Equity-Linked CDs and Notes

For conservative investors who have a limited appetite for risk, yet still yearn for good growth opportunities, there may be an attractive option. Several major U.S. banks, including JP Morgan Chase, Barclays, and Goldman Sachs have entered the equity-linked note/CD space. Notes are essentially short-term bonds backed by the full faith and credit of the issuer. CDs are backed by the issuer and indirectly by the U.S. government through FDIC insurance.

While there exist a multitude of permutations of equity-linked notes and CDs, for those looking for conservative growth, there are some interesting alternatives. Several major banks are offering five-year notes that credit interest like uncapped index annuities.

Several banks are currently quoting 110 to 120 percent participation in the S&P 500 index with a 30 percent downside buffer. Although index annuities typically provide a 100 percent downside buffer, according to AXIO, over the last 9,700 days, only 23 days had a five-year trailing return that was less than 30 percent. Therefore, a 30 percent buffer is probably going to protect all note holders from any loss.

Additionally, the structured notes have attractive tax treatment. No income is accrued until the note matures, and when it does, the increased value of the notes are taxed as long-term capital gains. With greater than 100 percent participation in the S&P 500 and much less investment risk, these notes provide a pretty compelling opportunity even for aggressive investors.

For those looking for FDIC insurance, structured CDs offer complete safety of principal, albeit with less upside. However, structured CDs and notes could lose value if not held to maturity. Current issues are offering 100 percent participation in the S&P 500 on five-year CDs with gains capped out at about 40 percent with no downside risk. With the average five-year return of the S&P 500 at 57.91 percent, structured CDs could pay substantially more than traditional CDs. Unlike structured notes, CDs will create annual taxable income, which will be taxed as ordinary income unless they are held in an IRA.

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Keith Singer

Keith Singer, a well-known financial advisor in Florida, is both a CERTIFIED FINANCIAL PLANNER™ (CFP®) practitioner and a licensed Florida attorney.

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