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Gain of stock CDs depends on timing

Are stock-indexed CDs great investments? Well, the first one among those recently introduced came due a couple of weeks ago and it paid a whopping . . . 3.045 percent.

The second piece of bad news is that the FDIC is warning stock-CD investors that while the principal on their accounts is federally insured, the interest may not be.

Shawmut Bank in Hartford, Conn., had a one-year CD whose return was tied to the Standard & Poor's 500. The account's 3.045 percent yield was based on half the gain of the S&P 500 between March 1 of last year and this Feb. 10. During that time, the S&P index rose from 442.01 to 468.93.

The Shawmut CD's performance was a far cry from the high-rate dream implied by bank ads for stock CDs _ less, in fact, than you would have earned from an ordinary CD.

The Shawmut yield looks weak next to a national average yield of 3.26 percent for an ordinary CD opened a year ago, according to Bank Rate Monitor.

It appears downright puny beside the top-paying, one-year CD in the country at the same time, which had a 4.15 percent yield.

If that wasn't enough, consider that Shawmut account holders were automatically rolled over into a plain-vanilla, one-year CD paying 2.4 percent in February, also below Bank Rate Monitor's average.

Without picking on that particular bank, the poor showing points up the lessons of timing:

Because of the stock market's meteoric rise over the past several years, many investors tired of 3 percent CD returns have jumped into the stock-indexed accounts. But if the market is having a bad day or week when their CD comes due, their return can be much less. That's because of the way some outfits plot the interest.

In the case of the Shawmut CD, the stock market took a big hit Feb. 3, just one week before the account was due to mature.

With the Federal Reserve again determined to raise interest rates to head off inflation, the stock market and thus stock-indexed CDs may not fare well. On the other hand, the market could interpret the Fed's next action as a strong preventive measure _ giving stocks a lift.

The gamble is yours.

Either way, a potentially risk awaits if you open a stock-CD account at a bank in a weak financial condition. Granted, odds are that won't happen because three-fourths of the 12 banks peddling the accounts have a top, three-star safety rating from Veribanc Inc.

But the FDIC warns consumers that if a stock-CD institution goes belly-up, only the principal and any paid interest are sure to be insured up to the $100,000 federal maximum.

The interest may not be covered. The FDIC's position is that the gain in a stock index is not the same as interest paid. It's not even the same as interest accrued because the index _ and calculated interest _ could change.

Why do banks continue to offer an account that so far has failed to deliver the goods? Two reasons:

1) It gives banks something to sell.

2) Given how flat the S&P 500 has been in the past two years, it has been relatively cheap for banks to cover any losses.

Questions to ask yourself:

What are the deposit minimum and term on the account?

What index is the stock CD tied to?

Exactly how is the interest-earnings formula calculated?

Is any of your principal at risk? (A small part of it may be at some institutions.)

How often is the interest paid out?

Latest rate trend: Thirty-year fixed-rate mortgages rose to 7.42 percent from 7.21 percent, as short-term CD yields inched upward. Bank Rate Monitor's ratio of savings increases to decreases widened to 7-1 from 3-1.

Robert K. Heady publishes Bank Rate Monitor, 100 Highest Yields and other financial newsletters from his office in North Palm Beach.