Individual Certificate of Deposit or CD Fund?

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

It is important to understand how this works. Depending on the 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.

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.

If CD rates go up, OK. But if they 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 bonds, however, you can invest more in bonds to take advantage of the opportunity. If rates go down the rates you are earning on all your bonds in a bond fund goes down and there is nothing you can do about it.

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, she pointed out that the costs of CD funds inherent in the profit making requirements of the fund managers are another mark against bond funds.

Suze is wary, to say the least, about these funds. She sees CD funds as one of the areas where people often lose a lot of their potential gain unnecessarily to financial institutions due to the fees involved. I agree wholeheartedly with Suze on this point.

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 bonds earning five time the current rate, bonds I bought several years ago when rates were high.

Of course, as with most other financial truisms special circumstances may prevail—although, to tell the truth I can’t think of one in this case. As always, the critical thing is to understand what you are doing.