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Indexed CD Investments: Are they RIght for You?

Barbara Marquand | guest writer for GoTalkMoney

If you're looking for a way to boost returns from cash investments, indexed CDs might have some appeal.

These CDs have been around since the late 1980s, the Wall Street Journal reports, but they've been attracting growing attention in the last couple of years as investors look for ways to benefit from stock market gains without losing everything.

Indexed CDs track a market index, such as the S&P 500, the Dow Jones Industrial Average, or treasury bills and pay a percentage of the return. If the index does well, you could earn well above what a typical CD pays, and if the index tanks during the CD term, you keep all of your original deposit.

With even the best one-year fixed CD rates under two percent, it's no small wonder that some investors are turning to indexed CDs.

But indexed CDs are complicated. They work differently than traditional CDs, and they're not without risk. Some experts advise against indexed CDs unless you're an experienced investor. Here's what you need to know:

• Longer Term

Indexed CDs typically have relatively long terms, typically five years or more, while traditional CDs are available in terms as short as one month.

• Early Withdrawal Risks

Indexed CDs are less liquid than traditional CDs. With a traditional fixed-rate CD, you forfeit a few months interest earnings if you withdraw your money before the maturity date. But with an indexed CD, you could lose some of your principal for early withdrawal.

• Sold Differently

While traditional CDs are easy to buy, and you can search for the best CD rates online, indexed CDs are usually sold through financial planners and stockbrokers.

• Harder to Compare

Traditional CDs are easy to compare because they have fixed rates. Just search for CDs with the same term, and you can compare many choices side by side and select the one you want. With indexed CDs, however, it's hard to predict how much you could make or lose, so it's tougher to decide which product on the market is right for you.

• More Investment Risk

With a fixed-rate CD, you're guaranteed a certain rate of return. With an indexed CD, you won't lose any of your principal of the index drops, but you could end up with zero earnings by the end of the term. At that point, traditional CD rates might not look so shabby.

Moreover, some indexed CDs base their returns on more than one index, making it even more complicated for investors, especially newbies, to assess the risk.

• FDIC Insured

Most indexed CDs are FDIC insured, but double check to make sure. Anytime you buy a CD through a broker, find out which financial institution is issuing the CD and make sure it is FDIC insured and your deposits there are within insurable limits. Also, thoroughly check out the broker and the firm selling the CD.

• Important Details in the Fine Print

Because these investment vehicles are complicated, it's important to read the fine print and make sure you understand how the CD works. Some of these CDs have "barriers," for instance, cap how much you can make and lose, and the products vary in what figures are used to measure an index's rise or fall. Some CDs use a point-to-point method, measuring returns from the start of the term to the end, while others use average quarterly or annual returns through the term.

Although indexed CDs do offer some promise in a market where interest rates are at historic lows, they're not for everyone.

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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