Making the call on CD types

These are sad times indeed for nervous, yield-hungry fixed-income investors.
If you want the ultimate in safety, the answer is federally insured bank savings that guarantee you'll get your principal back.
But the interest rate ... ugh! One-year certificates of deposit are paying an average of 2.04 percent, according to rate-tracking company Bankrate.com. You could have worked a lifetime to amass an impressive $500,000 nest egg -- and now earn just $10,000 a year on it.
Of course, safety is worth a lot these days. But still ... 2 percent! Aren't there any alternatives?
The other day I spotted an ad for a three-year callable CD paying 3.10 percent, with a minimum deposit of $10,000.
Doesn't sound like a lot, but it is 50 percent more than the average one-year CD. It's also better than the 2.79 average Bankrate reports for ordinary three-year CDs.
So are these more generous callable CDs a good deal?
Lots of investors may be attracted by the rate, but it's important to focus on the term callable.
What it means
In this case, that means the 3.10 percent rate is guaranteed only for the first year of the three-year term. At that point, the bank reserves the right to set a new rate. If it does, the customer can stick with the CD at the new rate or withdraw principal and accrued interest without penalty.
At first blush, it looks like a no-lose deal: If prevailing rates go up, the CD, you might think, will have to pay more, else you'll shift your money to someone else's CD.
But, no. In fact, it's a one-sided deal. The ad doesn't say anything that isn't true; it just doesn't spell out the whole story.
If the bank does not "call" the CD -- if it, in other words, leaves the rate at 3.10 percent -- you cannot withdraw your money without paying a penalty. Like with most CDs, the penalty for early withdrawal is a sacrifice of six months' interest. (Withdraw before the first six months are up, so that the penalty is bigger than the interest already earned, and the rest of the penalty will be taken from your principal.)
With an arrangement like this, the bank has you locked in at the 3.10 percent rate for three years. Hence, it has no reason to pay more, even if prevailing rates are higher 12 months after you invest.
With an ordinary CD, both parties are locked in. But in this case, the bank can bail out early if that's in its best interest -- you can't.
Another comparison
It's hard to make a case for this callable CD. You might argue that it should be compared to one-year CDs because the 3.10 percent rate is guaranteed for only that long. It certainly is better than the 2 percent offerings on most one-year deals.
But because the bank can lock you in at 3.10 percent for three years, it pays to look at what other three-year CDs are paying. As I said, Bankrate reports that the average three-year CD yields 2.79 percent. But the best deals listed at Bankrate pay as much as 3.5 percent -- and these were not callable CDs.
So here's how it boils down: If you think interest rates will be higher 12 months from now, don't get the callable CD because you'll probably be locked into the 3.1 percent rate. Look for a one-year CD -- the most generous are paying about 2.75 percent, according to Bankrate. You wouldn't be giving up much to preserve the right to jump to a higher-yielding CD a year from now.
If you think interest rates will be lower 12 months from now, you still should not get the callable CD. The bank is likely to reduce the rate. And even though you'd then have the right to get your money out without penalty, it will be too late to find another CD paying the rates available today.
Remember, if you're shopping for a CD, there's no need to limit yourself to a local bank. To search for good deals, try the Bankrate site at www.bankrate.com.
XJeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at jeff.brown@phillynews.com.