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Are Structured CDs Too Good To Be True?

Most people know what Certificates of Deposit (CDs) are. You buy one for a number of years, then at the end, the bank gives you your money back plus a little interest. They’re not huge moneymakers, but they’re about as reliable as can be, which makes them great tools for offsetting risk.

Of course, Wall Street had to get in on the action and now they’ve gone and turned one of the more reliable investing tools into something much riskier—and more profitable for them. They call them structured or market-linked CDs.

That doesn’t sound too far off from traditional CDs, but the rules are very different.

The Wall Street Journal recently exposed how big banks are shilling these products. Basically, they’re pitching them as a risk-free investment—if the stock market goes up while you own the CD, you get a percentage, and even if it doesn’t go up at all, as long as you hold the CD to maturity, you get your principal back.

Sounds great, right? Head, you win, tails, you don’t lose. But don’t forget principle #3 of the 9 Principles of Intelligent Investors: “If it sounds too good to be true, it is.”

Unfortunately, the fine print of these agreements is fraught with booby traps waiting to surprise the unsuspecting investor. Positive returns are usually capped at single-digit annual percentages, while negative returns are allowed to plummet steeply before they stop impacting end returns.

On top of that, the fees are unbelievable. I mean, if we charged anything near these fees, we wouldn’t have any clients.

The same WSJ article reports that structured CDs can get an advisor “up to 3% of the CD’s value.” As Steve Swidler, a finance professor at Auburn University said, “Banks have to be delighted with these structured products. There’s virtually no risk to them, and [the banks] sit back and rake in fees.”

You might be able to look past all of that. Who wouldn’t pay a little extra for the promise that you won’t lose your principle? But structured CDs are more than a little skewed in favor of big banks. WSJ again reports:

  • “[O]f 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.”
  • “[M]arket-linked CDs issued since 2010 by Bank of the West … revealed a similar pattern. Sixty-two percent produced returns lower than an investor would have received from a five-year conventional CD, while almost a quarter have yet to pay any return at all.”

Why start your investments out with an uphill climb? A seventy-nine-year-old widow told the WSJ she was shocked to see her $100,000 investment immediately drop to less than $96,000 due to fees.

Of course, the fees were disclosed in the 266-page description that accompanied her purchase, but she didn’t read it. While I strongly believe in reading the fine print on any investment, I can’t say I blame her on this one.

“This was not a CD as I know a CD,” she complained.

So What Should You Do?

You should insist on transparent costs and clear, understandable performance reports. In addition, always be suspicious of one-off products with the promise of higher returns and lower risks. Expensive traps are never far behind.

Instead, develop a well-structured plan and stick to it. Focus on the long term. It may not be fancy, new, or scintillating, but a boring old diversified portfolio is far more likely to see you through to your goals.

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