There's more than one way to buy a CD
When the North American Securities Administrators Association announced its top investor traps to watch out for in 2006, there were the usual suspects.
On the list again this year were ''prime bank schemes." These are sophisticated scams in which con artists promise high-yield, tax-free returns that are said to result from ''off-shore trades of bank debentures." Investors are told that they are lucky to be privy to such information since only the rich know about such practically risk-free investments.
Need I say there are no such prime bank investments offering high-yield rates. This is a straight-up con.
The association warns investors to watch out for schemes in which promoters offer great returns if you buy pay phones or ATMs.
In order to make the deal more attractive, investors are told that after a given period, the equipment can be sold back to the seller at the investor's purchase price.
Also on the list is a product that could easily confuse investors. Ever hear of an equity-indexed certificate of deposit?
The association is particularly concerned that many seniors will confuse equity-indexed CDs with the older, completely federally insured cousin, the traditional certificate of deposit. They're not.
These hybrid securities products offer a return that is based on a certain stock market index, usually the S&P 500. Although your principal is FDIC-insured, your return is not. Instead, your return is dependent on the performance of the specific index. In fact, you could get no return at all on your investment.
The association advises that this is not suitable for seniors who may need a guaranteed return for retirement expenses.
''The pace of innovation in financial services is ever increasing," said Patricia D. Struck, the association's president and Wisconsin securities administrator. ''There is a new hook weekly."
Investors may now choose among variable-rate CDs, jumbo CDs, callable CDs, and CDs with other special features. These CDs pose greater risks to investors.
Struck said she's concerned that with equity-indexed CDs, people will just hear ''certificate of deposit" and not understand exactly what they are getting.
''The risk isn't the product but the way it's marketed," she said.
The warning about equity-indexed CDs should be heeded for other hybrid CDs as well, Struck said.
For example, the association says seniors should be careful about buying callable CDs. Many elderly investors have been complaining they've been misled into buying these certificates with up to 30-year maturities, according to state securities regulators.
Callable CDs often have higher yields than traditional bank-issued CDs because they require a 10-, 20- or even 30-year investment commitment. You can withdraw your money from this type of CD, but you pay a high penalty for doing so. Redeeming the CD early may result in large losses -- as much 30 percent of the investment in some cases, according to the association.
Investors also often don't realize that with callable CDs, only the issuer can ''call," or redeem, the CD. A bank might decide to call its high-yield CDs if interest rates fall. But if you've invested in a long-term CD and interest rates subsequently rise, you'll be locked in at the lower rate.
Before purchasing a callable CD, go through a 13-question checklist prepared by the association. Go to www.nasaa.org/content/Files/CallableCD.pdf for the checklist.
For instance, one question asks you to confirm when your CD matures. A lot of consumers -- when they need their money -- realize too late they've got a CD with a longer maturity date than they thought.
Another question you are urged to answer is how the CD is held. It used to be you just bought a CD from a bank or savings institution.
But now many brokerage firms and independent salespeople offer CDs.
The association called its investor warning list this year the ''Unlucky 13." Really, you don't need luck to avoid being duped into investing your money in an inappropriate product. Just inform yourself.
Michelle Singletary is a columnist for The Washington Post. 