Are CDs from Troubled Banks Worth The Trouble?
By David Dierking
My folks are retired. They have been for a good ten years now and in between travelling and soaking in the warm weather, they do their best to manage their investment portfolio to fund their retirement plans.
They try to maintain a relatively safe portfolio that provides at least a decent return on their money but with savings account rates as low as they have been lately they’re having trouble finding it. So they’ve found a new hobby in their retirement – yield chasing.
I had a conversation with my parents the other day and they told me that the banks for which three of the CDs they owned were issued from had gone under. These CDs offered some of the highest yields out there but were issued by later failed banks that needed to offer abnormally high rates in order to attract deposits (remember WaMu and what it did shortly before going bankrupt?). So the fact that the banks went under wasn’t necessarily surprising.
The logic my parents used for investing in CDs did catch me a little off guard though. They said that since their deposit was FDIC insured and since their broker had their investment back in their account within a matter of several days, there was virtually no downside to investing in this manner. In fact, they believed that more people should put their money in “junk CDs”.
Could they be right? If the investment is guaranteed by the FDIC then you can’t really lose your money on it. Why not go for the highest yield?
You should be careful for a few reasons actually but most notably because a deal like this is almost never as simple as it sounds. Investing in a CD from a troubled bank entails risks that don’t normally come with a CD from a highly rated institution.
First, you should always be cautious of what it is that you’re actually putting your money into. Some companies will sell potential clients on securities billed as certificates of deposit only for the customer to discover later that the deposit is not FDIC insured (as people who invested their money with Stanford Financial found out the hard way last year). Any security with a much higher than average rate should be met with a healthy dose of skepticism.
Additionally, the rate being offered could be just a short-term teaser rate. I’ve heard cases of banks offering high teaser rates only to see the yield drop after a short period of time and suddenly you as the investor are locked in. Make sure you know how long you’ll receive the advertised rate before committing your money.
Also consider the fact that if the bank you purchase a CD from does in fact go under, how long it will take you to get your original investment back. In the case of my parents, they say they’ve gotten their investment back in a matter of several days but once the FDIC takes control of the assets it could take three months or longer for you to get that money back. Money that you may need quickly or use for monthly expenses doesn’t belong in a product like this.
The key with this (and every other investment you consider) is to know exactly what you’re buying. CDs from troubled banks are not the riskless assets that some might tell you they are just because they carry FDIC protection. There is some downside to them but if you do your homework, you could find a place for them in your portfolio.
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