Oct. 8, 2008 -- As stocks continued to take a dive this week, many Americans looked for a different, safer spot to keep their money.
One option is a CD, or certificate of deposit. But before investing in a CD, there are a few questions that need to be answered to make sure your money is safe.
What Is a CD?
A certificate of deposit is a solid and safe investment for your short-term investments today. I put these in the category of investing so you can sleep at night.
As a refresher, a CD is basically a low-risk investment vehicle that you can purchase with a fixed sum of money.
Typically, your money is locked up for a period of time -- between three months and 15 years -- and either intermittently or at the CD's maturity, you receive interest payments.
The interest rate is usually more than what you would receive from a traditional savings account. You can purchase a CD from a bank or a brokerage firm.
Are CDs the Best Place for My Money Right Now?
Since the president signed last week's $700 billion bailout bill, your CD is now insured up to $250,000 as long as it is held by a bank or thrift, which is part of the FDIC network, or a network of almost 8,500 institutions. Since the Federal Deposit Insurance Corp., was established 75 years ago, no consumer has ever lost a penny of their deposit at an FDIC-insured institution.
As to whether they are the best investment right now, they are a good choice for the short term, but in no way should be a substitute for the stock market.
Despite the market's recent volatility, the stock market remains the superior place to invest for the long term. Since the darkest days of the market on Black Monday, the market has averaged an annual return of about 8.8 percent -- far and away better than the average CD return.
So, my advice is to buy a CD for your short term or emergency savings money, and stick to the stock market for your retirement savings.
What Different Kinds of CDs Are There?
CDs are not one-size-fits-all.
The terms and conditions of the CDs are as varied as the institutions that offer them -- as are the minimum deposit requirements.
My recommendation is to focus on the following:
When does the CD mature?
Is the CD callable -- meaning the bank has the right to close out the CD before it is due and the penalties for early withdrawal?
What are the penalties for early withdrawal?
If you purchase your CD from a broker and not a bank or thrift, where will your money be deposited? Remember, your money is only insured if it is deposited at an FDIC institution.
Finally, for individuals who have a CD at Washington Mutual or Wachovia, you want to pay close attention to make sure the acquiring bank -- JPMorgan Chase, Citi or Wells Fargo -- sticks to the original terms of your investment.
Some brokerages advertise CDs that allow you to take out your money before the CD matures. The way it works is if the broker is able to resell the CD to another customer, you are able to redeem your investment. However, this is dependent on the direction of interest rates. If rates are going down, the broker may have luck selling your CD to someone, but if rates are higher than what your CD offers, they are not going to find a willing buyer.
How Do I Find Best Rate?
You absolutely should shop around for CDs at both traditional banks as well as Web-based institutions.
My favorite search tool is through bankrate.com. You can search rates from institutions across the country.
My advice: Stick to a bank or savings or loan, which is one of the 8,500 insured by the FDIC. If you are averse to buying a CD on the Web, let your fingers do the walking and call the banks in your area to find out who has the best deal.
Do not be afraid to negotiate and ask a bank to match the rate you find at another institution.
When Should I Be Weary of a CD Deal That Sounds Too Good?
Unfortunately, juiced returns on a CD are sometimes indicative of trouble brewing beneath the surface of the financial institution.
For example, just before the collapse of IndyMac, the bank offered CDs with much higher yields then their competitors.
Currently, the average yield on a one-year CD is around 3.6 percent. There is no one-size-fits-all rule on CD rates, but it is safe to assume if you find a one-year CD with a rate greater than 5 percent, you should walk away from it.
Mellody Hobson, president of Ariel Investments in Chicago, is "Good Morning America's" personal finance expert. Click here to visit her Web site, www.arielinvestments.com. Matthew Yale contributed to this report.