Is That Investment REALLY “Like a CD”?


by

28 July,2014

Even though the financial crisis was several years ago, many people still remember the impact it had on the economy, and on personal finances.

Not only do people remember the fear felt during that time, but with the slow growth of the economy, many people still feel as though they are living in a recession environment. The low rates frustrate savers because the low yields from CDs mean that you are probably losing money in real terms. Even though the Federal Reserve has begun raising rates, they are probably likely to move at a fairly slow pace — and the truth is that rates are still quite low and will be for some time.

In this type of environment, it’s little surprise that a number of investment products are popping up, promising that they are “like CDs” — including purporting to offer safe returns, but with better returns than you see with traditional CDs.

The reality, as you might expect, is that these products aren’t actually “like” CDs. There are some products, like market-linked CDs, that can contribute to better returns on your money, but even these aren’t particularly high-yielding, and you probably won’t get the “safe” returns that you think you have been promised.

Before you jump into something that is billed to be “as safe as” CDs, but with better yields, do your homework. Here’s what you should know:

Risk, Reward, and CD Returns

In order to understand the reality of CDs and return, you need to understand the concept of risk and reward when it comes to your money and investing.

Basically, the bigger the risk you are willing to take, the higher your chance of reward. The safer an asset is, the lower your chance of big returns. A guaranteed return is always going to be smaller than something that isn’t a “sure thing”. CDs are a good example of a safe investment. It’s a term deposit, so you are guaranteed a set rate of return, for a set period of time. Additionally, as long as you are getting CDs from an institution with the proper insurance, your money is protected, up to a certain amount.

Other investments are riskier. When it comes to bonds, you might be mostly safe, but the reality is that the entity might default, meaning you lose whatever principal and remaining interest is still left to be paid. However, bonds are still considered less risky than stocks. With stocks, you put money in, hoping that the value of the stock rises and you can sell for a return. This might not happen, though. This makes stock investing riskier, since you could end up losing the money you put in (although dividend payments can help mitigate some risk).

Consequently, you also have the chance of making more money. Cash and bond investments are limited by the yield offered. Stock investments have no upward limit on returns. But you also have a greater chance of loss. When making investing decisions, you need to balance your safety with the need for higher returns. CDs can be a part of this decision, but you need to be especially wary of “like” products that promise the same level of safety with better returns.

The Reality of CD Returns

Because a CD is safe, you aren’t going to see the same types of returns that you would if you were willing to take on a little more risk. This is why you need to be careful when deciding which assets you will invest in.

And this is where the “like a CD” claim comes in. There are some investments that are touted as being similar to CDs, or functioning like CDs. The truth, though, is that these assets ARE NOT CDs. You have to be clear on this before you invest your money.

They may have some of the same characteristics as CDs, but they aren’t actually the same thing. You could lose money — including your principal. However, because you’ve been told that the asset is “like a CD” you mistakenly think that you have all the same protections that come with a CD, when in reality you are investing in something that is not FDIC-insured.

Realize that these protections don’t exist. Any time you are told that you are going to get a better return, you need to be prepared for the reality that you are actually dealing with an asset that might not be insured by the government. As a result, you need to be on your guard. Don’t be lulled into a false sense of security by sales tactics designed to put you at your ease.

If you want to invest in a CD, and protect your principal, or build a CD ladder to serve as an emergency fund, that’s fine. CDs can make a good part of your portfolio, and be a part of your long-term financial plan, especially when it comes to semi-liquid cash (a CD ladder can help you liquefy your CDs to some degree).

You need to be aware of the truth of the situation: Anyone who tells you something is “like a CD” is trying to sell you something that isn’t a CD at all. Double-check to make sure you know what you are getting into, and that you understand the risks. “Like a CD” could mean that you lose money in the long run on an investment that isn’t as safe as you think, and you won’t get your money back.