Benefits of Structured CDs

(Note: This is part of a multi-part-series covering the benefits and risks of Structured CD’s.  Part One is here, which discusses the risks of Structured CDs.  Part Three is here, which discusses the Where and How Structured CDs may be appropriate.  At the time of this writing, I own a Structured Index CD in a retirement account).

Structured CD’s, Structured Notes, and Structured Products have received some really bad press- some deserved.  But here are:

5 Reasons that Structured CD’s Rule

1) You’re Guaranteed not to lose money.

If you’re investing in CDs equal or less than $250,000 per institution/bank, your principal (initial investment) is guaranteed by FDIC insurance.

2) You don’t need to be an institutional investor to buy super-long-term options.  

Normally, the longest option an individual investor can purchase is a LEAP contract, which only goes forward as far as 2 years into the future.   A Structured CD let you purchase option contracts going out 5 to 20 years.

3) You could get up to 100 percent participation in the rise of an index, with no downside.

Where else could you find this?  If the index value ‘only’ goes up 30 percent over 5 years, and your product has a participation ‘cap’ of 30%, you’ve just made the same as the index (less dividends), with no downside risk.

4) Did I mention you can’t lose money?  I can’t overstate the importance of this.

The Dow/S&P have lost HALF their value twice in the last 45 years (Hat Tip to Dr. Wade Pfau).

For those with really short-term memories, we had a 53% drop in the S&P/DOW from Oct 2007 – March 2009 .  That is, if you invested $1,000 in October 2007, you’d have $470 left in the bank at the end of March 2009.   For one full year (2008) the S&P (VFINX, including dividends) lost 37%.

Let’s take a practical example.  Let’s say it’s January 2000, and you have the option of buying a $1,000 S&P-Linked Structured CD or buying $1,000 of shares in the Vanguard Index 500 (VFINX)- which includes dividends.  Here’s a side-by-side comparison:

Year

VFINX Total Return

VFINX Balance

Structured CD Balance

2000

(9%)

$910

$1,000

2001

(12%)

$801

$1,000

2002

(22%)

$625

$1,000

2003

28.5%

$803

$1,000

2004

10.7%

$888

$1,000

Or in Layman’s Terms, $1,000 invested in the S&P proxy on January 01, 2000 would be worth $625 at the end of 2002, then ‘recover’ to a value $888 at the end of the 5th year.

Structured CD’s are overpriced and stupid, you say?   Call them all the names you want, but I’d still rather have $1,000 than $888 in my account after 5 years.

This reinforces an investment industry marketing trick- You are often shown the AVERAGE (MEAN) return, not the TOTAL return, or ACTUAL (IRR) RETURN.

Note that the MEAN return is -0.76% over this 5 year period – Which is what the marketing brochures will tell you, because a negative fraction of a percent per year for a few years does not sound all that bad.  However, the ACTUAL (Annual or Internal Rate of Return) on your $1,000 is -2.35 percent, which is the return rate you have to EAT at the end of the day.

 5) The ‘Survivor’s Option’

Another notable feature of many Structured CDs is the “estate feature” (also known as the “death put” or “survivor’s option”).  In the event the contract owner dies, most CD contracts provide the decedent’s estate the right- but not the obligation- to redeem the Structured CD for the full deposit amount prior to maturity, without penalty.  However, if the CD is ‘In the Money’, the estate also has the option to hold the Structured CD to maturity.

That’s a lot of arguments in favor of Structured Products… Perhaps Structured CD’s are worth another look? The next post in this series will discuss how to use Structured CD’s in your investment portfolio.

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