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Index CDs revisited

By Sheyna Steiner · Bankrate.com
Friday, April 15, 2011
Posted: 2 pm ET

Index CDs sound like a great idea: the high yields of riskier markets with the safety of a CD. Everyone wins, right? Maybe, or maybe not.

Everbank came out with a line of Marketsafe CDs in 2005. The initial CD offering was linked to the Standard & Poor's 500 index and subsequent market-linked CDs branched out into more exotic territory including Japanese REITs, gold and silver bullion, metals, currency and commodities.

Today on Marketwatch.com, in the story, "Commodities CD won't live up to the hype," Chuck Jaffe took on the Everbank commodities CD, dubbing it the "Stupid Investment of the Week." Here's why:

Most investors need this kind of product the way a moose needs a hat rack; they’re equipped to get the job done on their own.

The devil here is in the details. Like any principal-protected product, the MarketSafe CD uses insurance to offset the potential for market loss. The cost of that insurance is paid from returns, so while the CD has no out-of-pocket fees, its structure does eat into potential gains.

Though investors pay no fees for the index CD outright, there's no free lunch being offered here, as noted in the story.

Michael Kitces of Pinnacle Advisory Group in Columbia, Md., noted that investors have no clue from EverBank’s paperwork just how much of their deposit is needed to procure the principal guarantee, and how much goes to commodities. "This is why a lot of experts are critical of equity-indexed annuities and structured notes," Kitces said, "because in reality, the company keeps a very big slice of this interest spread, which the consumer never sees directly."

Plus, the structure of the CD caps the potential gains of any of the 10 commodities at 10 percent and the downside at 20 percent which, as Jaffe points out, means the underachievers will drag down the return more than the standouts will bolster it.

Instead of buying an expensive product that tries to accomplish two goals badly, principal-protection and exposure to the commodities market, he recommends two separate products: a zero-coupon bond and a commodity ETF.

By comparison, an investor with $10,000 could get a five-year zero-coupon bond -- paying 2.25 percent -- for a present value of roughly $8,950. That would leave $1,050 to throw into a broad-based commodity fund. The bond delivers $10,000 after five years, and the investor keeps whatever growth they get from the commodities, without any cap on earnings.

A zero-coupon bond is sold at a discount from the face value. When the bond matures, the investor receives the face value of the bond.

Many CDs that seem to offer more yield, or even liquidity, than a CD investor could otherwise get end up costing more in the long run. With a little bit of effort and, more importantly, knowledge investors can put together a similar investment without paying for the convenience.

What do you think?

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