Market Index Linked CDs

Market index linked CDs (MILCs) are combinations of certificates of deposit and stocks. These investment hybrids try to bring two great features together: the security and low risk of CDs and the potential for great return of stocks. They way they do this is to peg the interest rate on the certificate of deposit to some external variable rate rather than presetting it at an agreed upon fixed rate. Most of the time, this interest rate is based upon the performance of a certain stock market index. The normally the terms on these MILCs is about five years, although they can and do vary in length. Market index linked CDs are very intriguing products for a lot of investors who relish the idea of stability and income potential combined into one investment.

How MILCs Work

This stability is guaranteed if the investment is held to maturity, meaning it basically is a risk free investment. All the investor really risks is the lost value of the principal at maturity based on inflation in the intervening period. But these products are fully insured by the federal government just like ordinary CDs. As an investor, you are guaranteed to get back at least the original principal invested if you hold it to maturity.

In exchange for this wonderful stability and basically risk free nature of investment, those who hold market index linked CDs do have to give up some flexibility. They are authorized to make withdrawals, but these withdrawals are sometimes limited only to certain dates on the calendar, and there is no guarantee of recovering the entire principal investment. This is similar to other CDs, which typically charge a fee based on what a dividend would have been or something to that effect. All interest is paid out when the investment matures, so early withdrawals essentially only get the original less any charges, which can be one of several errors in investing. Although the principal balance is protected for investors who keep the money in for the whole time period denoted by the CD, there is no guarantee that interest will be paid out on the financial vehicle.

Things to Consider about MILCs

The stability and lack of risk are very appealing with this investment. However, it carries no guarantee of income, only protection against principal loss for those who ride out the investment to maturity. And investors do have a fair amount of hassle to deal with if they ever need to get at the funds before maturity. Given the fact that these funds average five years in length, it is certainly not a good idea to invest money in them that you have any notion of needing in the near future. This has to be thought of as a long term investment, with the only thought of accessing the funds in dire emergency circumstances when no other options exist.

These notes have some very interesting tax terms. They do not pay interest annually; but if the CD is held in a regular account, the account holder must declare income from these MILCs every year until they mature. To even figure out what to declare, the account holder must find out what a similar interest bearing conventional CD would be paying over the same term. It can get pretty confusing and these details especially call for the wisdom of a financial advisor. If the instrument is held within a tax deferred investment vehicle such as an IRA, all of this tax hassle can be avoided. Investors thinking about looking into market index linked CDs should contact a local financial advisor to discuss the pros and cons.

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