Financial Q&A: Callable CDs promise higher returns but carry more risk
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Q: What is a callable leveraged spread CD? Is it a safe investment?
J.H., via e-mail
A: Callable CDs are a variation on the traditional certificate of deposit theme. At their onset, they typically pay a considerably higher interest rate than traditional CDs, but they also carry extra risks.
Rita Cheng, a financial planner in Bethesda, Md., says that these CDs are issued by banks and carry FDIC insurance. They commit your cash for a specific period of time – often a decade or longer. But they can be redeemed, or "called," by the issuer prior their maturity. The terms of the CD will stipulate when the redemption can occur, which can be anytime after the call protection period expires.
Further, after the interest rate period lapses on a callable leveraged spread CD, the rate varies. The value of the CD will then depend on that new interest rate, which is based on a special, complicated calculation called a spread, Ms. Cheng says.
The investor thus assumes the interest-rate risk with a callable leveraged spread CD, says Cheng. The principal may be protected only if the CD is held to maturity, so these CDs aren't suitable for savers with a short investment time horizon. Those who are wary of their inherent uncertainties would be wise to steer clear, as well, she says.