CD or a CD mutual fund?

There are times when a CD can be a good choice for investing. But there is a big difference between investing in CD’s (certificates of deposit) directly and investing in CD mutual funds.

Individual CD and CD Fund Differences

It is important to understand how CD’s and CD funds work. Depending on circumstances one choice can produce results that are dramatically different than the other.

When you purchase a CD directly you have a guaranteed rate of interest for a set period of time. You may be offered several choices based on the length of time you are willing to commit to the investment. A CD mutual fund contains a variety of CD’s, each with different rates and time lengths, changing daily.

With individual CD’s time periods vary from as little as a few months to many years. And there are significant penalties for early withdrawal.

A CD fund on the other hand buys and sells CD’s every day based on whoever chooses to put money into the fund and whoever takes whatever amount out. You have the flexibility of buying and selling but you are at the mercy of the fund fluctuating with the market.

Is a CD Better or a CD Fund?

If CD’s in a mutual fund have rates go up, OK. But if interest rates go down—perhaps way down—the fund is buying at that low rate and the average earnings of the fund overall can go way down. Of course the reverse is true as well.

If rates go up on individual CD’s, you can invest in more of them to take advantage of the opportunity but previous rates remain the same. If rates go down the rates you are earning on all your CD's in a CD mutual fund goes down and there is nothing you can do about it, while with individual rates you would keep your higher rate.

Recently I witnessed a discussion of this topic by the “fabulous” Suze Orman that was quite spirited. In addition to the issue raised by the nature of the CD/CD fund difference (which she saw as an overall negative for the mutual fund), she pointed out that the costs of CD funds inherent in the profit making requirements of the fund managers are another mark against cd mutual funds.

Suze is wary, to say the least, about CD mutual funds. In addition, she sees CD funds as another area where people often lose a lot of their potential gain unnecessarily to financial institutions due to the fees involved. I agree with her.

In general, if interest rates are good, individual CD’s can be a good investment; CD funds are probably not so much so. Currently, as I write, I have individual CD's earning five time the current rate, CD’s I bought several years ago when rates were high. If I had invested the same money in a CD fund the income would have deteriorated severely.

Of course, as with most other financial truisms special circumstances may prevail—although, to tell the truth there are not many times I would look at a CD fund. As always, the critical thing is to understand what you are doing.

Should You Buy CD's or Funds?

Think carefully before buying either CD’s (certificates of deposit) or CD mutual funds. Either are specialty items in some ways for specific needs. Certificates of deposit and CD funds are not interchangeable. Do not compare them so much as choose them separately for different needs.