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Equity-Linked Certificates
of Deposit are a safer, low-cost alternative for those who must have
an Equity-Indexed Annuity type of investment. These little-known
investments allow you to participate in the growth of the market
index while your principal is guaranteed by the Government. Read on
to find out more.
Equity-Indexed Annuities are probably the most heavily promoted
investment for seniors in today’s marketplace. The sales pitch is
appealing and the payoff to the agent is very big—up to 13%. The
enormous commissions have led to sales abuses which leave seniors
holding the bag.
Readers of this column have wised up to the flaws of Equity-Indexed
Annuities. But what are the alternatives?
The best alternative to Equity-Indexed Annuities is to use a
diversified mix of investments and strategies that can provide an
income stream between 6% and 10% while limiting any risk of
significant loss. That’s what I do for my clients—without long-term
time commitments or surrender penalties if they want access to their
money.
Another alternative is called an Equity-Linked Certificate of
Deposit. They provide virtually all the benefits that Equity-Indexed
Annuities are designed to provide, without all the negative strings
attached.
Equity-Linked Certificates of Deposit are offered by banks. They pay
a return that is based on a stock market index, usually the S&P 500.
Just like all Certificates of Deposit, they are federally insured by
the FDIC up to $100,000 per individual. The minimum purchase for an
Equity-Linked Certificate of Deposit is usually $25,000, but some
can be found with $1000 minimums.
The return is based on the average performance of the S&P 500 over a
set period of time. Just like Equity-Indexed Annuities, how the
return is calculated depends on the issuer. The returns are all
based on averaging the gains or losses of the index at set points
over the life of your contract. Some Equity-Linked Certificates of
Deposit guarantee a 3% return. Those doing so will limit the index
return. Others provide 100% of the calculated index return.
The only way you can lose your principal with an Equity-Linked
Certificate of Deposit is if you pull your money out before the end
of the term. Most will have some form of a penalty, but since there
wasn’t a big commission paid to an agent to sell it, the redemption
penalties should be small. (Some don’t allow early redemption so
investigate before you invest.) All allow early redemption without
penalty if the account holder dies.
One of the major benefits Equity-Linked Certificates of Deposit have
over Equity-Indexed Annuities is a short term commitment, FDIC
insurance of principal, and much lower fees. They allows you much
more control and flexibility.
For instance, let’s say you intend to invest $75,000 in
Equity-Linked Certificates of Deposit. Instead of putting all the
money in a single CD, divide that money between three--purchasing
one each year for three years. Then as one comes due you can roll it
into another 3-year term. This will reduce the negative effects in
how the index returns are calculated while giving you access to
$25,000 every year.
There are several disadvantages to Equity-Linked CDs. They don’t
normally pay interest until maturity, so these investments are not a
good choice of those looking for steady income. And like
Equity-Indexed Annuities, you don’t really get 100% of the market
gains because of the averaging used in calculating the rate of
return.
You may be wondering why you haven’t heard of Equity-Linked
Certificates of Deposit before. In fact, you should wonder why the
advisor recommending you buy an Equity-Indexed Annuity hasn’t
recommended them! The reason is they don’t pay a large commission so
there isn’t a financial incentive for the advisor to do so.
Check with your local bank to see if they offer Equity-Linked CDs.
Not all do, but they are becoming more widespread. Any broker or
advisor that can sell bonds should also have access to Equity-Linked
CDs.
I still believe there are better ways to invest your money than
Equity-Linked CDs. But I’d much rather see someone invest in them
than an Equity-Indexed Annuity. Don’t let advisors who stand to gain
so much from your money pressure you into investing in an
Equity-Indexed Annuity when an Equity-Linked CD is a much better
alternative.
Have a financial question? I’ll personally answer it. Go to
www.guardingyourwealth.com and click on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
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