Index Powered CD Review: Stock Performance + Bank Safety?

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How would you like to get returns linked to the S&P 500, with no chance of losing a penny? You can with the Index Powered CD, a certificate of deposit being sold by a variety of smaller banks including Brentwood Bank. While the concept has been around for a while, it has been enjoying renewed popularity was people continue watching their 401(k)s shrink. Unfortunately, this is yet another product that uses clever marketing to hide important details from the less vigilant public. Here’s the pitch:

“Enjoy the stock market’s ups and not fret about the downs”!

The Index Powered® CD is a new FDIC insured certificate of deposit tied to Standard & Poor’s 500 Index. The Index Powered® CD was developed with today’s investor in mind and is available exclusively through community institutions. Enjoy the peace of mind of having your principal guaranteed and FDIC insured (up to $100,000.) while offering the potential higher returns of the stock market.

What The Average Person Thinks This Means
If the S&P 500 goes up a lot, I’ll match that return. If the S&P 500 drops – hey! – I’m FDIC insured so I can’t lose my money. Sign me up!! Let’s say this is a 1-year CD and here are the values of the S&P 500 for that year.

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It starts at 100 and ends at 108, so you would expect your CD with a “100% Market Participation Factor” to return… 8%, right? Unfortunately, if you spend the time to read the 17-page disclosure statement, you’ll see that it is not true. To put it bluntly, they manipulate the definitions to their advantage.

What It Really Means!
The problem is that I can say something is “tied to the S&P 500” or “linked to the S&P 500” without actually getting the full return. While they tweak many of the definitions, in particular this sticks out. “Closing Market Value” is defined as “the arithmetic average of the closing values of the S&P 500 Index on the Pricing Dates.” This changes everything. Using the example above again we’ll use the values given:

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By their definition, the “closing market value” was 103.4, and your starting value was 100. (Yes, the 100 is included in the average!) So your actual return would be a piddly 3.4%. Not exactly what you expected, huh?

And you know what? The S&P 500 Index they use doesn’t include dividends! That’s another 2% of annual return you’re missing out on.

There is no free lunch here. Not only do you on average less than half of the actual S&P 500 return if it does well, you also risk getting much less interest than a conventional fixed-rate CD if it does poorly. You cannot eliminate downside risk without giving up upside potential. Finally, this is actually a 51-month CD with heavy early-withdrawal penalties.

(For those that like “efficient” portfolios and optimizing risk/reward, here you are essentially taking on added volatility with no increase in expected average return. See my comment below for more details.)

Get your goals straightened out. Either you (1) have a short-term horizon with low risk tolerance and should get a conventional bank CD with a fixed guaranteed rate, or you (2) have a long-term horizon and are willing to accept the risk and full return of a S&P 500 index fund. Even if you don’t want to be 100% S&P 500 index and want less volatility, using a mixture of stocks and bonds would be the a much more cost-effective way of achieving this.

Again, I’ll avoid the word “scam” because this is technically a legal product, but the best weapon against such products is education. Know what you are buying and tell others!

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Comments

  1. Aurelien says:

    Excellent post. I remember seeing something like this a few years ago when an older friend of mine was interested in it, and while I couldn’t figure out what the catch was at the time, it seemed to good to be true so I made sure my friend didn’t invest in it.

  2. I believe products like these border on criminal. At the very least, they should be required to put a fat disclaimer on the first page stating the product calculates its return differently than what most people would assume. In my opinion, there is nobody anywhere on the planet who this CD is appropriate for.

  3. ongrowthtrack says:

    Very nice post, its best to stick with reliable names in the industry and know the risk by educating oneself, there is not shortcut to that.

  4. So in essence the only thing this protects you from is actually losing money (not counting inflation). Do they have a minimum return? Or could it be something like 0.1%?

  5. Structured products – these exotic hybrids are the ‘next’ can’t fail investment vehicle usually for the high net worth investor that is being packaged for the retail market. These investments are not for the average even pretty savvy investor as the tax treatment and the real risk reward trade-offs are confusing with alot of them carry a warning that there is currently no IRS ruling on the investment.

    Investor beware, do a search on structured investments / products for more information particularly about the ‘push’ into retail investorsphere.

  6. The return on this sounds like it could be sketchy…. is it worth the complication just to make sure not to lose money short term?

  7. Here’s a link for the term sheet for a S&P linked CD

    http://reports.incapnet.com/incap_pdfs/104261_opoffer_115531.pdf

  8. There are some annuities like this that aren’t as complicated in their returns. Mostly, they are capped for maximum return. They pay out a minimum interest per year even if the market loses. They have the tax benefits of annuities. However, they can have a high expense fee per year. They’re not a bad product if your time horizon is shrinking for retirement and you can’t stand to lose any of the money you’re putting away.

  9. This is how EverBank does their MarketSafe CDs. They have been doing them for a few years now and the most common one seems to be a Gold or Silver Bullion one. I have also seen a Japanese REIT one. They are long term (5 years previously and currently 7 years) for the Gold one. But the EverBank ones seem to be more of a speculative type product. Nothing linked to an index of the basic stock market. I’ll admit I did a $1,500 gold one about a year ago. I basically did it because i was too scared to actually get into real gold. So in the end, I won’t win as much as being in the “true” market (if it continues its current trend), but at least i got my feet wet with some decent returns with a guarantee of no losses. I’m content for now. PS. The formula for calcing returns was right on the EverBank product sheet, so no hidden “oops”.

  10. Jonathan,
    I know u are are smart nut.Can I ask u who did u get ur mortgage from and at what rates?
    I would like your post on who u went with and why.
    Let me know or write on it.It will help others.
    U r doing a good job keep this blog running.

  11. Excellent post. I went through this exact process of revelation about market-linked CD’s. Although there was one product by Everbank back in 2004 (?) that was better – instead of putting the floor at 0% (that you don’t lose your pricipal), it put the floor at 5%. That was an excellent deal. I hope Everbank brings that back when the interest rate climate imporves.

  12. I believe the minimum return on the Brentwood CD is 1.61% APY. Keep in mind that this is a 4-year 3-month CD, which is relatively long. That’s 7% total return over 51 months.

    You can get about 4.25% APY right now for a fixed-rate CD. This would equal 19.35% total return over 51 months.

    If we assume any increase in S&P 500 rises linearly (this is not necessarily a good idea, but it does make a simplified approximation), then the S&P 500 not including dividends must return 8% each year for the next 51 months in order to match this rate. So including dividends, it must return 10% annually. Anything less than 10%, and you would have been better off with the guaranteed CD.

    Essentially, you are taking on additional volatility for no extra expected return. I would say the expected return has actually decreased with this product. Usually, if you are going to risk ups and downs, you get compensated with higher expected returns, as the case with a “real” S&P 500 index fund over 15+ years.

  13. I make it a point to not buy investment-type products from banks.

  14. toasty aroma says:

    if I was a bank, I’d be trying to borrow people’s money too. It’s a win-win situation. If I get 8%, I give you 3.4% and keep the remaining 4.6. If I lose, bailout Ben will dig me out of the hole with taxpayer dollars and everything will be peachy!

  15. Feedback Secrets says:

    Good post, considering a lot of investors have no clue as to where should they put their money now’s that both real estate and property market are going down in flames.

  16. OK – so nothing is perfect. This product, with which I am familiar, went through very rigorous FDIC scrutiny and an approval process before it was allowed. Still no guarantee.

    However if you purchased this CD about 5 years ago when it first was introduced, your return over the 5 year period was around 50%!! And no, I am not affiliated in any way with this company and its various FDIC bank agents.

    This product is hedged through the securities markets to provide stability and does have a minimum rate guarantee.

  17. 50% over 5 years is only 8.4% annualized. Not that impressive, using total returns only inflates values, so it is more objective to stick to annual ones. I say not impressive because:

    1) Do you remember what money market rates were back then? They were around 6% annually.

    2) And how much would have an S&P 500 mutual fund returned over that time? Well over 15% annually during the same period.

    Hedging always comes at a cost, and the cost for this product is high.

  18. You are correct, education is key, why then do you only educate one side of the equation? If the market falls after you have saved for a period of time (in a point to point investment) you can lose your savings. You can never loose a penny with this deposit if you hold it to maturity. You don’t need protection if the market always increases. You want protection if it decreases. This product is safe and it still has upside potential. It is not point to point with risk. The definitions are clear. Banks are safe. So is the Index Powered CD.

  19. You’ll never lose a penny, but getting 0% or 1.6% is still not a good thing if you could have gotten 4%+ risk free.

    The fact is, as long as it is clear you only get less than half the actual return of the S&P 500 on average, I wouldn’t need to criticize this investment. But it’s not, and that is what I am primarily trying to make clear.

  20. The fact is from June 96 to June 2001 would have earned 13. 53%apy with S&P 12.8 Dec 99 to Dec 2004 IPCD no return, S&P lost 3.12%. You may get less, you may get more, but it is not a fact that you get less than half. It is a good alternative to fixed rates if you want no loss.

  21. What do you think of the index cd now?

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