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Financial Q&A: Callable CDs promise higher returns but carry more risk

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Q:

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.

Q:

R.Q., San Francisco

A: If your only goal is to avoid paying fees for service, then you may have eliminated that part with the deferred annuity. But rest assured that this annuity carries a commission, which will be paid to the person who's advising you.

Nicholas Yrizarry, a certified financial planner in Reston, Va., strongly suggests that before you commit to this annuity you consult with someone who can deliver some objective advice. "The reason I stress this is that I have yet to see an annuity that has a guarantee for life that doesn't have some other tradeoffs," he warns.

Mr. Yrizarry says that he often see advisers who claim there's a lifetime 7 percent income, but when you read the fine print, that's actually not the case. And with the fee issue, he often sees advisers who may not be able to justify their fee either by service or performance. Or they may have simply not communicated their actual value very well.

Lastly, says Yrizarry, you may want to leave money to heirs. That won't happen with this type of investment.


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