Market linked CDs, also known as indexed CDs or equity linked CDs, have become an increasingly popular investment product in recent years. They usually promise some degree of principal protection while also providing an opportunity to participate in market gains. However, there are risks associated with market linked CDs that investors need to fully consider. In this article, we will analyze the pros and cons of market linked CDs as an investment product through multiple perspectives, and examine whether they can be considered as good investments.
market linked cds provide downside protection but have capped upside potential
A key feature of market linked CDs is downside protection, which means that the initial principal investment is protected from market losses to some extent. This provides investors with a safety cushion against downturns. However, the trade-off is that they also limit the potential upside. Market linked CDs typically set a cap or limit on the maximum return an investor can achieve if the linked market index rises sharply. This capped return may underperform the underlying index or asset class over certain periods. So investors need to assess whether the downside protection justifies reduced upside potential.
market linked cds carry credit risk of the issuing financial institution
Market linked CDs are issued by financial institutions such as banks. So the products carry the credit risk of the issuing institution. If the bank fails, investors may lose part or all of their principal. This happened during the 2008 financial crisis when some market linked CDs defaulted. Therefore, investors should evaluate the financial strength of the issuing bank before investing. Large global banks generally have high credit ratings and lower risk of default. Small local banks may carry higher credit risk.
illiquidity and lack of transparency are disadvantages of market linked cds
Market linked CDs have limited liquidity compared to stocks and bonds that trade on exchanges. Investors generally cannot sell them until maturity. Also, the payout formulas can be complex and non-transparent for investors. It may be unclear how the potential returns are calculated and capped. The lack of liquidity and transparency makes market linked CDs more difficult to value and assess.
suitability depends on investor objectives, time horizon and risk tolerance
In conclusion, whether market linked CDs are a good investment depends greatly on an investor’s specific objectives, time horizon, and risk tolerance. They can provide stable income for conservative investors with short-term goals. But the caps may limit long-term capital appreciation for growth-oriented investors. The credit risk also needs to be considered. Assessing one’s own situation is key before determining if market linked CDs have a place in their portfolio.
Market linked CDs provide principal protection but limit upside potential. They carry credit risk and lack liquidity. Suitability depends on individual factors like objectives, timeline and risk appetite. Evaluating the tradeoffs is necessary to conclude if market linked CDs are good investments.