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With all the financial innovation in creating new investment products, old-fashioned investments have had to struggle to keep up with the pace of progress. Although several banks are trying to make a once-favorite product meaningful again, the efforts they've made thus far are too little and too late to resurrect its ailing prospects.

Low interest rates have had plenty of positive effects on the economy in general and on debt-burdened consumers in particular. But one aspect of the low-rate environment has really hurt banks in trying to lure potential customers: By making rates on bank CDs almost negligible, customer interest in the products has all but dried up, leaving banks having to consider fundamental changes to the nature of CDs.

CD 2.0
For conservative investors, the certificate of deposit was one of the most popular products of the last century. Nothing could be simpler than a CD; you put your money in the bank, it earns interest, and when it matures, you get your money back. You can choose to take your interest in regular quarterly payments, or you can have it reinvested and get it all out at the end.

Traditional bank CDs have some downsides, though. CDs make you pick a time period during which your money is essentially locked up. If you need to get at your money before the designated maturity date, then you'll typically pay early withdrawal penalties -- a hit that can take away a year or more of interest payments. Moreover, if interest rates rise in the near future -- something that many experts have predicted for some time -- then you might wish that you hadn't locked in a relatively low rate.

That fear of rising rates as led many investors to gravitate toward high-yield savings and money market accounts. Right now, top banks pay as much on these liquid accounts as they do on short-term CDs, giving you no real incentive to lock up your money.

So in crafting the next generation of CDs, banks have pulled out all the stops. Among the moves they've made are the following:

  • Ally Financial, which is currently majority-owned by the U.S. government along with a General Motors (NYSE: GM  ) trust and other investors, now has a CD with a four-year maturity that lets you raise its interest rate twice to match rises in overall rates.
  • Bank of America (NYSE: BAC  ) and PNC Financial (NYSE: PNC  ) have joined Ally in allowing penalty-free withdrawals on short-term CDs.
  • Discover Financial (NYSE: DFS  ) is even paying customers to open CDs, with $75 gift cards.

Same as the old boss
Coming up with gimmicks is an age-old tactic for banks. But often, the actual value of what they're giving you doesn't overcome the cons of opening a CD.

For Discover, which requires a $2,500 CD deposit, $75 represents the equivalent of a 3 percentage point interest rate boost on a one-year CD. That's certainly not bad, but as a one-time deal, it won't solve the larger problem for savers seeking a sustainable investing strategy.

Similarly, free withdrawals don't do much good if the rates on CDs aren't significantly higher than on savings accounts. And a rising-rate CD still locks you into low rates as long as the Federal Reserve chooses to hold rates at rock-bottom levels.

No, the real problem with CDs is that they simply aren't competitive. Even top-paying banks like Doral Financial's (NYSE: DRL  ) Doral Bank and AIG's (NYSE: AIG  ) banking unit can't manage to pay even 2% on three-year CDs. With Sallie Mae (NYSE: SLM  ) offering 1.15% on an online savings account, the extra yield from a CD just isn't worth it.

Stick with alternatives
Finding income has been a challenge for years, and bank CDs haven't delivered the goods for quite a while. Although new bank offers may be a step in the right direction, they're not a perfect solution. And until they go further, they'll remain offers that you can -- and should -- refuse.

Rather than banks, some savers have decided that dividend-paying stocks are the answer to their income needs. Stocks can be risky, but the right ones can help you. Let the Fool's free special report on dividend stocks get you started on the smart path.

Fool contributor Dan Caplinger loves banks when they treat him right. You can follow him on Twitter here. He doesn't own shares of the companies mentioned. The Motley Fool owns shares of AIG. The Fool owns shares of and has opened a short position on Bank of America. Motley Fool newsletter services have recommended buying shares of Discover Financial and GM. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy makes you an offer we can't refuse.


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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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