Almost everyone has heard of the CD, but what exactly is it? A CD is a time deposit. It can also be described as a loan that you make to a financial institution. Generally, a CD promises a fixed rate of return for a fixed time period. One of the most attractive features of a CD is its safety of principal when FDIC insured.
FDIC insures your principal and accrued interest up to $250,000 per account.
A CD may be a good choice for short term investing. However, many people use the CD for medium to long-term savings goals. So, is it wrong to have your entire retirement fund in CD’s?
No, it is not necessarily wrong as your investment choices should be in-line with your goals and risk tolerance. Peace of mind is an important aspect of any investment plan. The nagging question remains… CD’s offer principal protection but very low yields… seeking a better return might mean incurring more risk.
The Equity Linked Certificate of Deposit is an option I use occasionally for those folks who insist on the FDIC insurance. The ELCD is essentially a CD that holds a basket of securities thus providing the holder with exposure to some investment.
If you hold the ELCD to maturity, it will return all principal and accrued interest even if the basket of securities has a negative return. If the basket of securities has positive returns at maturity then you will get that too.
So you get some of the upside and none of the downside… sounds great? Well, don’t be dazzled. The ELCD is not a panacea.
If you liquidate prior to maturity the FDIC insurance may no longer be applicable. There is a limited secondary market for ELCD’s, which means that your CD can certainly be sold prior to maturity but potentially at a discount. (You would need to sell the CD for less than what you paid for it)
Taxes are treated differently on gains and losses. Long term gains on traditional stocks are taxed at the capital gains rate, whereas gains on a CD may be treated as current income. ELCD gains must generally be re-invested so any taxes must be paid from other sources of cash from year to year.
Local banks generally offer CD’s in a single flavor yet there are literally dozens of different types of CD’s available. The ELCD is only one potential alternative.
Bottom line… there is nothing wrong with owning CD’s as part of a well-defined and diversified strategy based upon specific goals.
What should you do? Take control, take ownership, and take responsibility for your own future. Any financial product should be evaluated for suitability and structured to your life objectives. Call my office for a complimentary review if you are in the market for insurance, investments, or financial planning.
The information presented here is for educational purposes only and shall not be construed or interpreted as a solicitation to sell or offer to sell any specific securities, investments, or investment strategies. The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.