When a CD Is Not a CDSubmitted by Castlebar Asset Management on September 7th, 2016
CDs have been a simple low risk investment for generations. What happens when you add a little spice to your grandma’s CDs? Banks and Wall Street firms are trying to add some zest to what is historically the most boring way to save outside of putting money under your mattress (until a house fire). According to the Wall Street Journal (WSJ), these structured CDs aren’t living up to their expectations.
Banks are issuing market linked or structured CDs. These are different than traditional fixed rate CDs. They are investment products where returns are based on the performance of a select group of stocks or other assets. These baskets have a complicated formula that caps your upside to 5% but also has a floor (or downside) of 20% in one example the WSJ cited.
According to the WSJ the structured CDs so far don’t have a great track record of outperforming fixed rate CDs.
“Of the 325 Barclays CDs reviewed by the Journal, 239 had announced at least one annual return payment. More than half of those returns were lower than an investor would have earned from an average five-year conventional CD. Of the 118 structured CDs that were issued at least three years ago, only one-quarter posted returns better than those of an average five-year conventional CD. And roughly one-quarter produced no returns at all as of June 2016.”
CDs have an important role to play in your financial plan. They are a reliable place to store money that offer lower rates of return, but have an extremely high probability of returning all of your money. By their nature they are supposed to be boring and are a great place to park your emergency fund, keep money for a future purchase or if you are conservative it may be where you are most comfortable investing.
Structured CDs are a by-product of the low interest rate world we live in. This environment has all investors looking under rocks for better rates. Savers who have relied on CDs to provide them with stable income have struggled to earn even low rates of returns. Most CDs are barely keeping up with inflation. Investors looking for a yield pick could be enticed by the appeal of better returns under the disguise of a CD.
Those selling structured CDs are not fiduciaries (they have no interest to act in your best interest). These investment products are not registered with the SEC but still see between $5 and $15 billion of inflows each year. These are fee generating product for banks.
Typically, everyone in the sales chain—a wholesale broker, a financial adviser and a bank teller—gets paid more for selling a market-linked CD than a conventional CD or a mutual fund. The adviser who actually sells the CD, for example, can get commissions of up to 3% of the CD’s value, according to information sent to brokers reviewed by the Journal.
“Banks have to be delighted with these structured products,” said Steve Swidler, a finance professor at Auburn University. “There’s virtually no risk to them, and [the banks] sit back and rake in fees.”
There may be a limited use, I have not figured one out yet for structured CDs, but it primarily looks like a mechanism to upsell current CD owners to a financial product masquerading as a CD.
I am a firm believer that you don’t often get extra credit for making your investments more complicated. If you want to own stocks, buy stocks. If you want to have the benefits of a CDs, buy a CD. Investment products that blur the line between conservative and risky investments leads to confusion about performance and fees.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your personal financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.