Dumb CD question

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Browser
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Dumb CD question

Post by Browser »

I'm comparing directly purchased (from local credit union) CDs of 21, 34, and 60 months offering 2.0%, 2.25%, and 2.50% APY respectively. There is a 6-month interest penalty for early redemption on each. Is there any reason in the world not to purchase the one with the highest APY (60 months), since I could effectively cash out of any of these at any point after 6 months; for example, if yields went up substantially. For the same effective holding period, I would always have earned more interest on the 60-month than the others (minus the penalty), so wouldn't this be the best choice?

More broadly, if you are comparing CDs that all have the same redemption penalty, shouldn't you always buy the one with the highest APY regardless of maturity? Am I missing anything here? For example, if there were a 10-year CD with 3.0% APY and a 5-year with, say, 2.5% APY, and they both had the same penalty for early redemption, why wouldn't I always buy the 10-year - duh?
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in_reality
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Re: Dumb CD question

Post by in_reality »

Browser wrote:For example, if there were a 10-year CD with 3.0% APY and a 5-year with, say, 2.5% APY, and they both had the same penalty for early redemption, why wouldn't I always buy the 10-year - duh?
Where can you get a 10 year CD with an early redemption? The 10 yrs I have are all brokered which means no early redemption and only sale (for a likely loss) on the secondary market.

If there is a 10 yr CD available for 3% that has early redemption, please post where.
LongerPrimer
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Re: Dumb CD question

Post by LongerPrimer »

The extra interest on the 60 isn't big enough for me to do 3-21s. I'd rather do the 21 CD and catch rising rates. Woe to me if rates were to fall :annoyed
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jimb_fromATL
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Re: Dumb CD question

Post by jimb_fromATL »

You're on the right track. You can come out better with a longer CD even with the penalty. However, the longer term higher-paying CDs nowadays often have a bigger penalty, often in the range of 9 months to a year instead of just 6 months like in the past; so you need to calculate the actual net return after the penalty, not just look at the rate alone.

HERE is an article about it on bankrate.com.

jimb
Call_Me_Op
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Re: Dumb CD question

Post by Call_Me_Op »

Interestingly, my credit union offers a 5 year CD with no early withdrawal penalty.
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targ
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Re: Dumb CD question

Post by targ »

It depends on how sure you are that you won't need to withdraw early. For example, if you put $1000 each in to the 21 month @ 2% and 60 month @ 5% CDs but then need the money at the 21 month mark.....

$1000 for 21 months at 2% APY = $1035.26

$1000 for 60 months at 2.5% APY but withdrawn at 21 months and subject to a 6 month interest penalty is equivalent to $1000 for 15 months at 2.5% APY = $1031.35

So, as with most things, the answer to your question is "it depends."
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G-Money
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Re: Dumb CD question

Post by G-Money »

If your holding period was 21 months, you'd come out ahead using the 21 month CD and not the 34 or 60 month. I use the spreadsheet at the bottom of this wiki page to run the math. http://www.bogleheads.org/wiki/Comparing_CDs
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G-Money
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Re: Dumb CD question

Post by G-Money »

Call_Me_Op wrote:Interestingly, my credit union offers a 5 year CD with no early withdrawal penalty.
That is interesting. Are you sure that CU allows early redemptions?
Don't assume I know what I'm talking about.
cherijoh
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Re: Dumb CD question

Post by cherijoh »

Browser wrote:I'm comparing directly purchased (from local credit union) CDs of 21, 34, and 60 months offering 2.0%, 2.25%, and 2.50% APY respectively. There is a 6-month interest penalty for early redemption on each. Is there any reason in the world not to purchase the one with the highest APY (60 months), since I could effectively cash out of any of these at any point after 6 months; for example, if yields went up substantially. For the same effective holding period, I would always have earned more interest on the 60-month than the others (minus the penalty), so wouldn't this be the best choice?

More broadly, if you are comparing CDs that all have the same redemption penalty, shouldn't you always buy the one with the highest APY regardless of maturity? Am I missing anything here? For example, if there were a 10-year CD with 3.0% APY and a 5-year with, say, 2.5% APY, and they both had the same penalty for early redemption, why wouldn't I always buy the 10-year - duh?
Here are three reasons:

1) Many people buy a CD to match the timing of a liability (e.g., a house down-payment or college tuition payment), so you would need to compare holding one CD to maturity vs. a longer-term CD with the penalty. Then the longest term one isn't always the winner.
2) They are setting up a CD ladder with staggered maturity, so they need to buy CDs with a range of maturities to start out. They replace the shorter ones with longer one as they mature to keep the ladder going.
3) They are betting on higher interest rates going forward and they don't want to lock up their money.
Call_Me_Op
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Re: Dumb CD question

Post by Call_Me_Op »

G-Money wrote:
Call_Me_Op wrote:Interestingly, my credit union offers a 5 year CD with no early withdrawal penalty.
That is interesting. Are you sure that CU allows early redemptions?
Yes, I called recently and specifically asked about their penalty for early redemptions. I was told "at this time, there is none." The rate they offer is 1.5% on 60 months, so not competitive with the best around.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
Topic Author
Browser
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Re: Dumb CD question

Post by Browser »

jimb_fromATL wrote:You're on the right track. You can come out better with a longer CD even with the penalty. However, the longer term higher-paying CDs nowadays often have a bigger penalty, often in the range of 9 months to a year instead of just 6 months like in the past; so you need to calculate the actual net return after the penalty, not just look at the rate alone.

HERE is an article about it on bankrate.com.

jimb
Thanks. The article describes exactly what I was thinking. Essentially, you would have earned more interest at the same redemption point with the higher yielding CD, even with the early redemption penalty (assuming the penalty isn't too large and is not different for the longer CD than the shorter CD - have to check the effective yield). Exactly what I was thinking about doing.
We don't know where we are, or where we're going -- but we're making good time.
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