Secured Certificates of Deposit vs. Bank C.Ds

Structured Certificates of Deposits (C.D.s) are one investment option for those that are unwilling to risk their principal in the stock market.

Firms that sell C.D.s use underlying assets such as a commodity, equity, index or foreign exchange accounts to generate enhanced income. Structured C.D.s protect the investor's principle (when held to maturity), are normally FDIC insured, limit market exposure and can offer an area for diversification.

The reason the risks are reduced are because investor's initial investments are typically protected which means you won't lose your principal. A word of caution though, the FDIC offers full repayment of up to $100,000 per depositor, not per bank account, not per bank branch. It is best to diversify your cash as well as your long and short-term investments.

Structured CD's can be bought in $1000 increments and are sold for a specific period such as four, five, six, ten or twenty years.

Why is a structured CD different from a bank CD

With a Structured CD, investors will not receive annual interest payouts. Instead, the money will accrue over time and at the time of maturity for the Certificate of Deposit, the investor will receive their initial investment as well as a possible gain up to the maximum promised cap. If the earned actual interest was higher, the investment firm keeps those additional returns.

Similar in the way that a mutual fund will spread your risk over various stocks, a structured certificate of deposit also spreads the risk of your investment, the same way. The difference is it also spreads it over a period of time.

For example, a structured CD of six years may promise a return or a gain of somewhere between zero and six percent. If the first year, the interest rates on the CD company's investments take a dive, you are still guaranteed your equity but no interest (up to FDIC insured caps).

If the second year, the stock makes twelve percent, you can be assured that a gain up to the contracted amount, in this case six percent will be credited to your C.D. account. The expectation is that in the next six years, the fund will pay the six percent maximum interest rate. However, to be clear, the least you would make is zero percent and the most you could make is six percent. This is medium risk.

With a bank C.D. the interest is paid annually. Right now, the local credit union offers about a half a percent on a bank one-year term C.D. Many banks have similar minimum deposits of $1,000. or more. If you purchase a one-year CD and continue to roll that over for the same period of time in our previous example (six years), the most you could make is three percent and the least you would make is three percent. This is low risk.

Compare that to a straight investment in the stock market where you might make far greater returns, but you might also lose everything, the risk here is high.

Note: Your age and your cash fluidity, as well as your debt-to-income ratio must be examined before making a decision.

Risks and Structured C.D.s

Risks associated with CD's include having money tied up for a definitive period of time. There are usually commission fees and possible financial losses if sold prematurely. Interest rate changes, and/or the volatility and possible depreciation of net worth of underlying assets are also something to consider.

When to Buy

If the stock market is rising, structured CD's often have an option to put or call the CD by the owner (not you the borrower). This allows them to pay out interest revenue to you, and put their capital in other things. Conversely, if the market tanks, they can keep your money for six years, preventing you from investing in something different.

Should you invest in a Structured CD?

If you are someone who is looking to diversify your portfolio, and you are unsure about the current stock market conditions, contact your broker or financial planner and ask them about structured certificates of deposit. Expect your money to be tied up for awhile but if you want a chance at making something a little higher than your bank is making for you right now, and you still want F.D.I.C. insurance, this product might be right for you.

If you think the market is going to go bull in the next few years, or you want your cash to be liquid, then this probably isn't the best option for you. Always consult a professional first, rather than after the fact.

Here is a great You Tube video that explains with Structured C.D's visually with an easy to understand narration: http://www.youtube.com/watch?v=mU7AYocTNSg

For more info on structured CDs, the FDIC has some great questions that you should consider before pursuing this type of CD. Check it out here: http://www.fdic.gov/deposit/deposits/certificate/index.html

Sources:

http://www.investmentnews.com/article/20090607/REG/306079969