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Question for the Money Doctors

Question submitted on Apr 23, 2010.

Question

What are the advantages and disadvantages of an Equity linked CD?

Answer

advantages

Potential for high return because it is linked to some sort of equity index. 

Typical market linked CDs will protect you from losing money in a market downturn, if you hold it to maturity.

Most are FDIC insured upto the typical FDIC limits.

disadvantages:

Typically significant early withdrawal penalties

Earnings taxed at higher rate than would have been had you owned the equity securities in a typical taxable brokerage account.

Returns are typically capped by what is known as a participation rate.

Risk that you may earn very little or nothing if the market goes south for the duration of the CD.

Lastly, while you do get the growth component of the return of the index to which it is tied, subject to a possible cap, you do not get the dividends related to the index.


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