Cash in with rising-rate CDs

Tired of earning a measly half a percent or so on your savings or money market account, but unwilling to lock yourself into a fixed-rate certificate of deposit (CD)? According to a recent Gallup poll, one in four Americans looks at savings accounts and CDs as the best investments. Yet with the less-than-stellar current interest rates, many people may be avoiding CDs in the hopes that rates will rise.

Buying now doesn't have to mean you are stuck if rates rise, though. There are some CD options that offer the liquidity or the flexibility you need with interest rates that are typically better than what you can earn with a savings or money market account.

Liquid CDs

"A liquid CD is somewhat like a traditional CD, but there's no early withdrawal penalty," says Rick Kahler, a financial planner in South Dakota and the author of several personal finance books. You'll get a fixed rate--typically a bit lower than what you'd get with a traditional CD but higher than what you'd earn with a savings or money market account--and you can access your funds at any time after the first six days. This leaves you free to cash in and invest in something else if rates go up.

"With a liquid CD you're basically buying liquidity by taking a lower interest rate," says Sheryl Garrett, a Certified Financial Planner and president of Garrett Planning Network, a group of fee-only financial planners with offices nationwide.

Your interest rate will typically be about half a percent lower than with a traditional CD, but a liquid CDs does have its benefits. If you need to be able to access your money at any time, you don't want to pay a penalty, and the rate you're offered is better than what you are offered with a savings or money market account, then a liquid CD could be a good bet.

Garrett's advice: Check local credit unions and online banks to make sure you score the best rate you can get on any CD you purchase.

Bump-up CDs

A bump-up CD allows you to take advantage of rising interest rates by letting you "bump up" to a higher rate (if rates rise) one or more times during the life of your CD. You get to choose when you bump up. You should know before purchasing how many times you're allowed to take advantage of potential higher rates.

For example, Bank of America currently offers the "Opt-Up" CD, which allows customers to take advantage of a higher rate one time after the first six months the CD is owned, with no term change or extension, says Donald Vecchiarello, Jr., media relations manager for Bank of America. A boost to a higher rate could mean a significant change in return if you've invested a lot in a CD.

Step-up CDs

These are similar to bump-ups, except you know ahead of time when your interest rate will rise. A step-up doesn't leave you guessing when to take advantage of a rise in rates.

Bump-up and step-up CDs also typically start out with a lower interest rate, and depending on the terms, that rate can rise one or more times over the life of the CD. While a bump-up CD could give you a measure of security and control since you'll be the one choosing when your rate goes up, Garrett warns that many people may worry about when to take advantage of the bump, and some may forget to take advantage of the option to raise their rate.

A step-up, on the other hand, doesn't leave you guessing; you know exactly what you're going to get. "A financial planner can help you figure out whether a step-up offering is a good deal," says Kahler, "or whether you're better off sticking with a traditional CD."

Because rates are lower on all three types of alternate CDs, you'll need to shop carefully and compare rates against traditional CDs, savings and money market accounts.

Don't forget, cautions Garrett, that you can likely earn a higher interest rate and get a measure of liquidity by laddering traditional CDs (buying several CDs with different maturities), so if you do ever have to cash in early, you're minimizing the interest and penalty fees.

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