Aggressive advertising and telemarketing campaigns are now being
mounted to lure consumer into a variety of so called "CD alternatives,"
even though some of the investment options being promoted are risky,
complex and unsuitable for many of those to whom they are being
pitched. The Securities Division of the Florida Comptroller's Office
has noted: "Scam artists see this as an easy time to dupe unwary
investors...They can promise a plausible-sounding return of 10 percent,
rather than an astronomical rate of return of 40 percent or even more
to lure money into their investment vehicle. Investors may not realize
for months or even years that they have been taken."
Lower interest rates and returns strike particularly hard at the
elderly and those with fixed incomes. It is not uncommon to find
situations where a retiree who received $600 a month in interest income
last year now takes in only half as much each month. Such precipitous
fall offs in household income will trigger tighter budgeting and an
increasing and perhaps unwise willingness to take on more risk.
If consumers are not rolling over CDs as they once did, where is all
of the money going? An increasing number of consumers are taking on
more risk by moving into stocks, bonds, mutual funds, fixed income insurance products such as
annuities and other investment vehicles. Indeed, almost any investment
product may be marketed as a CD alternative.
When considering putting your money in one of the many CD
alternatives, recognize that not all products offered by or through
banks are insured. Banks are now going to great lengths to hold onto
deposits, including offering investment and insurance services through
affiliates and subsidiaries, If you decide to use such services. always
keep in mind that while the financial institution's deposits and some
instruments (e.g., CDs) are government-insured, the same is not true
when it comes to the bank's brokerage and insurance services. Even if
the same person you have been dealing with for years on insured CDs
suddenly encourages you to switch into mutual funds or annuities, this
does not mean that such investments are either safe or a good fit for
you. Above all, do not assume that just because you are dealing with a
bank, the investment product is as safe as a CD or that no fees and
charges will be imposed.
"Blue Chip" Stocks.
Throughout the recent recession and painfully slow recovery, the
stock market has performed well. And "blue chip" stocks of big,
reliable and historically sound companies have kept the pace. Investors
seeking to improve on 3 percent CD returns are often quoted 20 percent
returns on blue chips by stock brokers. But remember, past performance
is no guarantee of future results, and investment in stocks, no matter
how prestigious, involves a direct risk to principal.
Mutual Funds
Mutual Funds, on the other hand, can minimize the risks of buying
stocks to a degree through their reliance on the fund managers'
expertise in buying and selling a variety of securities. Diversified
funds, in which the fund managers invest the funds' assets among
different sectors of the economy, lessen the risk of losing big during
a dramatic downturn in one part of the economy or stock market. Keep in
mind, however, that no matter how well a particular fund has done in
the past, things can change, and your principal is still at risk in
stock, bond or combination funds.
Corporate Bonds.
Long the favorite of conservative investors and exemplified in
modern folklore by the picture of the wealthy dowager clipping coupons
in the quiet of a safe deposit vault, corporate bonds often pay better
returns than CDs. But there are all types of corporate bonds, from the
risky and volatile "junk" bonds to relatively safer Investment grade
bonds issued by "blue chip" companies. No matter what corporate bond
you buy, there is always the risk that its value will decrease in a
falling bond market (When interest rates go up, bond prices tend to
fall, and vice versa.) In recent years a number of "junk" bonds have
defaulted leaving investors with only a fraction of their original
investments.
Collateralized Mortgage Obligations
Collateralized Mortgage Obligations(CMOs) have been highly touted as
CD alternatives because of their relatively high yields. CMOs are
bundles of home loans, many backed by the Federal Housing
Administration (FHA) or the Veterans Administration. Holders of
"tranches" (slices) of these mortgage backed certificates receive their
share of the mortgage payments of the homeowners. While you can't lose
principal if the CMO is backed by government guaranteed mortgages,
there is considerable risk in terms of interest rates, time of maturity
and liquidity. CMOs are complex and, in many cases, big, institutional
investors have better access to information on them than is available
to individual investors. This can lead to difficulty in competing with
the big players for the higher grade CMOs. These investments require
caution and should be bought only with the advice of a neutral
investment professional.
Foreign CDs.
While CDs offered in foreign countries can be legitimate, you should
always be aware of the effect exchange rate fluctuations can have on
your investment and investigate all risks. In many instances, con
artists seeking to capitalize on the sometimes desperate search for
something to replace low paying domestic CDs have pushed bogus foreign
CDs on unwary investors. These often come from so called brassplate
banks In the Bahamas, West Indies and some Pacific island
'micronations' such as Nauru and Vanuatu. Typically these schemes claim
to offer the equivalent of an overseas CD with sky high Interest rates
(15% and up) and zero risk. In one case in the Marshall Islands in the
Pacific, investigators found that the 'institution' was a gas station.
The gas jockey received the mailed in deposits of Americans and mailed
them back to the U.S. con artist who deposited the funds in his own
account. The scammer eventually fled to Asia when the scheme unraveled.
U.S. Savings Bonds
U.S. Savings Bonds, long ignored by investors, have lately become a
popular investment for safety minded CD holders looking to increase
their incomes. At present, they offer relatively high rates and are
exempt from state taxes. Series EE bonds held for five years will yield
6 percent and can be quite attractive when compared to 3 percent yields
of government insured bank CDs.
Avoiding Pitfalls
Know how much risk you are willing to assume. Moving away from
government-insured bank instruments is a big step for individuals who
are averse to exposing their principal to any risk. Keep in mind this
simple trade off: The greater the potential income from your
investment, the more you sacrifice the safety of your principal. If you
cannot afford to lose all or some portion of the money you have to
invest, it may be unwise to give up safety, no matter how tempting the
promised or projected returns.
Understand your investment objectives and act accordingly. The flip
side of the risk "coin" is that some investors are overly cautious and,
as a result, undercut the likelihood that they will be able to meet
their investment objectives. All risk is not equal and all risks are
not bad. If you require assistance in determining how best to meet your
investment objectives, consider seeking the advice of a professional,
such as an accountant or investment adviser. Always check out the
background of all investment advisers and financial planners with your
state securities division and Better Business Bureau (BBB).
Know your potential investment if you are thinking about buying a
security (such as a stock, bond or mutual fund), ask for and read the
prospectus before investing. Identify and understand the risks
associated with each investment. In particular, read carefully all
information about price, liquidity, fees, tax implications, etc. Keep
in mind that mutual funds, annuities, unit investment trusts and most
other securities are not protected by federal deposit insurance.
Deal only with reputable firms and individuals. Always exercise
caution when it comes to the handling of your money. Take the time to
do your homework and check out the background of all securities firms
and professionals. Your state securities division has disciplinary and
other information available about all licensed brokerage firms and
individual brokers. For the telephone number of your state securities
division, contact the North American Securities Administrators
Association (NASAA) at 202/737 0900.
The BBB in your city or area maintains records of consumer complaints on many businesses and promotions.
Shop around before settling on a brokerage firm and individual
broker. While it is relatively easy to shop around for the best deal on
CDs, do not assume that it will be as easy to identify the best deal on
brokerage or insurance services. For example, the commissions that
stock brokers charge are not fixed and can fluctuate widely, even among
discount brokerage firms. "Loads" and other costs involved in mutual
funds also may be dramatically different. Make sure you understand not
only the investment you are contemplating, but also how much and
exactly how you will be charged for the services of the brokerage or
insurance firm involved.
If You Decide to Stay with CDs...
You may well decide to sit tight and keep your money in CDs. If you
do, watch out for "special deals" that banks will advertise
periodically in which CDs will be offered at 2 or 3 rate points above
the average of other financial institutions. What is going on here is
quite simple: The banks offering the deal have short-term capital needs
that require quick infusions of time deposits. Some high-rate offers,
however, may be available for as little as a week or two. Others may be
linked to the future of interest rate movements or other circumstances.
Make sure that you fully understand the conditions and special
features of any "special" CD deal in which you may place your funds.
Some consumers shop CD rates in other cities. Barron's and the Wall
Street Journal publish weekly lists of top yielding CDs at institutions
around the nation. Keep in mind that you must move quickly when dealing
with a distant financial institution. Rates can fluctuate daily and so
mailing a check may mean that a different rate will prevail when your
money arrives. (Even wiring funds is no guarantee that you will lock in
a specific rate, since electronic transfers that take place in the mid-
or late afternoon may not be processed on the other end until the next
business day.) Recognize that it may be somewhat more difficult to
monitor the health of a distant financial institution, since you will
not have ready access to news reports about the local economy and the
financial posture of the financial institution with which you are
dealing. However, if you are careful to keep your principal and
interest under $90,000 (so your total will not exceed the $100,000
federal insurance limit), your funds will be secure.
