In an economic environment in which many investors have opted out of the market, “structured” investments that promise investors upside but guarantee against losses have gained in appeal, and sales of the products have skyrocketed since 2007.
But a new consumer alert from the FDIC on market-linked CDs, one of the most popular structured products, counsels investors not to let the possibility of higher returns obscure their view of the risks.
Government consumer alerts are a genre unto themselves in that it is hard not to come away from them without thinking the product described is a very bad thing indeed, sold by Snidely Whiplash after he has tied his own mother to the train tracks. But it is a useful service nevertheless, helping investors know what risks to look out for.
Market-linked CDs, also known as indexed, structured or equity-linked CDs, are certificates of deposit that are tied to a variety of indexes, including the S&P 500, the Dow Jones Industrial Average, bond indexes, global indexes, currencies and other risk assets. Barclays Capital and DWS Investments are among a number of product providers active in this market.
The FDIC suggests a number of factors investors should consider before entering a contract to purchase these products, starting with the most basic: Is the principal really guaranteed against loss? While consumers associate CDs with FDIC protection, and these bank products are generally guaranteed, the absence of such a guarantee means the FDIC will not protect an investor in the event of a bank failure.
The CD’s maturity is another key factor. CD investors are used to short maturities of 3 months to 5 years, but market-linked CDs can be 10- or 20-year affairs. Yet these products are often marketed, aggressively, to seniors with shorter time horizons.
CD investors are also accustomed to early withdrawal penalties, but should be on guard for provisions that disallow any early withdrawal. While the contracts may allow exceptions for heirs in the event of the depositor’s death, consumers—seniors particularly—should pay attention to those details in the contract’s fine print. Sales on a secondary market may provide another exit possibility, but the FDIC warns consumers to consider that such a sale may be at a loss (if current rates are higher than the depositor’s rates). The broker’s sale might also incur a commission.