New and seasoned investors alike are drawn to certificates of deposits for their portfolios because they’re safe investments. If you seek stock market-like returns or want exposure to a variety of indices like securities, currencies and commodities, you’ll typically incur more risk. You can get the best of both worlds by adding a market-linked CD to your portfolio.
Similar to a traditional CD, a market-linked CD is an FDIC-insured time deposit account that guarantees your principal investment will be protected as long as you don’t withdraw your money before the CD matures. A market-linked CD’s return, however, is tied to the performance of a securities or market index like the Dow Jones Industrial Average or Standard & Poor’s 500 index — or it can be linked to currencies, commodities and stocks.
Before investing in a market-linked CD, familiarize yourself with its rates, terms, fees, tax implications and risks to make sure it’s the right investment for your situation. Here’s what you need to know about market-linked CDs.
The Four Common Types of Market-Linked CDs
By selecting the right market-linked CD, you have the exposure to potentially thousands of types of investments in a single fund. Here are the most popular types of market-linked CDs:
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1. Equity-Linked CD
An equity-linked CD is a bank-issued CD that is tied to the performance of a stock index like the DJIA or S&P 500. Investors are attracted to equity-linked CD rates when they believe the corresponding stock market index might generate bigger returns than those on fixed CDs. The typical term for an equity-linked CD is three months to five years.
2. Index CD
Index CDs are generally tied to a specific market index, like the S&P 500, but they can also be tied to interest rates, currencies or commodity prices. Index CDs are typically long-term commitments that might last up to 20 years. Because some index CDs don’t allow you to make early withdrawals, they’re best if you don’t think you’ll need access to your money.
An index CD has the potential to earn more than a traditional CD because its return is linked to the future performance of a market index. Investors are often drawn to index CDs when interest rates are low. If you’re interested in an index CD, it’s essential you understand the complexity of its specific market, the impact of inflation on its term and how the return is calculated.
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3. Market-Indexed CD
A market-indexed CD is linked to the performance of one or more securities or market indexes that might include equities, bonds, foreign currency or other assets. If the index you’ve invested in rises, you earn a portion of that return. If it falls, you lose the return but not your initial investment.
The performance of market-indexed CDs depends on a combination of their underlying funds and involves a complex formula. Like index CDs, market-indexed CDs are typically long-term investments and you should understand how your return will be calculated.
4. Structured CD
Structured CDs are linked to the performance of an index or basket of securities. Banks issue these CDs and the returns vary depending on the issuer. Structured CD terms generally range from three months to seven years.
When you invest in a structured CD, your initial principal payment is protected. If you’re interested one, compare different banks to get the lowest fees and best return structure.
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