MARKET LINKED CDS: WHAT YOU SHOULD KNOW

What is a market-linked CD?

A market-linked CD is a certificate of deposit that ties the rate of return to the stock market's performance. Not only is there income and growth potential but a market-linked CD’s principal is also insured up to $250,000 by the government-backed Federal Deposit Insurance Corporation (FDIC) insurance program as long as an FDIC member issues the CD. [i]

 What are the benefits of investing money into an FDIC market-linked CD?

  • FDIC INSURED; Principal guaranteed – As long as an FDIC member issues the CD, market-linked CDs are backed by FDIC insurance.

  • GROWTH – If the market is doing well when your CD matures, you receive returns on your investment.

  • INCOME- This investment can be structured to provide income greater than traditional CDs

  • ESTATE FEATURE – MLCDs can have an estate feature, also called a “survivor’s option,” that allows beneficiaries, upon the death or adjudication of incompetence, to redeem the CD for the principal amount, without interest, before the CD matures.

  • DIVERSIFICATION – MLCDs invest in multiple indexes and securities, for example, equities, currencies, commodities, or interest rates. This creates diversification within your portfolio. Diversification is a technique that can potentially mitigate risk should a decline in the market affect one or more of the investments.

 Is the principal amount of a MLCD guaranteed against loss?

If the MLCD issuer is an FDIC member, the principal amount is insured up to $250,000. [iii]

 How long does it take for the CD to mature?

The terms of CDs vary depending on how the contract is structured. Some CDs mature in as little as a month, and others, for example, a one-year CD, will mature in 12 months. You can also get CDs that last multiple years. By definition, CDs held for 12 months or longer are considered long-term investments. [iv]

 How is a market-linked CD different from a traditional CD?

A traditional CD pays a fixed interest rate for a period of time and does not grow if the market appreciates.

 How do I achieve the full benefit from this type of investment?

To receive the full benefit from this type of investment, you have to hold the investment to the date it matures.

 How can I calculate my return?

The return is determined by what is called the “participation rate,” how a market-linked CD will compare with the market performance, and whether there is, for example, an interest cap set by your issuing bank. You may also have to consider how the interest is applied. For instance, if interest is paid when an index remains at a certain level or is based on the increase within an index. It depends on how you and your issuing bank set up the investment. A financial professional can help you with the more complex aspects of this investment decision. [v]

 What are the risks associated with a market-linked CD?

  • Performance – Because it is difficult to predetermine the fluctuations in the market, there is a chance that it could be lower when your MLCD matures than when you first invested. However, there isn’t any guarantee that this will happen. Remember that the FDIC insures your principal, and you won’t lose it because of a down market.

  • Interest cap – MLCDs are often subject to an interest cap on your gain per year. Consider discussing this feature with a financial professional to learn more about it.

  •   Bank call – Some market-linked CDs are callable, which means they are set up with a call feature that permits the issuing bank to redeem the CD before maturation. This might occur when interest rates fall after you have opened your CD. There is also the option for a non-callable CD that doesn’t have this feature and prevents the issuing bank from redeeming it before it matures.

  •  Liquidity risk – Similar to a traditional CD, attempting to recover the money before it matures can cost you in penalties. Cashing out early may also prevent you from receiving earned interest.

What is the best approach if I am interested in a market-linked CD?

If you feel a market-linked CD is an option you would like to explore, consider consulting with a financial professional who may assist you in making an informed investment decision.

Schedule a complimentary 15-minute consultation with an SCM team member to learn more and discuss this investment opportunity.