-- Q: What are "equity-linked certificates of deposit" and are they a good idea for investors?
A: Some vacationers are willing to sit through a half-day seminar to get a free champagne breakfast buffet. And similarly, some investors are willing to endure some major research in the quest to get cash from their investments.
There are many investments that have become more popular given the low-interest-rate world we live in. With "high-yield" savings accounts paying just 1% interest, investors looking for income must be more creative to find it.
Preferred stock and master limited partnerships are just two examples of investments that have gained more attention due to the relatively high yields they've paid in the past. But for savers, or people who don't want to risk their principal, you bring up another option: equity-linked certificates of deposit.
Equity-linked certificates of deposit, or ELCDs, are a type of CD. CDs are usually FDIC-insured contracts typically between savers and banks that promise some sort of interest rate over a set period of time. ELCDs attempt to give savers the confidence their money is safe and secure, while giving them a chance at getting higher returns.
One of the biggest drawbacks of CDs is that they typically lock investors, and their money, in. Getting money out of a CD early usually, but not always, results in a fee. Also, the interest rates paid on CDs are typically very low relative to non-guaranteed investments. CDs with a one-year maturity, on average, are yielding 0.79%, Bankrate.com says.
But ELCDs are an attempt to make CDs more lucrative. With ELCDs, investors are typically promised a rate of return that can move up based on the performance of the stock market. These CDs usually have a five-year life span. If the stock market does well during that time, investors will get a baseline interest rate plus an extra kicker.
ELCDs can be a useful tool for investors with money they don't need for five years or more, who can't afford to lose principal and are willing to give up the full upside of the stock market.
There are some major downsides to ELCDs, though. For one thing, the fees to get out of these contracts can be very onerous and expensive. And unlike some other CDs that can be sold, it might be difficult to find a market for ELCDs. Also, while ELCDs provide exposure to a rising stock market, the benefits are typically limited to a percentage of the market's gains. So if there's a big bull market, investors in ELCDs can miss out. Also, you might be forced by some ELCD issuers to return them if they decide to retire them, or "call" them, early.
Most importantly, ELCDs can vary significantly between issuers. It's critical to fully read and understand all the terms and conditions of ELCDs, since these contracts can bind you for five years and penalties can be significant.
If you'd like to learn more about ELCD, the Securities and Exchange Commission provides quite a bit of information on its website.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at email@example.com. Follow Matt on Twitter at: twitter.com/mattkrantz