It can be difficult to find an investment vehicle that gives you a safe, yet lucrative return on your deposit these days. Rates on savings accounts, Money Market Accounts (MMAs), and Certificates of Deposit (CDs) have remained low since the Great Recession began; the stock market is doing its best Yo-Yo impression; and commodities like gold have left many scratching their heads.
That’s why private-label corporate bonds – more commonly known as floating-rate demand notes – might seem so attractive.
After all, the 1-1.6% annual return that such notes provide dwarfs the average money market account’s 0.51% APY, the 0.12% return currently being offered by your run-of-the-mill savings account, and the 0.27% and 0.88% rates for one and five-year CDs, respectively.
The thing is these floating-rate demand notes lend credence to the saying “all that glitters is not gold.” For those who don’t know, these notes are essentially debt being sold by major corporations like General Electric, Duke Energy, Ford Motor Company, and Caterpillar to consumers with the promise that you can write checks against your investment as well as cash out whenever you want. Unfortunately, there are a number of major drawbacks to this type of investment, which typically requires a minimum deposit of $500-$1,000.
- Confusing Marketing: Investment experts are concerned that floating-rate demand notes are being marketed in such a way as to appear almost indistinguishable from MMAs and CDs. That’s problematic because the differences actually outweigh the similarities.
- No FDIC Insurance: Unlike investment vehicles offered by traditional banks and other major financial institutions, floating-rate demand notes aren’t insured by the federal government. That means if the company selling you one goes bankrupt, your investment is likely lost.
- Payout Rate Fluctuation: Apparently, companies offering these notes can change their payout rates as frequently as every week, which underscores their risk and provides further contrast to Treasury Bonds and CDs.
- Not Tradable on Secondary Market: Traditional bonds offer a certain measure of flexibility in that you can always sell them to a third-party if you need cash. You can only sell floating-rate demand notes back to the companies that issue them.
With that being said, these newfangled investments aren’t all bad. Not only do they tend to offer higher returns than semi-comparable investments, but they also don’t involve middle men. You can buy them directly from the corporations offering them and thereby avoid wasting money on broker fees and the like.
Ultimately, while many investors probably aren’t quite sure of the exact pros and cons of floating-rate demand notes, their popularity is skyrocketing. As of March 2012, consumers owned $126 million in Duke Energy PremierNotes (a 59% increase from just three months prior) and $8.7 billion in GE notes (up 55.4% from December 2008).
It’s therefore important that you are aware of this type of investment and its corresponding risks and rewards. While these notes are great for the companies that offer them since they help diversify funding, whether or not they suit your needs depends on how you use them.
By no means should you use them as a fill-in for FDIC-insured accounts. Rather, floating-rate demand notes are somewhere in between savings accounts and stocks. That means they can be useful as a cog in a balanced overall portfolio approach – alongside savings vehicles, mutual funds, bonds, options, and individual stocks – but should not be relied upon as your primary form of investment.