Market-Linked CDs
Market-Linked CDs
These investments may yield more for you than the typical fixed rate of return.
Provided by David McBride
You say you’re a conservative investor who wants more yield? Then you may want to consider market-linked CDs – certificates of deposit linked to the performance of a market index.
With yields on fixed-rate CDs so low right now, investors are turning to these indexed CDs because of their potential for comparatively greater returns.
These CDs credit you with a “participation rate” in return for your investment. For example, if the associated index rises 12% in a year and your participation rate is 50%, you get a 6% return. (That certainly beats a 1% return.) The linked index might be the S&P 500, the Dow Jones Industrial Average, a tech index, a global index – it varies per CD.1
A market-linked CD is usually a short-term investment. Most of these CDs have maturity dates of 3-5 years. The deposits typically range from $1,000-$20,000. You are guaranteed not to lose your principal if you hold the CD to maturity, for the Federal Deposit Insurance Corporation insures these investment vehicles.1
Indexed CDs do have some downsides. The interest on them is only paid when they mature, and before maturity, the CD might produce “phantom income” – that is, taxable interest you must report to the IRS. (These are not tax-deferred investments.) Some of these CDs are “callable” – if interest rates fall, the issuer has the option to execute a call and terminate the CD, paying you back your principal and accrued interest.1,2
If you decide to take money out of a market-linked CD before the end of its term, you will probably pay for that decision. You will likely be hit with a penalty as you redeem your principal. Some indexed CD contracts allow you to sell your CD before it matures, if you like – but if the linked index has performed poorly, there is the chance that you could sell at a loss since the value of the CD depends strongly on the performance of that index. These CDs can also be illiquid during their first year.1,2
That said, there is much to like about these CDs. They offer you the principal protection guarantee of a standard certificate of deposit, plus the chance for notably better yield than a fixed-rate CD. You just have to recognize the necessity of holding the CD until maturity.
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This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
Citations.
1 - investopedia.com/articles/bonds/09/equity-index-cds.asp [8/25/16]
2 - finance.zacks.com/disadvantages-structured-cd-investment-11399.html [8/25/16]