Better Rates Heating Up CD Market
Some Banks Offering 4 Percent Interest

By Annys Shin
Washington Post Staff Writer
Sunday, November 16, 2008

It's hard to find an investment you can trust these days. Not blue chips. Those investors are looking pretty blue themselves. Steady money-market funds haven't been all that steady. And once high-flying hedge funds -- never for the faint of heart anyway -- are crashing to earth.

Now consider the humble certificate of deposit.

To jittery consumers, the CD suddenly looks like more than just a good place to park birthday checks from grandma. Banks are busy trying to one-up each other on rates to land customers. In advertisements on ATM screens around the Washington area lately, Citibank is offering 3.5 percent on a six-month CD. Online, GMAC, the finance arm of automaker GM, is advertising 3.9 percent for a six-month deposit. Not to be outdone, ING Direct is hawking its Orange CD at 4.25 percent. All three are far higher than the national average for a six-month CD of 2.13 percent, according to Bankrate.com.

Even the highest rates may not be eye-popping, but a 4 percent return over the next six months looks lucrative when you consider the battering that stocks are taking almost every day.

"It's a perfect marriage at a time when the stock market has been very volatile and the economy is weakening," said Greg McBride, senior analyst for Bankrate.com, which offers consumers information on financial rates.

CDs are deposits on which banks pay a fixed rate of interest for a fixed period of time starting at six months. They are federally insured up to $250,000. The financial crisis has created something of an anomaly in the CD market. Banks are pushing up CD rates even though the Federal Reserve has been cutting short-term interest rates. In normal times, CD rates rise and fall in tandem with short-term rates. But because banks are so desperate for deposits to bolster their finances -- and in the long run to loosen up credit -- they are willing to offer attractive rates, even if it means smaller profits.

The CD market started heating up about six months ago, said Nancy Davis, senior vice president and director of marketing for Acacia Federal Savings Bank, which has a branch in Falls Church where CDs have been a bedrock of its business for 23 years.

But the scramble for customers really started in recent weeks.

"There's a lot more competition for the CD business, particularly from the larger commercial banks such as Wachovia, who in the past didn't compete for the CD business," Davis said.

"Certainly the market is competitive," said Ferris Morrison, a spokeswoman for Wachovia, based in Charlotte, N.C. "We see [CDs] as one tool to drive additional customer acquisitions."

So far, Acacia is holding its own against the big guys. Since Oct. 6, it has been offering 4 percent interest on a 12-month CD with a minimum deposit of $500. As of Friday, the only banks offering CDs in the Washington area that came close to matching Acacia were Wachovia and Capital One -- with an offer of 4 percent on a minimum deposit of $1,000.

Because rate offers change, the most efficient way for consumers to shop around is online, where they can also get access to nationwide offers from banks that may not have branches in their area.

"There's a big difference between the average rates available and what you can find if you're willing to be a free agent and send your money to the highest bidder," McBride said.

His advice comes with one caveat: don't go overboard. CDs are no replacement for a diversified portfolio.

"Don't think this is a market timing solution," he said. "If you have a definite cash need at some point in the next couple of years, a CD is perfect. If you're looking to diversify your portfolio by including cash investments, CDs are perfect for that. But it's not a solution to someone who is nervous about market volatility."

Consumers still should invest in accordance with their goals and time horizon. If you're 50 years old, saving for retirement and nervous about volatility in the market, you may want to diversify and put some of your holdings in cash -- but not all, financial advisers say. You need to keep some money in stocks for long-term appreciation and to benefit from the eventual rebound from the current malaise.

CD buyers also should be careful about how long they lock up their money, said Herbert G. Hopwood III, president of Hopwood Financial Services in Great Falls.

If you put your money in a 10-year CD, inflation will likely eat away at your long-term return, but it is less likely to have an impact in just three or six months. So if you put all your money in short-term CDs out of inflationary fears, you run a risk when they expire that rates will have gone down and you've lost a chance to lock in at a higher rate.

"The Federal Reserve and Treasury have no concern about inflation," Hopwood said. "The dragon they're trying to slay is deflation. They're probably going to cut rates again."

Hopwood is a big advocate of laddering, a strategy in which you don't put all your money into one rate of return and or in CDs of the same duration. For example, you invest equal amounts in CDs with maturities of one, two, three, four and five years. When each comes due, you roll it into a five-year CD, keeping the maturities coming at regular intervals and providing a steady flow of interest income. Laddering also lets you maintain a degree of access to your money and helps protect it from both inflation and interest rate shifts.

"We laugh when we see people on CNBC say the market is going to be up, down, or sideways," Hopwood said. "With interest rates you don't know either. A lot of it is not in our control."