In low interest rate markets such as these, it’s natural to want more. Certificates of deposit (CDs) certainly appear safe, so why not shop around for better deals?
Regulators want you to be forewarned that higher rates may mean higher risk, even with CDs. The Financial Industry Regulatory Authority (FINRA), the largest independent regulator for all securities firms doing business in the United States, warns:
"Higher returns come with a cost. While financial institutions occasionally offer slightly higher than normal rates on CDs, such offers tend to be for (and may be limited to) customers who open a new account. In other instances, a ‘market-linked’ or ‘structured’ CD can legitimately provide potentially higher yields because its performance depends on the performance of a market index or some other benchmark. But, as the Federal Deposit Insurance Corporation explains, this type of CD is risky and complex — and differs significantly from traditional CDs."
What about just plain-vanilla certificates of deposit? FINRA wants you to be alert to dangers there as well.
"Investors should be wary of unsolicited emails and calls that offer outsized interest from financial institutions, including banks and brokerage firms, particularly those with which you have not had a business relationship," warns FINRA in an investor alert issued recently called "High-Yield CDs: Red Flags That Signal a Scam."
Furthermore, don’t be duped by scammers who pose as representatives of legitimate firms. "Never provide personal information or authorize any transfer of funds to any unknown person who emails or calls you or to any institution that you have not checked out," warns FINRA.
How do you protect yourself? Quoting from the investor alert, here are red flags to watch out for:
• Interest rates that are significantly higher than average.
• Emails with addresses that are not originated and sent by the financial institution that is cited in the promotion.
• Emails that contain misspellings or grammatical errors.
• Promotions that claim to be from a U.S. financial institution that has aligned with an international bank.
• Promotions that claim to be for a ‘limited time only.’
• Promotions that claim to be directed at ‘best customers’ and that require extremely high minimum investments (for example, $100,000 U.S. dollars)."
If you are itching to go ahead, FINRA suggests asking these questions, adapted from FINRA’s "The Grass Isn’t Always Greener — Chasing Return in a Challenging Investment Environment."
• Is the higher yielding CD risky? "The promise of higher return is almost always associated with greater risk and an increased possibility of investment losses," says FINRA.
• How does the CD work? If you do not fully understand how your investments function, you could find yourself surprised by outcomes you didn’t expect, such as illiquidity, exit fees, loss of principal or the return of your investment in a form other than cash.
• What are the fees? "Not only is the promise of higher return associated with greater risk, but some of these investments have higher costs as well."
• Is the CD callable? "Some investments are callable after a period of time, which means that the issuer can redeem the investment prior to the investment reaching maturity. ... [If the CD is called] you may find it difficult or impossible to find an equivalent investment paying rates as high as the original rate, a phenomenon known as reinvestment risk. "
• Could the CD be fraudulent? "Always independently verify who you are dealing with and whether the seller of the investment is licensed to do business with you."
Before you decide to buy a higher-yielding CD, take the time to educate yourself. FINRA’s resources are a good starting point. Go to www.finra.org. Search for "certificates of deposit," then narrow your search category to "investors."
Some higher-yielding CDs are legitimate investments that are suitable for those who do their research and understand how the more-complex products work. Some are simply frauds. Just in case you believe that you’ll never be approached by a fraudster, consider this: A FINRA study found that eight in 10 people were solicited to participate in a potentially fraudulent offer. The report, "Financial Fraud and Fraud Susceptibility in the United States," was published in September 2013 based on a 2012 national survey by FINRA’s Investor Education Foundation, which you can find at http://tinyurl.com/ohubpx7
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/comments (firstname.lastname@example.org).
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