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Stock Market Indexed CDs

PhotonicsPays
Jan 2007

People work hard for their money, so risky investments often make them think twice. A volatile stock market means higher risks, even for people who have been investing for years. For those who have amassed substantial savings but don't want to risk a penny - no way, no how - there are a few securities that provide access to the market without jeopardizing the original sum invested.

Stock market indexed CDs yield a rate of return that is linked to a stock market index, like the S&P 500 or the NASDAQ 100. You can think of these as either safe paths into the stock market, or a daring certificate of deposit.

They're daring because you have no idea how much you'll make, unlike with ordinary CDs, which have fixed interest rates.

But they're safe because the principal is guaranteed up to $100,000 by the Federal Deposit Insurance Corporation (FDIC). The current average return on a one-year CD runs just short of 6 percent. If you plug into a one-year stock indexed CD and the market dives, all you lose is the 6 percent opportunity cost.

"Investors buy stock indexed CDs in the hope the market will soar," said Bill Ellis, assistant vice president at Seattle Northwest Securities Corp., "but last year the DOW was down 5 percent, the S&P dropped 9 percent, and the NASDAQ a whopping 39 percent."

Another detractor with index-based CDs is the length of time you're required to commit the money. They're usually only available for three- or five-year terms, and it's not wise to commit money that you're likely to need before the CD matures. Some index-based CDs prohibit any withdrawals during the first year, even with a penalty. These types of CDs are also sold differently, with very specific start and end dates decided by the bank or institution that issues the security, not by the investor.

New South Federal Savings Bank in Alabama offers a three-year CD that's indexed to the S&P 500. The interest rate the investor receives at maturity is determined by using an average based on the S&P close every six months during the three-year term.

"Indexed-based CDs seem to have very limited availability. They're neither well known nor widely marketed," said Dennis J., an investment advisor at a smaller Western bank. "Even if they do suddenly become popular, the banking community isn't likely to jump in wholeheartedly. Public pressure on banks doesn't change banks. Ultimately it is investments that generate the greatest returns for the bank that determine policy.

- Audrey Arkins, Salary.com contributor
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