The real story behind high-yield CDs
The offer is amazing, but there it is. Plain as day, a newspaper advertisement offers an FDIC-insured certificate of deposit. It's a big, bottom-corner ad with "5.5 percent" in huge bold type. The ad also contains a reassuring Better Business Bureau logo, two phone numbers and some fine print.
Is this a great country or what? Millions of people are watching their retirement income dwindle and disappear. Yields on safe savings have gone from puny to pathetic. Then a courageous businessperson finds the Lost Mine of Good CD Yields and shares it with the long-suffering public.
If you don't think about money all the time, you may not appreciate how amazing this offer is. So let me fill you in. If you take your savings to Wells Fargo and put your money in its shortest-term CD offer, currently a 0.01 percent annual percentage yield for a six-month term, you'll need to keep your money there for quite a while to earn the same amount as you'll earn in three months from the kind source with the Better Business Bureau stamp of approval.
Quite a while, in this case, is a cosmic understatement. If you invest $10,000 in the 5.5 percent CD, you'll earn $137.50 in interest over three months. If you invest $10,000 in the 0.01 percent CD from Wells Fargo, you'll earn $1 in a year. So it will take 137 years and six months to earn the same amount, not counting the itsy-bitsy benefit of compounding over a century.
The offers from Uncle Sam are no better. Three-month U.S. Treasury bills currently yield 0.01 percent. So it will take the same 137 years to earn the same amount of interest as you can earn in three months with this magical CD. Just for perspective, the longest-living person in history was Jeanne Calment, a French woman who died in 1997 at 122 years, 164 days. Even she could not have held a Treasury bill at current yield long enough to earn the interest this fabulous CD will earn in three months.
So if you want to invest your money safely, this newspaper ad is the way to go, right?
Well, let's not be hasty. Let's look a little further afield. The largest exchange-traded fund that invests in junk bonds, the BlackRock iShares High Yield Corporate Bond Fund (ticker HYG), recently provided a yield of 5.46 percent over the last 12 months. Morningstar notes that its current SEC measured yield is 5.66 percent.
So, if you're willing to give up those silly FDIC guarantees, you can get the same yield in a $14.2 billion pile of junk bonds as this amazing CD offer. But if that level of risk is what it takes to get a 5.5 percent market yield, maybe we ought to be asking some other questions.
Like, how is this possible? Why do they do it? How do they do it?
The answer is simple. This is a prospecting ad. The business that pays for the advertisement is prospecting for people with money who are hungry for yields that are simply not available, with safety, in the current market.
The same business is also willing, if necessary, to subsidize the interest on the CD so that it calculates to 5.5 percent. That might cost $137.25, more or less, for a $10,000 CD. Is that a lot of money to secure a prospect?
Not really. It may be pretty close to the all-in cost of that free steak dinner offer you may have found in your mailbox last month. The whole idea is to get people through the door so they can be sold. Trust me, if they didn't get their prospecting money back, they wouldn't do it.
If you make the call, you won't be able to get any information until you speak with an agent. And there is a pretty good chance that you'll never hear about the 5.5 percent three-month CD because the agent will have something else that fits your needs "perfectly."
It will be an insurance product.
Some people would call this bait-and-switch. The real pitch isn't for anything like a CD. It will be for an insurance product that will tie up your money, usually with unseen fees.
So tell me this. Do you think "advice" that starts with bait-and-switch deserves your trust? No way.
On the Web:
• Scott Burns, "Beware of Special Places With High Yields" (7/9/2010): assetbuilder.com/scott_burns/beware_of_special_places_with_high_yields
• Scott Burns, "What's Behind Those High-Yield Advertisements?" (5/16/99): assetbuilder.com/scott_burns/whats_behind_those_high_yield_advertisements
• Ken Tumin, "Very High CD Rates Advertised in Newspapers - Are They Real?" (8/23/2010): depositaccounts.com/blog/very-high-cd-rates-advertised-in-newspapers-are-they-real.html
• Scott Burns is a principal of the Plano, Texas-based investment firm AssetBuilder Inc., a registered investment adviser.
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