Q: I have a few certificates of deposit maturing soon. Two different banks have suggested eight-year fixed annuities from the same insurance company. I do not need the money for maybe 10 or more years. Are they as safe as CDs?
A: No, they aren’t as safe as bank certificates of deposit because the FDIC does not insure them. They are as good as the general account of the issuing insurance company and the state guarantee fund in the state in which the contract is issued. That’s pretty good, depending on the financial rating of the issuing insurance company, but not as good as FDIC insurance.
That’s one of the reasons many of these instruments now offer somewhat higher yields than comparable maturity bank certificates of deposit. Since the interest is tax-deferred, this is a good way to exercise some control over your income tax bill. You should be aware that the banks are earning a commission on this transaction, and that is their primary motivation, not your safety.
Q: My wife and I own about a million dollars in call-able CDs that have been devalued by our brokerage firm. These CDs are FDIC-insured. They pay 2.7 percent to 3 percent monthly. The maturity dates are between 2032 and 2037. Our statement showed they had been devalued from 9 percent to 15 percent, but when I attempted to sell two CDs, the broker said they are now devalued by 25 percent. I was willing to take the 10 percent hit, but it is hard to accept a 25 percent reduction. I understand bond values go down when interest rates tick up, but was not aware that these long-term CDs would be so devalued with only a 100 basis point rise (or 1 percent) in interest rates. We don’t need to liquidate all of these CDs, but we would like to liquidate a few of them. Are we doomed to a continued drop in their values as interest rates rise over the next few years?
A: I assume you meant an annual yield of 2.7 to 3 percent, paid monthly. Most recent yields on 10- and 20-year Treasury obligations range from 2.5 percent to 3.25 percent, somewhat more than the yields on your CDs. So you would expect some amount of devaluation. The question is how much?
The payment you should receive would be the calculated value of a lower coupon instrument in a higher coupon market, less a dealer bid/ask spread. With marketable broker-sold CDs, these spreads can be painfully wide. A total of 25 percent would be considered rapaciously wide.
You can understand this by using one of the online websites that will calculate the market value of any bond in different yield environments. On www.free-online-calculator-use.com/bond-value-calculator.html, for instance, I found that the value of a $1,000 CD at 2.5 percent with monthly interest and with 14 years to maturity would be worth $915.73 in a 3.25 percent environment. So today’s interest rates reduce the value of the CD by about 8.4 percent. Any greater amount is due to a combination of low-ball offers and/or a very high dealer spread.
What can you do? The first thing you can do is decline to sell. This isn’t out of spite; it is rational. If your $1,000 CD were priced rationally at $750, it would reflect a yield environment of 5 percent, nearly double current rates. The second thing you can do is visit your brokerage office and ask them to explain why the offers are so low. You may get no satisfaction, but at least you can make a few front office people squirm.
(Follow-up: This reader did visit his broker and was told there were no bids at the time of their earlier call. A sale was arranged at a price close to the estimates above. Getting a reasonable price on broker-sold CDs if you want to sell them before maturity date is a regular source of complaint from readers.)
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