Ever since the fall of Lehman Brothers, structured deposits have been the financial world’s equivalent of leprosy. If you’re selling them, no one even wants to inhale near you. But as of 2010, structured deposits have been creeping back into the Singapore market. Banks like UoB and Citibank have made some enticing offers; and public opinion has gone from “lol” to “Umm…maybe”. So, are structured deposits a good deal?
How do Structured Deposits Work?
Imagine, for a moment, that you’re watching a high stakes Poker game. Millions of dollars on the table. You’d like to join in, but the only Poker you understand is the sort used in fireplaces. That’s pretty much the relationship between Joe Average and the world of corporate finance: we don’t understand their game.
Now imagine one of the players comes along, and makes you an offer: she can play Poker, but you can’t. So how about you pass her your money, and she’ll play Poker with it. If she wins, you take a cut of the winnings. If she loses, you lose part of your investment. Of course, you have to put your money down till the game is over; no pulling out halfway.
If you say yes to that deal, then you’re ready to buy some structured deposits.
Not a Standard Deposit
A lot of people are confused by the term “deposit”. These are the differences between structured deposits and typical fixed deposits:
- Variable Growth – The growth rate of a structured deposit is tied to the performance of a financial instrument. For example, structured deposits tied to a bundle of stocks will pay out more as the stocks rise, and less as the stocks decline. If it’s tied to a company, your payout may vary based on the company’s performance.
- Variable Maturity – The term of the deposit is not fixed. You may have agreed to put down your money for a year, but the bank may “call” the deposit before that. In short, a five year structured deposit may not actually last five years.
- Less Security – Structured deposits are not covered under Singapore’s Deposit Insurance Scheme. In the event the bank collapses, your money is gone. This was what happened with Lehman Brothers. Fixed deposits guarantee your money back (to a limit of $50,000).
Better Return on Investment
Growth wise, a structured deposit is like having a chauffeured Ferrari in a one-legged sack race. A typical structured deposit starts at 1 percent, and potentially grows to double that over the years. Compare it to fixed deposit rates, which tend to stay at 1 percent until maturity.
Safer than Stocks
Structured deposits are great for people who want to invest, but don’t understand how. If I were to hit the trading floor and battle it out with brokers, I’d get beaten like a step-child in a fairy tale. With structured deposits, the bank at least guarantees my principal. I mentioned before that a bank can “call” the deposit:
When the underlying financial instrument (whatever the structured deposit is tied to) isn’t doing well, a banker somewhere will freak out. Then the bank will “call” the deposit, and the whole deal is off. In such a situation, I’d at least get my principal back from the bank. It might be safer than playing with stocks myself, where I could lose even more.
There’s plenty. But it’s to be expected of any financial product with huge gains:
- Opportunity Costs – The bank calling a deposit is a huge opportunity cost. If you’ve had your deposit down for two years, and suddenly the bank calls it, that’s two years you could have invested the money elsewhere.
- No Guarantee on Growth – You may find, upon your structured deposit’s maturity, that the payout isn’t as big as expected.
- Harder to Start – Structured deposits need bigger initial sums than fixed deposits. On average, you’d need at least $5,000 to even start one.
- Illiquid – Withdrawing your money before maturity can result in a loss, even to your principal. So if I put down $5,000 for two years, but I choose to withdraw after two months, I might only get back $3000.
- Complexity – Structured deposits are complicated. The calculations verge on astrophysics. Unless you have a deep understanding of finance (and if you did why wouldn’t you invest on your own?), you’ll just have to trust the bank on the payout.
Structured deposits can be a great deal, under specific conditions. In particular, make sure the money you invest in it is really spare cash. Structured deposits make for terrible retirement plans, because of the uncertain payout.
Once you have a fixed deposit and sufficient savings, then consider structured deposits.
Are you considering any structured deposits? Comment and let us know!