Structured CDs are certificates of deposit whose returns are variable because they are linked to the future performance of a market index. Regular CDs typically have fixed interest rates, which continue to remain low. This has generated more interest in structured CDs, which have the potential for higher returns for investors.
Possible Loss of Principal
A structured CD is essentially a derivative, or an investment whose value is based on the performance of underlying assets, such as stocks, bonds, commodities and foreign currency. Structured CDs differ from regular CDs. Although you may earn more interest than with a regular CD, for example, you may also lose your principal. Even the way returns are calculated may differ. Banks have great flexibility in setting the terms of structured CDs, and they can offer many variations.
Structured CDs have limited liquidity. It's more difficult to cash out of them than with regular CDs. The return of your principal is guaranteed only if you hold the CD until it matures. Even so, it's possible you may not earn anything for the entire term of the CD, depending on the associated market index. You should not commit any funds you may need before the CD matures.
Do not assume your principal is guaranteed by the Federal Deposit Insurance Corporation, as a regular CD is. If the bank fails, you lose your money if your principal is subject to loss because of the specific terms of your structured CD. Even if your contract allows you to sell your CD before maturity, you may have to sell at a loss, according to the FDIC. Also, some structured CDs are "callable"; this means a bank can close an account early when interest rates fall, preventing you from benefiting from higher rates the CD would otherwise pay you.
Structured CDs can have complex terms. They may have fees, valuations and payouts that are comprehensible to professional investors but are difficult for the average investor to comprehend. Tax consequences can be unpleasant. For example, you may have to declare interest income on your annual tax return even though you don't actually receive the interest until the CD matures.
Lexa W. Lee is a New Orleans-based writer with more than 20 years of experience. She has contributed to "Central Nervous System News" and the "Journal of Naturopathic Medicine," as well as several online publications. Lee holds a Bachelor of Science in biology from Reed College, a naturopathic medical degree from the National College of Naturopathic Medicine and served as a postdoctoral researcher in immunology.