re going to pay you this interest for this period of time,'” Clark says. “And then, ‘Oh. We were just kidding! Interest rates turned. So now that you can’t get a good deal anymore, we’re not going to offer it to you.’
“Using brokerage-placed CDs is a very convenient way to do it. But if these Schwab rates don’t seem competitive when you put in non-callable as a choice, go look at other sources.”
Where Else To Look for CDs
If your particular brokerage only offers competitive rates via callable CDs, you’ll want to look elsewhere.
Go to the Clark standard of comparison shopping. Are the non-callable CDs at Schwab (or wherever you’re doing business) offering worse rates than you can get elsewhere?
If that seems like too much work, Bankrate keeps an updated list of the best rates for CDs of various lengths.
“One thing about Bankrate — they frontload [their list with banks that] must pay them money to be frontloaded. Almost like advertorial listings,” Clark says.
“You move past it to find the best rates on Bankrate. But that would be a way that you’d be able to compare if what Schwab’s offering non-callable is good or not compared to what the best are in the marketplace.”
Final Thoughts
Interest rates are great now, especially compared to recent history. But be careful trying to squeeze every percentage point of yield you can get out of your cash.
CDs are FDIC insured. And unless you withdraw before the stated time period, you won’t face any penalties. But callable CDs are a gamble that often isn’t worth taking.
The higher interest rate upfront can be a mirage. Depending on how much better it is and when the call date takes place, you may be positioning yourself to make less money in interest rather than more.
