cds

Know risks of investing in structured CDs

Don TaylorDear Dr. Don,
I bought two structured certificates of deposit valued at $22,000. Is this a wise investment or is this junk? I am very confused about this type of CD. Can you help me out by making it simple and explaining what it is to me?

Thanks in advance for your reply,
-- Pam Pecuniary

Dear Pam,
I will make it simple. The time to learn about an investment is before you buy it, not after. Once you've learned the basics, you might get validation that you've made a good investment. Or you might regret that you didn't do the right thing.

There are a number of different ways they are structured, but typically the yield on a structured CD is tied to the return on a specific stock market index. The most commonly used is the Standard & Poor's 500, the index of the 500 leading U.S.-based publicly traded companies.

This type of CD tends to become popular after a market decline. Investors think that they'd like to be exposed to the stock market's possible gains without having to face the prospect of a painful loss. With a deposit protected by the Federal Deposit Insurance Corp., you're guaranteed against a loss of principal. That protects against downside risk.

Investors who wouldn't dream about investing in derivative securities, like puts, calls and futures, can own a CD with exposure to derivatives. The FDIC has counseled consumers to be cautious when investing in structured CDs.

The typical structured CD limits the return you can earn on the market. It doesn't pass through the dividend yield paid by stocks in the index. Can you make more in a structured CD than you'd make with a plain-vanilla deposit? Sure, but you can also get nothing more than your deposit returned at maturity. Here's the most important lesson for you to remember: Next time, before you make an investment, make sure you understand the risks first.

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