The Best CD in America

Last Updated Sep 1, 2010 10:09 AM EDT

Note: This Discover Bank CD is no longer available: See Four CDs That Protect Against a Bond Bubble for more current information and how to find the best rates
I've written about CD rates too good to be true. Well here is one I've checked out that is both really good and true, though even the bank itself may not know how good it can be for investors. Here are the features of this certificate of deposit:

Featured CD
    • Pays a rate of 2.25 percent APY for a two year period, allowing a withdrawal after the two years.
    • Gives you an option to earn 3.50 percent APY for as long as you'd like over the next eight years. If you find a better rate or need the money any time during this eight year period, just withdraw as little or much as you'd like with no penalty.
    • If you do leave the funds invested for the ten year period, you will get a one-time bonus payment of 2.58 percent of original principal.
    • The CD is federally insured by the FDIC.

What makes this CD so good?
There is wide range of opinion as to whether we will be going into an inflationary or deflationary environment over the next ten years. If it turns out we have an inflationary environment, long-term CDs and bonds will be paid back with less valuable dollars, leaving investors much better off opening two year CDs and reinvesting when rates are much higher. If we have deflation, earning 3.50% annually will be looking pretty good.

This featured CD gives us the best of both worlds. It pays investors 2.23 percent APY over a two year period. By comparison, at the time of this writing, Bankrate.com shows the highest two year CD paying 2.00 percent APY, while DepositAccounts.com shows one at 2.15 percent APY.

This CD not only pays higher than any two year CD, it also gives you the option to earn at the 3.50 percent APY after the first two years without one iota of risk. Thus, after two years, you earn 3.50 percent risk free if you want. But if rates have skyrocketed by then, you have the option to just withdraw your money after two years and go for that better rate.

In a have-your-cake-and-eat-it-too nutshell, you earn higher short-term rates than the highest paying institution, and lock in the option of a 3.50 percent return going forward, if it's to your benefit. What's not to love?

Enough Already - What's this CD?
This CD really does exist, though I'm going to have some explaining to do. It's a ten-year CD at Discover Bank paying 3.50 percent APY.

Before you think I've mislead you, this CD has an early withdrawal penalty of nine month's simple interest. By my calculations, earning 3.50 percent APY for two years and then paying this penalty results in a net 2.23 percent APY. Curiously it's far higher than the 1.85 percent APY Discover is currently paying on their two-year CD. That means you'd be better off opening a ten year CD and paying the penalty than you would be by opening a two year CD.

In effect, Discover Bank is paying you to take out an option to hedge your bet on what interest rates will actually do. The longer you leave the money in, the greater your annualized return.


It gets even better
Finally, I've confirmed with Discover Bank that you can take out any accrued interest without incurring a penalty. For example, after five years, your CD would have grown by 16.16% and you can withdraw this without any penalty. Finally, Discover Bank throws in an extra .05 percent yield if you are a AAA member.

My advice
I'm essentially using this Discover CD as an off-label use much in the way Viagra was originally designed for treating high blood pressure. Like Viagra, or so I've heard, this CD seems to work quite well for the off-label use. Check out the facts for yourself and always remember to stay below FDIC insurance limits.

Check out the early withdrawal penalties at each institution before opening up a CD. The penalties vary from simple interest to much more severe charges. Find institutions with high rates and low penalties.

Author's note
I have owned a Discover Bank CD for over a year and a half. I just opened a second one - the ten year CD with the AAA bonus featured above.

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  • Allan Roth On Twitter»

    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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