Be careful when you see a 9 percent CD
We recently were astounded to note an ad for a 9 percent CD.
Sure sounds great in these lean times. We all can use some safe high yields for a change!
But if you read the flyspeck type, the CD rate is guaranteed only for the first year.
The ad fails to say how long you must keep your money on deposit after the first year – when that interest rate may well nosedive!
Such missing information is critical.
This ad is just one example of the new wave of broker-placed ads that hype CDs as a way to get you in the door. These CDs are different from the old, reliable FDIC-insured fixed-rate bank CDs you know and love so well.
In fact, the ad acknowledges its 9 percent rate belongs to a CD, known as a "Steepener."
Steepeners are CDs that often mimic derivatives-which, as we already learned the hard way — even the Wall Street big guys can't seem to price reliably!
See a steepener with an interest rate that fluctuates based on the performance of an index associated with the U.S. Treasury? Don't necessarily let this comfort you. We ran one such a published index passed a U.S. Treasury spokes- person. Never heard of it!
Good luck trying to learn how it has performed in all kinds of markets!
On this particular advertised CD, "After the first year, the interest rate will be based on four times the difference between the 10-year and two-year CMS rates," the ad says. There is a 10 percent cap.
Do you have a clue as to what the CMS rate is or where it's published? If not, how do you know if this is a good or bad deal? How happy are you that your rate can't be higher than 10 percent?
Meanwhile, the ad identifies the CD as "callable." This means that if your CD happens to perform great after the first year, expect to get your principal back. You'll be forced to reinvest your money at lower yields.
On the other hand, if your CD performs miserably, and you'd love to get rid of the critter, you can't. We've seen terms run 10 to 20 years or more, with no withdrawals allowed!
Your only option may be to sell your CD on the secondary market-most likely at a steep loss.
Is it worth it?
That depends. Some actually could be if you're very careful. Among the issues you need to evaluate:
• The term.
• What happens if you need to withdraw early? If you'll need to sell it on the secondary market, consider that there may be few buyers. Some — but not all — institutions may allow the deposit to be withdrawn without penalty upon your death.
• Whether there is a minimum guaranteed interest rate.
• Tax repercussions. Some of these types of CDs require you to report income to the IRS-even if you have no earnings until maturity.
• Who's offering it? Make certain the broker is registered, reliable and has no complaints against it.
• Whether the full principal is FDIC-insured. Some formulas, for example, guarantee you 110 percent of the performance of an index. But if the index does lousy, you only get back 90 percent of your principal-despite FDIC insurance. Beware that if you only get interest at maturity, you may earn nothing if the bank fails earlier.
• Do you pay a brokerage commission?
Spouses Gail Liberman and Alan Lavine are syndicated columnists. Their latest book is "Quick Steps to Financial Stability (Que/Penguin)." You can e-mail them at MWliblav@aol.com.
