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As market volatility continues to keep investors cautious, many are holding cash on the sidelines where interest rates remain dismally low. And with interest rate increases looming, no one wants to get locked in to today’s low rates. Financial institutions know that too. So to attract and keep your deposits, more of them are offering certificate of deposits (CDs) with flexible options.
CDs are offered to consumers by banks, thrifts and credit unions. They are similar to savings accounts in that they are covered by the Federal Deposit Insurance Corporation (FDIC) or by the National Credit Union Administration (NCUA).
So as long as your institution is insured and your investment amount stays within the insured limits, you have some measure of safety. But even with insurance coverage, you’ll want to be sure you’re putting your money in a safe institution.
Why? Because insurance may take time to kick in, possibly leaving you without access to your cash when you need it. And the entities that provide insurance have a set amount of funds, which could leave folks holding the bag if too many institutions fail in a short timespan.
Keep Your Money Safe
While all federally insured institutions are regulated and examined by the U.S. government, those government entities don’t share that information with the public.
So it’s smart to do some checking on your own before turning over your money. And always refer to Weiss Ratings to be sure the bank, thrift or credit union is financially sound. The ratings are free! All you need to do is register.
Different than a Savings Account
Although CDs are similar to savings accounts, they’re different in that they have a specified time to maturity. Maturity terms usually run from three to six months, or from one to five years. For a consumer to receive their full principal and interest return, the deposit must remain for the full term.
CDs are especially good if you have a time-specific savings need or if you just want to diversify risk in your portfolio. CDs allow you to decide how much money to put in and for how long.
Usually financial institutions offer CD customers higher interest rates than on regular deposit accounts. That’s because you can withdraw money from a regular deposit account whenever you want. The higher interest rate for CDs is a reward to customers for keeping money with the institution for a set timeframe.
Generally institutions also pay higher rates for longer-term CDs. But in today’s economy where rates are expected to go higher in the future, locking in today’s rate might not be the smartest move. It would tie up your cash and keep you from grabbing a higher rate later.
Ladder Your CDs
Laddering CDs can help keep your cash invested, and also give you an opportunity to take advantage of rising rates. To implement a “ladder” strategy, you would try to take advantage of the highest available current rate, and then have your CDs mature at different intervals.
For example, you could invest one amount for three months, another for six months, yet another for one year, three years and five years.
This way, as your CDs mature, you’ll be able to renew the CD or withdraw the funds. And not all of your money will be subject to whims of the rate environment that exists at that particular time.
This is a strategy that you manage rather than the bank. So you can distribute your money to different institutions. And you can change institutions at maturity if better rates are available elsewhere.
Some institutions are offering step-up CDs as an incentive for investors concerned about locking in their investment at today’s low rates.
A step-up CD usually has a built-in schedule for when the interest rate will be adjusted. The rates change at intervals specified at the time you purchase. The rate at each step up may also be specified. Or they may be based on movements of the U.S. prime rate or the London Inter-Bank Offered Rate (LIBOR), both of which are often used as benchmarks.
Often the initial rate on a step-up CD will be lower than rates for traditional CDs. So if rates don’t actually rise, you may end up with a lower yield to maturity. Depending on your needs the flexibility may be worth it.
This is another way to earn interest without worrying about missing out on rate increases after you’ve signed on the dotted line. They’re similar to the step-up, with just a slightly different twist.
Most banks allow only one bump up to a higher rate before maturity. You may find a few banks that do allow it on a more frequent basis.
Again, these CDs usually start out with lower rates than traditional fixed-rate CDs. But this may be a small price for the flexibility to get in on a rate increase.
These are not recommended for shorter-term maturities because there is a much smaller chance rates will rise in that timeframe. And if they don’t, you’ll earn less than with a traditional CD.
The no-penalty CD allows you to withdraw from a CD before maturity without incurring a fee.
The step-up and bump-up options are forms of no-penalty CDs. Without the bump and step options, you would have to pay a fee to close the CD early and buy a new one at a higher rate.
Customers like the flexibility of these CDs. Financial institutions like them too because they can offer lower entry rates and quite possibly pay the customer less over the term of the CD.
Where Can I Find Them?
Most large institutions have some form of flexible CDs. But you might find more variations at smaller banks that want to attract and retain customers. Check online and visit local branches. Often branches have special offers or walk-in offers that you won’t see advertised.
Compare, Compare, Compare
The next time you’re considering a CD, make sure you compare the different features offered.
Look at the time to maturity. Make sure you know how long your money will be tied up and how that compares with alternate investments.
Compare the rate and the yield. Interest compounding methods, daily versus monthly or quarterly, can make a real difference in the interest your investment will earn.
Find out whether the interest will change. Is the rate fixed or variable? Are there bump-up or step-up terms? And find out whether and how much of a penalty there might be if you withdraw your money before the CD matures.
Know what the minimum is for you to qualify for the stated interest rate.
Understand when and how you will get paid. How often does the bank pay interest? It could be for instance: Monthly, semiannually, or at maturity. Also find out how you’ll get paid. Will they send a check or transfer funds into your account electronically? And how long after maturity can you expect to receive your original deposit.
If you have any questions, ask the sales person to explain the terms and features.
And while you’re doing that, make an assessment of the answers you get and the customer service you receive during your shopping process. That’ll give you a good feel for the institution’s personnel.
For details on how we help investors protect and growth their wealth, visit Weiss Research.
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Latest CD Options Give You More Flexibility
In yesterdayâ€™s, Chart of the Week: VIX Support, I made a statement that several readers have had some difficulty putting their arms around.
Specifically, I noted:
â€œVIX puts are extremely inexpensive right now and one can actually buy VIX puts for March, April and May of 2011 for less than half the price of what the December 2010 puts are currently being offered.â€
This strange, but true phenomenon arises because of the confusion over the underlying for VIX options. At the moment VIX options expire, the underlying for the options is indeed the cash/spot VIX. Prior to expiration, however, the appropriate underlying to focus on is the VIX futures. With the VIX currently at about 18 and the VIX futures for the middle of 2011 approximately 50% higher at 27, the VIX futures term structure actually reflects a different underlying for each month of VIX options and futures.
The graphic below summarizes some of the consequences of the steep VIX futures term structure for VIX options. By means of illustration, note that the VIX December 18 puts can be bought for 0.85. The same puts in for March, April or May 2011, however, can be purchased for less than half that price, as I noted yesterday. The explanation is simple: when investors expect the VIX to be at 27, the VIX 18 puts are going to be a lot cheaper than when the VIX is at 18.
For comparison purposes, refer to a similar VIX put matrix from April 2009 that appeared in Selling VIX Puts with the Help of a VIX Put Matrix. At that time, stocks had formed a major bottom the previous month and the consensus expectation was that volatility would be on the decline. For this reason, with the VIX at 34.82, any puts that were â€œin the moneyâ€ (in terms of the cash/spot VIX, not vis-Ã -vis the VIX futures) were more expensive the farther one goes out in time.
With VIX options, the key ingredients are almost always the VIX futures term structure and what it implies about mean reversion expectations.
- Chart of the Week: VIX Support
- Selling VIX Puts with the Help of a VIX Put Matrix
- VIX Futures: What Were/Are They Thinking?
- VIX Futures Contango Soars
- More Strange Happenings in the VIX Term Structure
- Chart of the Week: VIX Macro Cycles and a New Floor in the VIX
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VIX Put Matrix Offers Glimpse of Expected Future
Suddenly, using hefty cash balances to buy back stock or boost dividends is all the rage in the sector, and the chip giant wants in on the action. I took a look at this trend last week and since it shows no signs of abating, it's time to look at all the cash-rich tech companies to see how a stock buyback or a dividend move would impact their stock. [See: Why the Cheap Debt Frenzy is Great for Stocks]
I ran a screen to find the largest tech stocks that have at least $1 billion in net cash. I then also looked at their cash flow levels, and by combining cash and cash flow, looked to see how much they represented as a percentage of a company's market value. (Did you know that nearly half of Yahoo!'s (Nasdaq: YHOO) market value is accounted for in cash and cash flow?)
By using this as a yardstick, companies could theoretically reduce their share count by that percentage. For example, eBay (Nasdaq: EBAY) could afford to buy back 31% of its stock, and then simply let the cash balance rebound as future cash flow pours in.
Lastly, I was curious about potential dividend yields. In the past, tech companies usually loathed dividends because they were a sign that management no longer had compelling uses for the company's cash, which meant that growth opportunities were lacking. By now, we all know that the days of high-growth have ended (except for Apple (Nasdaq: AAPL), Google (Nasdaq: GOOG) and a few others).
A few companies offer paltry dividends with meager yields (except for Intel's more impressive 3.4% payout), but all of these companies could offer fairly hefty dividends simply based on cash flow and leave their hefty cash balances intact. Symantec (Nasdaq: SYMC), Dell (Nasdaq: DELL) and Hewlett-Packard (NYSE: HPQ) could offer dividend yields in excess of 8%. More likely, these companies would seek to have lower payout ratios, so I looked at what kind of dividends could be offered up if these companies paid out 60% of their annual cash flow in dividends. For most of these companies, that would translate into a dividend yield in the 4% to 5% range. Not bad, but not overly impressive either.
With coming tax changes that hike the capital gains rate on dividends, companies may look to go the buyback route instead. [Read: What Could Happen to Your Favorite Income Spots]
Looking at the column “cash flow as % of market cap,” these companies could look to use all of their cash flow to buy back stock, leave the cash balance intact, and in the cases of Dell, HP and several others, could reduce the share count by more than 10% annually. That's just what HP is doing with its recently-announced $10 billion buyback. Microsoft (Nasdaq: MSFT) is rumored to have similar plans afoot.
What are the implications of a 10% annual share buyback? Well, at a minimum, it boosts earnings per share (EPS) by a commensurate amount. So a company that is only growing profits by +5% would see per share profits grow by +15%.
Action to Take –> Although firms like Dell and Yahoo have ample financial firepower relative to their market value, I'm especially intrigued by Symantec, which is now the largest standalone software security vendor, now that Intel has agreed to acquire McAfee (NYSE: MFE). The company also possesses a hefty data storage division, thanks to a 2005 acquisition of Veritas.
Symantec's shares now trade for half the value that they traded when that deal was announced, because the company has never been able to derive major synergies from the two divisions. But on a standalone basis, each of these businesses would hold real value to a suitor, and Symantec should look to shed one and focus on the other. Analysts seem to focus on a potential full buyout of the company. Jefferies thinks shares would fetch $19 or $20 if that happens, while UBS recently boosted its rating on Symantec to “buy” with a price target of $20 under the assumption that Symantec is “in play.” But I think a sale of one part of the business if more likely.
Even without any moves, Symantec is still quite undervalued, trading at 10 times next year's profits, and management should seize on that. It could buy back nearly 15% of its stock every year simply out of cash flow. Sales growth is expected to be flat in the current fiscal year, but based on very recent trends, are expected to rise more than +5% next year. That should fuel slightly higher bottom-line growth, and when coupled with a large buyback, could again make Symantec a real EPS growth story.
– David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More…
This article originally appeared on StreetAuthority
Author: David Sterman
This Sector's Mountain of Cash Could Soon Line Your Pocket
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This Sector’s Mountain of Cash Could Soon Line Your Pocket