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Yet Another Goldman Investment You Shouldn't Buy

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Goldman Sachs (NYSE: GS  ) earned a terrible reputation during the financial crisis. It ended up paying $550 million to the SEC to settle charges, admitting that it offered complex investments involving subprime mortgage-backed securities to investors -- without bothering to tell them that the hedge fund that helped choose those securities also had a short position against the offering.

You'd think that having paid such a high penalty for its misdeeds, Goldman might have learned its lesson. But late last week, reports surfaced that Goldman is planning to offer a new investment that unsophisticated investors may find just as misleading -- and which may disappoint them nearly as much.

The best of both worlds?
According to reports, Goldman plans to offer equity-linked certificates of deposit. In contrast to regular CDs, with which you can predict with absolute certainty exactly how much interest you'll receive throughout the length of their term, equity-linked CDs typically use well-known stock indexes like the Dow Jones Industrial or S&P 500 to help determine their total return. And as their name suggests, the idea is that if the stock market does well, then your CD's return will be better.

The key incentive for most investors, though, is the downside protection that equity-linked CDs provide. Obviously, investing in a stock index fund exposes you to the full extent of any losses for the market. By contrast, equity-linked CDs usually guarantee that you'll at least get your full principal back, no matter how badly the market does. Reports suggest that Goldman's four-year CD will give a minimum annual return of about 0.5%, while potentially maxing out at 24%.

To be clear, Goldman isn't the only bank that offers equity-linked CDs. JPMorgan Chase (NYSE: JPM  ) sold the first such market-linked product back in 1987. Today, you can find such CDs at banks including Wells Fargo (NYSE: WFC  ) and HSBC (NYSE: HBC  ) . Each bank has a slightly different angle on how it ties returns on its CDs to the stock market, but they all share the same general idea: Limit your downside while potentially boosting your upside.

Why these CDs aren't worth your time
The problem, though, is that "equity-linked" doesn't mean that you'll get the exact return of the index the CD tracks. According to Bloomberg, the Goldman CDs will look at the Dow's returns every month. If the Dow rises, then the gains are capped at 1.5% to 2% for purposes of calculating the CD's total gain. If the Dow drops, however, then the losses are fully incorporated into the tracking value for the CD.

Obviously, that puts a downward bias on the CD's total return. And again, while investors may have guaranteed return of principal -- a guarantee that the FDIC backs -- the chances of them earning exactly no interest whatsoever are a lot greater with such artificial calculations underlying the deposit.

Get smarter
In fact, last month's issue of Rule Your Retirement included some information on this exact subject. With insurance companies like ING (NYSE: ING  ) offering similarly structured equity-linked annuities, Foolish retirement expert Robert Brokamp talked with special guest Allan Roth about cheaper alternatives to get the protection you want. The problem, in Roth's eyes, comes from two places: complicated prospectus materials that obscure the actual calculations involved, and huge fees that make these CDs losing propositions. The Bloomberg article cited one structured CD expert who says that fees on a five-year deposit can be around 3%.

With banks like Goldman, Citigroup (NYSE: C  ) , and Bank of America (NYSE: BAC  ) having taken so much taxpayer money in bailouts, the American public is outraged at practices that try to trick customers into thinking they'll get better returns than they actually will. Equity-linked CDs are exactly the type of innovation that you don't need to get richer for your retirement.

There's another product that banks offer that you may not need, at least in the near future. You can find out all about why credit cards are destined to be a thing of the past right here. Banks may not like it, but you can find the companies that will profit from what replaces them. Click here and learn more.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

Fool contributor Dan Caplinger has a natural suspicion of all financial engineering. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Bank of America, JPMorgan Chase, Wells Fargo, and Citigroup, as well as having created a covered strangle position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't charge you for its guarantee.


Read/Post Comments (3) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 12, 2011, at 6:09 PM, Darwood11 wrote:

    Haha! Another GS toxic asset I should not buy!

    Thanks for the info!

  • Report this Comment On December 12, 2011, at 10:54 PM, goalie37 wrote:

    If GS is offering a new product, the desired result is more money for GS, not the sucker buying the product.

  • Report this Comment On December 13, 2011, at 6:38 AM, KurtEng wrote:

    As a general rule if GS is selling something, it is not a good idea to buy it. That also includes stock in GS.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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