In a challenging market, getting back to basics may be good.
provided by Rose Greene, CFP ®
Respect for the humble CD. When the stock market turns bearish, people take a second look at fixed-rate investments, including certificates of deposit. In a bull market, the CD may seem like just about the most unattractive investment choice out there. But at the moment, those who own CDs can be thankful for their cautiousness.
A classic interim investment. Often, people choose to put money in a CD when they are “between investments” – that is, as they move a portion of their assets out of the market or a market sector for the short-term. While leaving the stock market altogether is a laughable and ill-advised idea for the serious, committed investor, most CDs are FDIC-insured and thereby offer safety of principal (up to $250,000) along with a guaranteed rate of return.
A CD is certainly a commitment: you can’t pull the money out of one until the end of the specified term. (If you need to withdraw your money, you’ll almost always pay an early withdrawal penalty.) You also want to find a CD that offers returns sizable enough to keep ahead of inflation. Since the inflation rate is just over 4% right now and since your gains will be taxed (assuming your CD is a short-term investment and not held inside a retirement account), it is therefore only logical to look for one that offers at least a 6% rate of return.
The tradeoff of a CD is easily expressed. We all want CDs with higher rates of return, but this usually means CDs with longer periods until maturity. The longer the wait, the longer the investor goes without access to those funds, and the greater the potential opportunity cost of not assigning those assets to an investment that might perform better.
Index-linked CDs. Some CDs offer you the chance to earn stock-market like returns. As the term implies, index-linked CDs are linked to the performance of a particular stock index. Often, they will match 90-100% of the return generated by an index, and some offer guaranteed minimum returns regardless of how the linked index performs over the term of the CD.1
Should you move money into a CD? For the short-term, given this challenging market, it is an option to consider. But before you make a move, be sure to speak to a qualified financial advisor about your financial direction – for today, and for the long term.
CD’s are FDIC insured and offer a fixed rate of return if held to maturity whereas the return and principal value of an investment in equities fluctuates with changes in market conditions and does not offer FDIC coverage.
Investors of equity linked CDs should be aware of the risks of these products, including liquidity risk, market risk and call risk. While the principal is guaranteed by the issuer, the rate of return will fluctuate in accordance to the closing price of the underlying index over a set period of time. One cannot invest directly into any index.
Rose Greene, CFP ® is a Representative with LPL Financial, Member FINRA/SIPC and may be reached at http://rosegreene.com, (310) 399-1200 or rose@rosegreene.com.
