Introducing Your CD's Edgier Cousin: The Market-Linked CD

Certificates of deposit (CDs) are a tried-and-true investment that retirees and others often turn to when they want to preserve their money while earning at least a smidgen of interest.

These investment stalwarts serve as quiet guardians of your money rather than as risk-takers that could expose you to danger. Those traits are both their strength and their weakness.

Yes, the money in a CD is insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 and guaranteed to give you the promised rate of return. But because of the low interest rates that CDs typically come with, they sometimes even struggle to keep up with inflation.

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In other words, the spending power of your money is often just holding steady rather than making gains.

About Adviser Intel

The author of this article is a participant in Kiplinger's Adviser Intel program, a curated network of trusted financial professionals who share expert insights on wealth building and preservation. Contributors, including fiduciary financial planners, wealth managers, CEOs and attorneys, provide actionable advice about retirement planning, estate planning, tax strategies and more. Experts are invited to contribute and do not pay to be included, so you can trust their advice is honest and valuable.

What are market-linked CDs?

Fortunately, these reliable but low-return CDs have a cousin of sorts with significantly more upside: market-linked CDs. If you're unfamiliar with them, an explanation is in order.

Market-linked CDs differ from traditional CDs in that they have a return on investment that's connected to an underlying asset, which could be a group of stocks, an index (such as the Russell 2000) or a commodity (such as gold).

That means they offer a significantly higher upside than their traditional counterparts because their performance is tied to how well the market is doing and not to a set interest rate.

At the time of this writing, many traditional CDs are paying slightly under or slightly over 4%. In contrast, a market-linked CD can soar with the rest of the market during good times, although the issuer may place a cap on the CD's value.

Generally, though, the growth potential of a market-linked CD is higher than that of a traditional CD. In a good year, that might be a 12% to 15% return.

Of course, we all know that good times aren't constant in the market. In the worst of times, the market can drop precipitously.

To lessen the blow in such circumstances, market-linked CDs often come with a minimum guarantee, which limits how much their value can drop if the market takes a turn for the worse.

Length of investment

Another way in which traditional CDs and market-linked CDs differ is the length of time you hold them.

Although traditional CDs may have longer maturity dates, some can mature within a few months, giving you the option to cash in or roll them over in a short period.

With market-linked CDs, the minimum maturity term is one year, and for many, it's several years.

In other words, they are not a particularly liquid investment; the money you put into them won't be available to you during their term — unless you're willing to pay a penalty for early withdrawal.

That means you need to think carefully about how long you feel comfortable tying up your money.

Typically, I would say three to five years is a good range, which most people can handle, assuming they have other funds stashed away that they can quickly access if needed.

With some market-linked CDs, you may be investing your money for up to 10 years, but I would steer clear of these. That's a long time not to have access to your money.

Advantages and disadvantages

As with any investment, market-linked CDs come with advantages and disadvantages.

Some advantages include:

Like traditional CDs, market-linked CDs are FDIC-insured for up to $250,000, giving you added confidence that your money is preserved
You have the potential to reap higher returns — in some instances, much higher — than with a traditional CD
Your principal is preserved, no matter what happens in the market

Some disadvantages include:

The earnings cap limits how much you can make, while there is no limit to how much money you can earn if you invest in the market
You may not make any money at all, ending up with the amount you initially invested
Market-linked CDs are taxed as ordinary income rather than at the lower capital gains rate

As with many investments, a market-linked CD should comprise only a portion of your overall portfolio.

A financial professional can help you review your current investments, determine whether a market-linked CD might be suitable and discuss with you the advantages and disadvantages based on your individual situation.

For investors wanting to add more diversity to their investments and looking for a potentially solid return while limiting their risk, market-linked CDs can be an attractive alternative.

Ronnie Blair contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Bill Skillender, founder and financial adviser at William Skillender Wealth Management and Tax Advisory, has 20 years of experience as a financial professional. He specializes in retirement planning. His firm offers such services as retirement income strategies, IRA legacy planning, tax-efficient strategies, wealth management and asset protection strategies. Bill is also the author of New Jersey Retirement Roadmap: A Definitive Guide to Successfully Retiring and Thriving in the Garden State.