Equity-Linked CDs: A Comprehensive Guide for Investors

Equity linked CDs are a type of CD that is designed to provide you with some exposure to the stock market. Many people choose to invest in equity linked CDs as part of a retirement portfolio. Here are the basics of equity linked CDs and how they work.

How They Work

An equity linked CD is a product that is sold at a bank or financial institution, just like a traditional CD. You will purchase this type of CD from the financial institution for a certain amount of money. Just like a traditional CD, you will also have a certain amount of time that you will have to leave the money in the CD before you can take it out. If you take it out early, you will have to pay an early withdrawal penalty.

Where this type of CD differs from a traditional CD is that it is tied to a financial index. Where traditional CDs pay a fixed rate of interest over the life of the CD, this CDs rate of interest is determined by the performance of a financial index. For example, the CD might be tied to the performance of the S&P 500. If the S&P 500 goes up significantly in value, you will receive a proportionate rate of return with your CD.

Low Risk

This type of investment is one of the lowest risk investments available. Even though this is a different type of CD, it is still a CD. This means that it is insured by the FDIC. Anything that you put into this type of investment under $100,000 is guaranteed by the federal government. If the bank that you invest with goes under, the federal government will come in and reimburse you for your deposit. Most other investments do not offer any such guarantees, so for those that have a low risk tolerance, this makes a potentially attractive investment.

Returns

With this type of CD, you can potentially bring in a much higher return than you could with a traditional CD. If the financial index performs well, your CD is also going to perform well. If the index does well, you have essentially chosen an investment that has no risk of losing your initial investment, but you can still bring in a nice return at the same time.

On the other end of the spectrum, this type of investment may not perform very well. If the index does not move while you have the CD, you may not be able to bring in much of a return. In that case, you would be better off sticking with a traditional CD that has a guaranteed rate of return.

Investment Considerations

Before choosing this type of investment, you should put some thought into what is involved with it. When using an equity linked CD, you will essentially have to time the market correctly in order to benefit. If you do not like the risk that is associated with the stock market, but do want to potentially increase your returns over a regular CD, the equity linked CD might be the way to go.