What Is A Market Linked CD?

What Is A Market Linked CD?

Market Linked CD’s are like traditional CD’s, but feature a more reasonable rate of return. Instead of a fixed interest rate, a Market Linked CD can be tied to a major index like the Dow Jones S&P 500. The rate of return can also be linked to commodity prices, currencies, and even benchmarks like the Consumer Price Index (CPI) to allow CD owners to invest in areas that are otherwise unfeasible under normal circumstances.

Market Linked CD’s are protected by the FDIC so they are insured like any traditional CD. On top of that, a Market Linked CD can be set up so if the benchmark (or index) falls by the maturity date, you still get your principal back. Market Linked CD’s are also known as equity-linked CD’s, market-indexed CD’s or simply Index CD’s.

Market-Linked CD’s allow risk-averse investors to dip their toes in the markets while staying under the secure umbrella of FDIC protection. Additionally, Market-Linked CD’s are ideal for buy-and-hold investors with little need for liquidity seeking to diversify their portfolios.

Advantages of Market Linked CD’s:

Market Linked CD’s offer the best of both worlds for those interested in keeping their savings safe, but still want a more reasonable rate of return. Market Linked CD’s feature the following advantages:

  • FDIC Insurance – The principal in invested in a market linked CD is insured to a maximum of $250,000 this year and up to $100,000 thereafter, just like any other savings accounts or CD’s. By properly allocating funds, CD consumers can effectively protect more then $250,000 through a variety of investment and account holdings.
  • Unlike the stock market, you are guaranteed to get your principal back as long as you don’t withdraw before the maturity date
    Keeps you from buying and selling since a CD gives you the “locked-up” effect that traditional CD’s provide (lack of liquidity can sometimes be a good thing)

Disadvantages of Market Linked CD’s:

  • Large Minimum Purchase – Market Linked CD’s require a high initial investment or deposit, typically around $100,000, but in some cases, deposits as small as $25,000 may be accepted.
  • Early Withdrawal Penalties – Even though the principal is guaranteed if you hold it to maturity, this is not the case for early withdrawals. Therefore, it might be possible to have a huge withdrawal penalty if you need the money before maturity. Typically, this is not a problem for CD investors that are used to using CD’s to hold funds. They understand the long-term nature of such deposits.
  • Tax Rates – Your returns are considered interest, so even though it might be from the performance of a stock market, it doesn’t qualify for the long term tax rate of 15%.
  • Tax Treatment – CD owners have to report returns as income every year they own this CD (if held in a taxable account). So while you might not even receive anything until maturity, you have to pay taxes on some return (the return is based on a traditional CD that the bank deems comparable).
  • Possible Upper Limit – Some MLCD’s have a cap on the high end that limits the returns, so the comparable index returning 100% doesn’t mean you will get a 100% return in your MLCD investment.
  • Dividend Reinvestment – A big chunk of market returns are actually provided by the dividends that the company pays. Investing in MLCD’s that track the index will not benefit from this.

Market Linked CD’s Work Best For:

Who could really benefit from something like this are people who are retired or will retire in the next 10 years. These people might not have the time horizon to wait for the stock market to come back, so giving up the dividends might be worth it to lower the risk of possibly another market crash before, or during, retirement.

Market Linked CD’s are also a great option for those that need to have their funds in an FDIC insured savings institution, in other words, only a bank will do as a place to keep their money. Even though an an annuity or life insurance product may be a better solution, some people just need that FDIC assurance, so a Market Linked CD is a great solution to the needs of those consumers.

If you plan to park your money in a conventional CD anyway, the market-linked CD may be a better solution given that the CD is in a tax sheltered account to avoid the unfavorable tax liabilities and you are sure that you will not need the the money before the CD matures to avoid early withdrawal penalties.

The worst-case scenario is that the market goes down and you get no benefit from market returns. The best-case scenario is that the market goes up and you get the guaranteed return plus a kicker from the market.

Smart Safe Money Tips:

Market Linked CD’s with shorter terms are great way to make money since you can take advantage of the volatility and only pocket the interests when the benchmark goes up. Look for MLCD’s that have shorter terms to increase your potential rate of return on your money.

In any investment, be wary of any claims of “guaranteed” returns, a la Bernie Madoff. When you purchase a Market Linked CD, all you are guaranteed to receive in the end is your principal back and whatever interest the bank agrees to pay if the market tanks for the entire duration of the CD.

A Market Linked CD sounds too goo to be true. Keep in mind that all other things being equal, an investor would find a MLCD to be just as risky or risk-free as opening a traditional CD at their local bank and using the interest earned to purchase options at various strike prices and at various expiration dates. The difference is that by buying a Market Linked CD from one of our top-rated, financially stable banks, you have professionals dedicated to finding the best opportunities for your CD funds to earn a more reasonable rate of return year after year.

Market Linked CD’s are a great solution for investors who:

  • want to earn a more reasonable rate of return, or higher potential return,, than a traditional CD can offer
  • want, or need, to avoid risk, but still want to participate in the markets
  • want to diversify their portfolio, but maintain FDIC protection for their money
  • want the security of having their funds in a financially stable & strong banking institution
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