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A certificate of deposit allows investors to put their money into a financial vehicle that offers a higher rate of return than some other investments. A CD with variable rates can be part of an investor's portfolio, but it comes with risks that a fixed-rate CD does not have.
Definition
When a CD's interest rate changes at predetermined intervals, it is a variable-rate CD. The changes could be pegged to a specific formula, a key interest rate or a stock market index.
Rates
Some financial institutions schedule variable-rate CDs to adjust at regular intervals, such as quarterly or weekly, and tie them to U.S. Treasury note rates. Other institutions use the action of a stock market index to set the rates. If the rates or index goes up, the CD rate goes up; if the rates or index drops, so does the interest paid on the CD.
Advantages
A CD with a variable-interest rate can make more money than a traditional CD in an up market.
Disadvantages
In a down market, a variable-interest rate CD may not generate as much income as a fixed-rate CD.
Considerations
Most financial institutions offer a guaranteed return for a variable-rate CD if it is held to maturity, so it will not be a net loss. However, there are usually significant monetary penalties for early withdrawal, so if the interest rate is falling, the money in the CD will not be available for other, more profitable investments.
Source:
FDIC: Certificates of Deposit: Tips for Savers
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