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Structured CDs catch on

By Claes Bell · Bankrate.com
Monday, December 12, 2011
Posted: 5 pm ET

Where there's money, there's Goldman Sachs, so it's telling the investing giant is getting into the marked for structured CDs. Matt Robinson of Bloomberg reports that Goldman is creating a line of four different structured CDs to meet growing customer demand for a deposit product that can provide some hope of returns beyond today's rock-bottom standard CD rates:

The structured CDs are the bank's first and are set to price at the end of the month, said a person with knowledge of the offerings who declined to be identified because terms aren’t set. One four-year CD is linked to changes in the Dow Jones Industrial Average, with annual returns at a minimum of about 0.5 percent and a possible maximum of 24 percent, according to a preliminary sales document. That compares with the average yield of 1.15 percent for a three-year, fixed-rate deposit, Bankrate.com data show.

Demand for CDs tied to assets such as equities, commodities and exchange-traded funds has soared as the Federal Reserve has held its benchmark rate at zero to 0.25 percent since 2008. Bank revenue from the investments has more than tripled to $99 per million dollars in retail deposits in October from $30 in January, according to Kehrer-LIMRA Research compiled from approximately 30 lenders, including Wells Fargo & Co. and SunTrust Banks Inc.

If you're wondering how banks are making so much money on these instruments, wonder no further:

Banks benefit from issuing structured CDs, which the FDIC insures up to $250,000, by raising deposits at lower funding levels and collecting commissions, said Tim Bonacci of CD Funding Securities LLC, who’s helped about 30 financial institutions set up their own proprietary CD business since 2005. The average fee on a five-year deposit is about 3 percent, Bonacci said in an interview last month.

I think CD investors have to be extremely careful with products like these. While they're called CDs, these products don't have much in common with a conventional certificate of deposit beyond the guaranteed return of your principle.

For those who've never heard of the products, they basically work by using the majority of your principle to buy a zero-coupon bond that, like a savings bond, is bought at a price lower than its face value, but is redeemed at maturity for the face value. The other part of your principle is put into derivative contracts whose value rises and falls with a certain stock index, the price of a commodity, or some other value. Structured CDs tied to a stock index are sometimes referred as index CDs.

Unlike regular CDs, structured CDs can come with a hefty commission and may have restrictions on when they can be cashed in. They're also much more complex than regular CDs, and the contracts that govern them can contain all sorts of restrictions on returns and other caveats. Investors could end up getting a better return than a conventional CD, but they could also end up getting little to no return at all.

I think the biggest drawback to all that complexity is you're going to need a financial adviser to go through all the particulars with you, and that's going to increase their cost even more. Conventional CDs may be paying abysmal returns, but they're simple enough that a quick look through the terms and conditions will be enough to figure them out.

What do you think? Would you put your money in structured CDs?

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2 Comments
lightrider
December 13, 2011 at 2:30 pm

Sounds like a lot of work for too little return. I checked out ETF's & had a hard time understanding them also. If I don't grasp the instrument I stay away! Good article though!!