They’re called stock-indexed CDs. The rate you earn from the bank depends on how well the stock market performs over the next year to five years.
If there’s a big rise in stock prices, you make out like a bandit. But if stocks take a dive, you could even lose part of your principal.
Who’s selling stock-indexed CDs? Only a handful of banks. The idea is spreading because people are fed up with earning 2 percent on their CDs while they watch stock prices soar.
Know this before you gamble with stock-linked accounts:
– They’re not for everybody. You need stock-market savvy and/or extra cash to burn before diddling with these investments.
– Your rate of return is based on how well the Standard & Poor’s 500 index does over time. And that rate is determined by complicated formulas that differ from bank to bank.
– The accounts are FDIC-insured for up to $100,000 per person. But at some outfits, the percentage of your principal that is protected (in the event the market goes down) is related to the profit formula you choose.
So make sure to check on the amount of principal protected before you invest.
– You can often open the accounts from out of state, usually for $1,000 to $10,000. Stock-indexed CDs are restricted to IRAs, SEPs and Keoghs at Citibank offices nationally (800-321-2484) and at Republic National Bank, New York (800-522-5214), and at Mellon Bank, Pittsburgh (800-801-2257).
– But the trend is toward non-retirement, stock-indexed CDs, such as those offered by Great Western Bank, with offices in California and Florida (800-537-7197), and NationsBank, the Southern giant (800-400-7616).
Charter One Bank, Cleveland (216-566-5300), limits its $500-minimum account to local customers, but the CD is available as both a retirement and non-retirement CD.
– Some banks pay you interest only when the CD matures; others, such as Great Western, NationsBank and Charter One, pay every year.
OK, so how well would you have done had you bought these stock-indexed creatures in the past?
Citibank boasts that under the best of circumstances in the 1980s, its five-year CD would have yielded an average of 25.4 percent per year. By comparison, the highest-yielding regular CDs of that decade returned an annual average of nearly 19 percent over five years.
NationsBank quotes an average annual yield of 7.19 percent over a recent five-year period and Great Western claims 10.88 percent over the last three years. But let’s look at what might happen starting this month. If the S&P 500 went up 10 percent every month for the next five years, the Citibank CD would return a grand total of 57 percent.
Over the same time period, the Great Western and NationsBank’s CDs would pay you 50 percent, not including interest you might get from investing the interest paid out annually.
In contrast, a plain-vanilla five-year CD opened Nov. 1 would earn a total of 25.5 percent, assuming you left all interest on deposit. The highest-yielding CD from our “100 Highest Yields” survey would return 31 percent. Remember, these high numbers are the total interest over the life of the CD.
What if the market went flat or consistently went down each of the next five years? All but one of the stock-indexed CDs would pay zip, as in $0.00.
Republic National Bank has an option that promises a minimum 1 percent return each year, so you’d get 5 percent if the market dropped. With the bank’s other plan, which pays more of the S&P increase, you’d get nothing.
Stock-indexed CDs were around before, in the summer of 1987 when the stock market was racing upward. The market crashed Oct. 19 that year, with the S&P 500 plunging nearly 58 points, a 20 percent decline.
As you might have guessed, stock-indexed CD promoters ran for the hills and didn’t come back until the past year. The same thing could happen again if stocks take a tumble. That’s the gamble. Do you want to risk your hard-earned money in an investment that may yield zero, and perhaps eat into your principal? Or are you the type of person who’ll roll the dice in hopes the S&P 500 will go up some more?
