The lower CD interest rates go, the more desperate people become to do a little better. That can leave consumers vulnerable to scams.
The Financial Industry Regulatory Authority (FINRA) warns that pitches for high-yield CDs are often used to lure people into riskier and more expensive investment products. Hunting for better CD rates is especially important in a low-yield environment, but you should also know what the dangers are.
How CD bait-and-switch works
FINRA advises that some advertisements for high-yield CDs are intended to set customers up for a bait-and-switch. The way it works is that ads for high-yield CDs are used to get customers in the door. It may turn out that the promised "high yield" rate is not really all that special, or applies for a short-term promotional period only, or is artificially inflated by sales incentives designed to get you in the door to hear a pitch.
The salesperson's real goal upon meeting with you is to shift you away from a CD and into other products like annuities. These are high-commission products that are not as safe as CDs. In particular, older people who are dependent on income may be especially vulnerable to this type of sales pitch.
What to watch out for
The problem with this kind of bait-and-switch technique is that it finesses you into buying a financial product that is fundamentally different from what you intended. If your intention is to get the safety of a CD, then here are some things to watch out for if a sales person starts talking about something else.
- Non-guaranteed product. Keep in mind that FDIC-insured banks often also sell investment products that are not insured. So, if you are looking for FDIC insurance, don't assume you automatically get that because you are dealing with an FDIC-insured bank. You need to make sure the specific product you buy is covered. FDIC insurance typically extends to deposit products like saving accounts, money market accounts, and CDs.
- Loss of principal or interest. CDs are designed both to keep your principal safe and to pay you a set rate of interest. In contrast, many investment products may be subject to variations in principal or interest which could result in you losing principal or earning less yield than you intended.
- Uncertain liquidity. CDs are designed to mature on a specified date. Many other investment products do not provide as much certainty of liquidity.
- Excess fees. Annuities and many brokerage products carry high fees and sales commissions. The higher charges like these are, the harder it is for the consumer to earn a decent return.
What to look for when shopping for CDs
In contrast to what to avoid, here is what CD shoppers should be looking for:
- Compare like terms. CD rates vary according to the length of the instrument, so for apples-to-apples comparisons you need to compare CDs which have the same length terms.
- Consider only FDIC-insured products. Don't compare insured and non-insured products, because they have a fundamentally different risk profile. Non-insured products may offer the potential of higher returns, but you also have to be willing to accept the uncertainty.
- Compare rates. Once you are comfortable you are making apples-to-apples comparisons of insured products, by all means compare rates. It can make a big difference.
- Check early withdrawal fees. Another thing to be aware of with CDs is the size of the charge should you need to withdraw your money before the term is up. If all other conditions are roughly equal, a smaller early-withdrawal fee will give you more flexibility should something unexpected come up.
Comparing products can help you find the best CD rates, but it can also have another benefit. The more familiar you are with the market and where rates are generally, the more easily you can spot an offer that stands out because it is too good to be true and deserves to be viewed with caution.