What Risks Does a Variable CD Have?

A regular certificate of deposit (CD) is one of the conventional methods of safe investment, while you have other options like variable CD, callable CD, short-term CD, liquid CD, etc. Regular CD ensures a fixed rate of interest irrespective of the market fluctuations, whether the interest rates go up or come down. With a regular CD, you are quite sure of what yield you would be getting when the CD matures. However, the fixed rate CD has one disadvantage in that you get locked into that interest rate for the entire term of the CD. You benefit when interest rate drops but you do not gain when interest rate rises.

How Can Variable CD Help You?

Variable CD specifically addresses the disadvantage in fixed-rate CD. With a variable CD, the yield that you receive goes up when interest rate rises. At the same time, your yield diminishes when interest rate drops. Hence, variable CD also carries its own risk. Further, there are different types of variable CD options that banks offer to their customers.

A few banks offer a ‘multi-step’ variable CD structure, in which the interest rate gets adjusted proportionate to pre-determined schedules. Normally, this multi-step structure is linked to the rates of U.S. Treasury Notes. Many other banks offer variable CD structures that track a particular index like the Dow Jones Industrial Average (DJIA). Still, there are restrictions on banks as to how many times they could change interest rates during the period of the variable CD.

Is Variable CD an Investment Risk?

Variable CD investment is quite similar to all other investments, carrying a fair amount of risk. When you purchase a variable CD, you assume that the interest rates would go up and you could get a better yield. However, the economy is always volatile and it is very difficult to predict which way Treasury Notes interest rates or market indices would move. A clear example of is the situation of those who purchased variable CDs before the economic downturn that started in August 2008. When many banks collapsed, they found that interest rates fell considerably and their yields also got shrunk significantly. If they had opted for fixed-rate CDs, they would not have been affected by the sudden economic slump.

Still, there is an advantage in variable CD that many investors are not aware of. Majority of banks offer guaranteed amounts when the variable CD matures. This assured return on principal protects you from losing out on your yield even in a down market, when your variable CD matures. Even if you are unable to purchase such a guaranteed return variable CD, it is not a big gamble, though there is a small risk of reduced yield in a down market. A variable CD is a much safer investment option, compared to other investments like stock investing, bond investing, etc. Whatever happens to the financial market, your principal amount remains safe, while it could get completely wiped out in other types of investments. However, you would have to enquire with several banks on their terms of offer for variable CDs or browse the website to get the right variable CD option. You could also consult a professional investment advisor on this subject.