How does this "bridge" investment account work
May 4, 2011 1:47 PM Subscribe
How does this "bridge" investment account work?
North Carolina State Employee's Credit Union offers what they call a Bridge Account (details, disclosure pdf). It is marketed at novice investors as a feeder for their fee based investment service. The account is NCUA insured and the rate of return is tied to the S&P 500 Index, capped between 0 and 3% per quarter (12% APR max). If the Index posts a negative return for the quarter the account pays 0%. If the Index goes up more than 3% in a quarter the returns are capped at 3%. There are no fees and money can be moved in and out freely. The maximum balance is $3,000.
How does the credit union make money on this? Presumably they actually invest your money in the Index and use returns above 3% per quarter to offset future losses but from looking at the past 10 years returns I don't think this wouldn't have worked very well for them. When the Index is performing poorly they might assume people will transfer their money to a standard savings account so the CU don't have to cover as significant a loss but that seems risky for them. A few other credit unions offer the same type of account so it is probably put together and sold by a larger entity. Is it just a loss leader to promote their investment service?
I normally assume the worst of financial institutions but I can't figure out how this isn't a good deal for the customer, especially as a storage place for emergency funds. Not knowing how they are making money makes me nervous. Can anyone explain how this works?
North Carolina State Employee's Credit Union offers what they call a Bridge Account (details, disclosure pdf). It is marketed at novice investors as a feeder for their fee based investment service. The account is NCUA insured and the rate of return is tied to the S&P 500 Index, capped between 0 and 3% per quarter (12% APR max). If the Index posts a negative return for the quarter the account pays 0%. If the Index goes up more than 3% in a quarter the returns are capped at 3%. There are no fees and money can be moved in and out freely. The maximum balance is $3,000.
How does the credit union make money on this? Presumably they actually invest your money in the Index and use returns above 3% per quarter to offset future losses but from looking at the past 10 years returns I don't think this wouldn't have worked very well for them. When the Index is performing poorly they might assume people will transfer their money to a standard savings account so the CU don't have to cover as significant a loss but that seems risky for them. A few other credit unions offer the same type of account so it is probably put together and sold by a larger entity. Is it just a loss leader to promote their investment service?
I normally assume the worst of financial institutions but I can't figure out how this isn't a good deal for the customer, especially as a storage place for emergency funds. Not knowing how they are making money makes me nervous. Can anyone explain how this works?
Best answer: Its a pretty simple structured product. They are making money on the volatility in the S&P 500 because they've capped the return. The only time it ends up being a good investment for you is during times when the S&P is down or is very steadily increasing at 1-3% a quarter. Historically both of those times are quite rare.
It is essentially capitalizing on peoples loss aversion.
posted by JPD at 2:03 PM on May 4, 2011
It is essentially capitalizing on peoples loss aversion.
posted by JPD at 2:03 PM on May 4, 2011
If you take a look at the historical record you can see that in plenty of years the annual return can be credited to one oustanding quarter and three meh ones.
Let's pick an outstanding year: 2003. The quarterly returns were -3%, 14%, 2%, and 11%. The return for the whole year was 27%, but you are are only seeing about a third of that.
Oh, sure, in bad years you do fine, but in good years you miss out on all the fun.
posted by It's Never Lurgi at 2:18 PM on May 4, 2011
Let's pick an outstanding year: 2003. The quarterly returns were -3%, 14%, 2%, and 11%. The return for the whole year was 27%, but you are are only seeing about a third of that.
Oh, sure, in bad years you do fine, but in good years you miss out on all the fun.
posted by It's Never Lurgi at 2:18 PM on May 4, 2011
Fundamentally, they can offer this kind of deal because there are people out there who are trading to get more volatility (eg some funds will double any gains or losses).
It's entirely possible (even likely) that inflation will exceed 3% in the next 10 years, so even if you don't lose nominal value you could easily lose real value.
Plus I'm guessing they collect a very healthy fee for providing this account.
posted by miyabo at 2:20 PM on May 4, 2011
It's entirely possible (even likely) that inflation will exceed 3% in the next 10 years, so even if you don't lose nominal value you could easily lose real value.
Plus I'm guessing they collect a very healthy fee for providing this account.
posted by miyabo at 2:20 PM on May 4, 2011
Plus I'm guessing they collect a very healthy fee for providing this account.
I assumed the same, but it looks like its actually free (other than what they make on the structure itself) - it really is a credit union trying to get people to invest in equities - makes me slightly less annoyed at the nature of the product. (also the return is capped at 12.55% annually - not 3%)
posted by JPD at 2:28 PM on May 4, 2011
I assumed the same, but it looks like its actually free (other than what they make on the structure itself) - it really is a credit union trying to get people to invest in equities - makes me slightly less annoyed at the nature of the product. (also the return is capped at 12.55% annually - not 3%)
posted by JPD at 2:28 PM on May 4, 2011
Response by poster: Thank you for the answers so far. JPD is correct that the return is capped at 12.55% per year or 3% per quarter and there are no fees.
I put together a spreadsheet (in Google docs here) using the quarterly closing prices from the past ten years and compared returns. It looks like $1,000 invested in the S&P 500 Index in 2000 would be $952.55 on 12/31/2010 but the bridge account would have returned $1,807.61 in the same period. I don't understand the intricacies of options and hedging but it seems like they would have a hard time making money offering this account over that period. Is that true?
Moving the starting date to 1988 shows almost exactly equal returns, although the S&P 500 direct investment would have been up almost 2:1 at the end of 2000.
I understand that long term the S&P 500 will probably outperform since the past ten years have not been normal, but would you consider this an appropriate place to store emergency funds when liquidity is important?
posted by ChrisHartley at 3:40 PM on May 4, 2011
I put together a spreadsheet (in Google docs here) using the quarterly closing prices from the past ten years and compared returns. It looks like $1,000 invested in the S&P 500 Index in 2000 would be $952.55 on 12/31/2010 but the bridge account would have returned $1,807.61 in the same period. I don't understand the intricacies of options and hedging but it seems like they would have a hard time making money offering this account over that period. Is that true?
Moving the starting date to 1988 shows almost exactly equal returns, although the S&P 500 direct investment would have been up almost 2:1 at the end of 2000.
I understand that long term the S&P 500 will probably outperform since the past ten years have not been normal, but would you consider this an appropriate place to store emergency funds when liquidity is important?
posted by ChrisHartley at 3:40 PM on May 4, 2011
Response by poster: Oh, also what are these sorts of things officially called?
posted by ChrisHartley at 3:41 PM on May 4, 2011
posted by ChrisHartley at 3:41 PM on May 4, 2011
Response by poster: Whoops, sorry I see that JPD identified it as a structured product and the Wikipedia page is pretty good.
posted by ChrisHartley at 3:45 PM on May 4, 2011
posted by ChrisHartley at 3:45 PM on May 4, 2011
heh, well its been one of the worst periods for equities in the last hundred years.
Your call - as a general rule there are no free lunches, but this is just a very cheap one. Its really the NCUA you need to worry about, and frankly I know nothing about that, so won't comment. Is it federally backstopped?
posted by JPD at 4:21 PM on May 4, 2011
Your call - as a general rule there are no free lunches, but this is just a very cheap one. Its really the NCUA you need to worry about, and frankly I know nothing about that, so won't comment. Is it federally backstopped?
posted by JPD at 4:21 PM on May 4, 2011
I don't understand the intricacies of options and hedging but it seems like they would have a hard time making money offering this account over that period. Is that true?
I think it depends on the path....each quarter resets the needle.
posted by Diablevert at 4:29 PM on May 4, 2011
I think it depends on the path....each quarter resets the needle.
posted by Diablevert at 4:29 PM on May 4, 2011
Response by poster: You are lucky to have not seen Suze Ordman's PSA videos. NCUA is the functional equivalent of the FDIC but for credit unions - same federal guarantee on accounts up to $250k.
Thank you for you help. From reading Wikipedia and linked articles it seems like structured products are generally a bad deal but this one does seem to avoid the common pitfalls.
posted by ChrisHartley at 4:55 PM on May 4, 2011
Thank you for you help. From reading Wikipedia and linked articles it seems like structured products are generally a bad deal but this one does seem to avoid the common pitfalls.
posted by ChrisHartley at 4:55 PM on May 4, 2011
ChrisHartley: "I put together a spreadsheet (in Google docs here) using the quarterly closing prices from the past ten years and compared returns."
The problem you're investigating is selection sensitivity. If we adjust the dates on your ten year analysis by a quarter or ten years, do the results change? December 2000 is the second closest quarter to the peak of the dotcom bubble, so you might not have chosen the worst starting and stopping points, but it's a close second. I really like this chart from NYT. Equally important is what would happen if you had put the money in treasuries, which often have sharp gains during stock market turmoil.
It seems they only allow small amounts into the fund, so it's possible just using this as a loss leader to drive business to their investment services arm. You might call up NCUA and ask if they insure this union and this sort of account, because I've only seen one other like this and they're identical offerings, word for word down to the disclosure.
posted by pwnguin at 6:13 PM on May 4, 2011
The problem you're investigating is selection sensitivity. If we adjust the dates on your ten year analysis by a quarter or ten years, do the results change? December 2000 is the second closest quarter to the peak of the dotcom bubble, so you might not have chosen the worst starting and stopping points, but it's a close second. I really like this chart from NYT. Equally important is what would happen if you had put the money in treasuries, which often have sharp gains during stock market turmoil.
It seems they only allow small amounts into the fund, so it's possible just using this as a loss leader to drive business to their investment services arm. You might call up NCUA and ask if they insure this union and this sort of account, because I've only seen one other like this and they're identical offerings, word for word down to the disclosure.
posted by pwnguin at 6:13 PM on May 4, 2011
Its really the NCUA you need to worry about, and frankly I know nothing about that, so won't comment. Is it federally backstopped?
Most definitely. Think FDIC for Credit Unions.
posted by Nonsteroidal Anti-Inflammatory Drug at 6:43 AM on May 5, 2011
Most definitely. Think FDIC for Credit Unions.
posted by Nonsteroidal Anti-Inflammatory Drug at 6:43 AM on May 5, 2011
Response by poster: Quick followup - Apparently the deal was too good to last. I received a letter from the credit union saying that they are discontinuing the bridge investment account at the end of this year.
Thanks again for all the answers.
posted by ChrisHartley at 9:45 AM on July 15, 2011
Thanks again for all the answers.
posted by ChrisHartley at 9:45 AM on July 15, 2011
This thread is closed to new comments.
posted by kindall at 2:01 PM on May 4, 2011