cds

Indexed CDs offer investor protections, risks

But sometimes the index performance is measured using other methods, such as looking at the averages from each quarter. The method of computation can either raise or lower your return compared to point-by-point measuring.

"That's something I'd immediately look at," says John Largent, chief investment strategist at Members Trust Co. in Tampa, Fla. "People might not get the equity participation they think they are."

Justin Capetola, a managing partner at Blue Bell Private Wealth Management in Blue Bell, Pa., says consumers should be able to find a matching return on an index up to 45 percent or so. He recently offered his clients five-year indexed CDs that pay no interest and match the Dow's return up to 47.8 percent.

"These clients want to be safe, but they still want to have some chance for market participation over the next five years," he says.

Other risks remain. Some indexed CDs have a "knockout" rate, which sends the return back to zero if the index soars too high. In such cases, "you're really making a bet about market volatility -- that the market will stay in a range," Geczy says.

Two other areas to watch out for: taxes and fees.

Typically, a bank issuing the CD will hedge against the potential cost of making a payout to you. It will pass along the cost of that hedging contract to you. Similarly, a financial adviser may charge a fee of roughly 3 percent of your investment.

As for taxes, earnings are taxed like a normal CD's interest payments, and you may be taxed for paper income you haven't yet received. You might consider putting it in an IRA account, which can build wealth tax-free, to avoid this issue.

Finally, find out if the issuer has the right to call your CD, as bond issuers do.

"All this just underscores the importance of shopping around and reading the fine print," says Geczy. "This isn't like just going in and buying a CD. Investors should understand the parameters of these investments and how they might change in different market environments."

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1 Year CD 0.89%  0.01 0.88%
2 Year CD 1.01%  0.02 1.03%
5 Year CD 1.59%  0.07 1.66%
 
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