Beware Of "Structured Certificates Of Deposit"

Beware Of “Structured Certificates Of Deposit”

by | Dec 27, 2018 | Investments

With interest rates at historically low levels, and a very unsettled stock market giving the entire economy a collective anxiety attack, you may be looking for other ways to safely earn a favorable return on your cash savings. In your quest to find a reliable investment, you may come across something called a “structured certificate of deposit”.

For risk-averse investors, a certificate of deposit (commonly referred to as a “CD”) is a popular way to invest money. CDs offer a higher rate of return than a standard savings account from a local bank, and there’s no risk of losing your money like there is with the stock market.

CDs are incredibly simple financial instruments: you deposit your money into an account for a predetermined period of time – typically one, three, or five years – and earn a set amount of interest during that period. Different banks will offer different rates of return, so it pays to shop around for the best rate.

The only downside to a regular certificate of deposit is that it doesn’t offer the same income potential as investing in the stock market. A “structured certificate of deposit” on the other hand, is intended to remedy this issue.
 

What Is A Structured CD?

A structured CD is a new product being offered by some financial institutions as a “risk-free” investment that are supposed to mirror the type of returns an investor would get in the stock market. But there are some big caveats.

First of all, structured CDs are not actually CDs at all. A structured CD is essentially a derivative product where the performance of the CD is linked to an underlying investment, usually a stock market index. For example, you might purchase a structured CD that is designed to perform like the S&P 500. This is why a structured CD offers a potentially higher rate of return than a normal CD.
 

What To Watch Out For

Unlike a regular certificate of deposit, it is possible to end up with no return on a structured CD if the stock market goes down. Furthermore, because many structured CDs come with associated fees, it’s possible to incur a net loss on your original investment.

If the markets go down, and you have to pay fees on the CD, you end up with less than what you started with.

While both regular and structured CDs have penalties for early withdrawal, the penalties are much higher with structured CDs. It’s also possible you may not be allowed to withdraw your funds before maturity at all. This is because structured CDs are set up so that you only get paid at the end of the maturity date.

Finally, it’s important to note that the financial institution that sells you a structured CD has no obligation to buy it back. You may be forced to try and sell it on the secondary market, if one exists, and, there will likely be hefty fees that cut further into your return.
 

Tax Liabilities

A structured CD can also be a problem from a tax perspective. If you purchase one, you’ll have to pay taxes on the earnings of your structured CD each year, even though you won’t receive any returns until your CD matures.

Even worse, any gains you accrue on a structured CD are taxed at the rate of regular income, not the lower rate given to capital gains and dividends.
 

Alternative Solutions

At the end of the day, if your goal is to find a solid return on investment without the risk of losing your principal, there are better options to be found than a structured CD. Dividend stocks, bonds, and traditional CDs are all worth looking at before considering as structured certificate of deposit.

If you do choose to purchase a structured CD, be sure to read all of the terms and conditions thoroughly beforehand, and consider consulting with an experienced financial advisor before making your investment.

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