Stock market-indexed CDs safe, and offer higher
returns -- if the market rises
an investment product that you can look at from two angles: it's
a risky certificate of deposit, or it's a safe way to invest in
the stock market. It's a CD with a rate of return that's linked
to a stock market index. The S&P 500, NASDAQ 100 and Dow Jones
Industrial Average are some of the more common ones.
These CDs are risky -- as CDs go -- because
there's no guaranteed interest rate. But when used as a way to invest
in stocks, they're safe because your principal is guaranteed --
up to $100,000 under FDIC. Not a bad deal in a year like this when
the S&P 500 is down about 8 percent year-to-date, the Dow is
down almost 9 percent and the NASDAQ has lost more than 28 percent.
Betting on the bulls
If you want a safe CD that will return a guaranteed amount of interest
at maturity, stick with regular CDs. But if you're willing to give
up that guaranteed interest in exchange for what might be a much
bigger payday -- without risking your initial investment -- this
may be for you.
"From the responses we've been getting,
this appeals to two different segments -- people who do a lot of
investing in the stock market or in mutual funds and want to diversify
into something more secure -- and those who are skittish about investing
in the stock market but want to try it out," says Tommy Little
of New South
Federal Savings Bank in Birmingham, Ala. New South Federal is
offering a three-year CD that's tied to the S&P 500.
You'll need to understand how the CD issuer
determines the interest rate you receive at maturity. New South
Federal will use an average based on the S&P 500 close every
six months during the three-year period. In other words, they'll
essentially base your return on how well the S&P 500 performed
during six days over those three years.
Little says that should help even out whatever
volatility affects the index during the term. But it could also
mean that if the S&P 500 rose 30 percent over the three years
based on the beginning and ending date of the CD, your rate of return
using the bank's averaging formula could be less. It can't ever
Capping the gains
Bank, based in Orlando, Fla., is offering a five-year CD indexed
to the NASDAQ 100. Marketing director Joanie Vincent says Crown
won't use an average when figuring the interest rate, it will go
with the actual NASDAQ 100 return, but it will cap the customer's
gain at 20 percent per year.
"If the market is wailing you're not going
to exceed 20 percent. By the same token, the interest rate on the
account will never be less than zero."
Certified financial planner Chris
Cooper of Chris Cooper and Associates in Toledo, Ohio, isn't
a fan of index-based CDs. He says if you're interested in the stock
market; invest in the stock market.
"Forget these products; there are too many
complications. These things only perform well when the market is
really, really flying," says Cooper. "In order to be guaranteed
you don't get a negative 20 percent, you give up some of the upside.
You're not going to get the same return the market gets. You limit
your upside to limit your downside."
No withdrawals at all
Another aspect to consider is how long your money will be tied up.
You can probably find a bank offering stock market indexed CDs for
a one-year term, but it's more likely to be a three- or five-year
term. Make sure you won't need the money until maturity. If Crown
Bank and South Federal Savings are typical examples, there will
be a period where you can't get your money out -- even with a penalty.
South Federal doesn't allow withdrawals for
the first year, and after that there's a penalty. Crown won't allow
customers to cash CDs until maturity -- unless the CD owner dies.
Stock market indexed CDs also differ from other
CDs in that there is likely to be a set starting and ending date.
Banks advertise the offering and then send a packet of information
to anyone who requests it. Everyone who wants to participate has
to send money by a certain date. Terms, minimum investments, payout
dates and the way interest is determined will vary from bank to
bank and maybe even offer to offer.
Stock market indexed CDs aren't new -- credit unions
and brokerages have been offering them for some time. Expect to
hear much more about these CDs as more banks jump into the fray
in an attempt to broaden their investment offerings to customers.