COMMENTARY Goldman Sachs (GS) apparently plans to sell CDs linked to the Dow Jones Industrial Average (DJI). My Right Financial Plan co-author Kevin Grogan recently took a look at the product, based on the details released by other media outlets, and here's what he found:
-- The CDs are debt instruments, and the principal is FDIC insured.
-- The least investors can earn is their principal plus 2 percent at the end of four years. (Note that the minimum return is 2 percent total return, not 2 percent per year.)-- Investors receive the return of the DJIA, capped at a monthly return of 1.5 percent. The investor receives a sum of the monthly returns, without compounding.
The main attraction of the investment is the guaranteed return of principal plus 2 percent. Unfortunately, investors must give up a lot of upside to obtain the downside protection. The cap of 1.5 percent and lack of compounding are bigger concessions than many investors realize.
To demonstrate the importance of these concessions, let's consider alternative portfolios that are a mix of DJIA returns and rolling short-term CDs, rebalanced annually. The allocation to the DJIA is listed first. The data covers 1991 through 2010, and we looked at rolling 48-month periods.
Are there any situations where this Goldman Sachs CD makes sense? What if you have a known liability four years from now, but you aren't crazy about current yields? With the Goldman product, the worst-case scenario is a 2 percent total return, but you also have the potential for upside. As the numbers for the alternative portfolio show (comprised of 5 percent DJIA and 95 percent traditional CDs), you don't need the Goldman product to accomplish this goal. The Goldman CD outperformed the 5-95 portfolio in just one 48-month time period, and it had a much lower average return.
A spokesman for Goldman Sachs declined to comment.
The analysis shows that this product was designed to be sold, and not bought. However, we don't really need to do this analysis to know whether the product is in investors' best interests. It's the job of the issuer's CFO to raise capital at the lowest possible cost -- not to provide investors with higher returns. These instruments are very complex, and the complexity isn't designed in the investor's favor. We have looked at many structured products and have yet to find one that benefits investors rather than issuers.