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Are Commodity-Linked CDs a Good Idea?

A reader writes in, asking:

“I’d love to hear your thoughts on Everbank’s ‘5 Year MarketSafe Commodities CD.’ It guarantees return of principle and offers upside on the performance of several commodities.”

A quick perusal of the CD’s fact sheet (available here) shows three important points:

  • The CD is FDIC-protected against loss (i.e., you won’t get back less than you put in),
  • You may not withdraw any part of the CD prior to maturity, except “in the event of death or adjudication of incompetence,” and
  • The CD’s performance is “based on the performance of six commodities [gold, silver, copper, nickel, soybeans, and sugar.]”

The first two points are pretty straight-forward. The trickiness is all in that last point. If a person read only that statement, he/she might think that the CD provides something like the average return of those commodities, but with no downside (i.e., no ability to lose money), when in reality that’s not the case at all.

Instead, your total return for the 5-year period is equal to the arithmetic average of the annual returns for the commodities in question. (That is, with 6 commodities each having 5 different annual returns, they average those 30 different annual returns, and that average is the total return that you would get.)

For example, imagine a scenario in which each of the commodity prices in question goes up 10% per year for each of the five years. Without taking the time to read the details and work through the math, a person might expect that their CD would match the performance of the commodities. That is, they would expect a 10% compounded annual return, for a total return of 61% over the 5-year period. Not bad for a CD!

But that’s not what you would get. Not even close. Instead, your total return over the period would be 10% (because 10% is the average of the 30 annual returns of 10%).

In addition, the calculation of the annual return for each commodity is capped at 50% each year. And given the volatility of commodity prices, it’s not at all unthinkable that such a limit could come into play.

By way of comparison, it’s currently possible to get a 5-year CD with a 2.3% yield, which would grow your money by a little over 12% over the course of the period. So using this commodity-linked CD instead of a more typical CD would only make sense if:

  1. You expect the six commodities in question to increase in price by, on average, more than 12% per year for the next 5 years, and
  2. You don’t care about not being able to withdraw your money prior to maturity.

More generally, whenever a product offers downside protection and an upside that is linked to the performance of something very volatile, you only get a small portion of that upside. That’s the case with fixed indexed annuities linked to stock or commodity prices, and it’s the case with CDs such as this one.

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