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Making Your Money Last

Beware Pitches for High-Yielding CDs

Turbocharged certificates of deposit could be a risky investment.

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Seniors struggling to generate income in a low-interest-rate era may easily be tempted by certificates of deposit promising juicy yields or participation in the market's upside. But many safe-sounding investments are loaded with risk.

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Some advertisements touting turbocharged CDs are nothing more than a bait and switch, the Financial Industry Regulatory Authority warned in a recent investor alert. In such cases, consumers who express interest are often pitched a completely different product, such as an annuity.

In other cases, the CDs being marketed are real—but extremely complex. “Structured” or “market linked” CDs offer interest payments that are tied to the performance of a market index. They often impose annual return caps and other features that can limit the investor’s participation in any index gains.

Such products are far removed from the world of traditional fixed-rate CDs. If the CD is touting higher returns, that “should always be a signal that you need to do a little bit more digging,” says Gerri Walsh, senior vice president of investor education at FINRA.

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While souped-up CDs are nothing new, they tend to be more aggressively marketed when rates are low. FINRA’s investor alert was prompted by investors who called the regulator’s Securities Helpline for Seniors (844-574-3577) with questions about advertisements promising CD yields as high as 15%, Walsh says.

In the CD scheme described by FINRA, investors who respond to ads are typically asked to go to the financial institution, where they are pitched a different product—often an equity-indexed annuity, Walsh says. Equity-indexed annuities are complex products offering interest payments tied to an index—and they carry the risk of losing money on your investment.

If the investor turns down the alternative product, he can still buy a CD—but one that yields the going rate. In some cases, the salesman will offer a “bonus” that gives the investor the advertised yield—but only for one month or one quarter, Walsh says.

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Risks of Market-Linked CDs

Like traditional CDs, market-linked CDs generally guarantee that you’ll get your principal back at maturity. In some cases, they also guarantee a small annual interest payment. Guaranteed principal-and-interest payments are covered by federal deposit insurance.

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Market-linked CDs are tied to indexes that may include stocks, bonds, foreign currencies or other assets. While issuers tend to emphasize the potential for market gains, those profits can be elusive. In some of these products, returns are calculated by averaging the underlying index’s closing price over a period of time, rather than using the closing price when the CD matures. So if the index rises steadily during that period, the investor may get far less than the index return.

There may be annual or quarterly caps on returns. In some cases, a “participation rate” limits your gains. If the index goes up 5% and the participation rate is 70%, you’d get 3.5%. Interest is often credited only when the CD matures. So if the index performs poorly during the term of the CD, you may get no return at all. Because of the product’s complexity, “people don’t understand the upside is so limited,” says Craig McCann, president of Securities Litigation and Consulting Group, in Fairfax, Va.

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What’s more, Walsh says, “your investment can be locked up for a very long time—up to 20 years.” It may be difficult or impossible to withdraw your money early. Some of the CDs have call provisions, allowing the issuer to hand back your original investment, along with any accrued interest, at certain times before maturity—perhaps after your money has been tied up for years.

Before buying a CD, go to research.fdic.gov/bankfind to make sure the bank is insured by the Federal Deposit Insurance Corp. Also check out the individual who is recommending the product. Use FINRA’s BrokerCheck and www.adviserinfo.sec.gov to check the disciplinary history of brokers and investment advisers.