(MONEY Magazine) – An increasing number of banks are trying to cash in on the allure of a rising stock market by offering certificates of deposit whose returns are pegged to a stock index, usually the S&P 500. Citibank (800-328-2484), Mellon Bank (800-801-2257) and Republic National (800-522-5214) currently sell such equity-linked CDs for IRAs and Keogh accounts. And recently, Republic National, NationsBank (800-400-7616) and Great Western (800-492-7587) introduced versions for taxable accounts. Equity-linked CDs come with a money-back guarantee. If the stock market falls, your full original principal is returned. Still, a closer look reveals some drawbacks: -- Your returns won't match the market's. Such CDs, which usually carry terms of three or five years, pay interest at a variable rate that depends on stock market performance. In most cases, your rate is based on an average of monthly changes in the S&P 500 index. Because the market will have months with little or no gain even in a good year, however, averaging tends to depress your returns. Furthermore, all equity-linked CD yields are based solely on stock price gains; dividends are not included. As a result, you get only a fraction of the market's total return. For the five years that ended June 1, 1993, for example, the S&P's total return was 102.6%, including a 30.6% gain from dividends. By contrast, Mellon Bank, using a fairly generous formula, would have paid interest totaling only 75% for the five years, and NationsBank would have paid a laughable 21.3%. -- You'll pay stiff penalties for cashing out early. Early-withdrawal penalties on equity-linked CDs run as high as a devastating 30%, well above the 2% or so most banks charge on conventional CDs. -- The IRS hasn't decided how to tax the returns yet. One proposal would force investors to assign a ''market value'' for their equity CDs every year, which ''would be a nightmare for most people to figure out,'' says Michael Edleson, a professor of finance at Harvard Business School. If you're eager to participate in market gains, most financial advisers recommend that you plunge in directly, via mutual funds, after making sure you have a sufficient cash reserve to cover emergency expenses. Gordon K. Williamson, president of his own investment management firm in La Jolla, Calif., thinks that equity CDs are a bad deal because the S&P 500 has lost money in only 5% of the 46 five-year periods since 1943. ''Why give up so much of the potential gain,'' he says, ''when you would have made money in the market 95% of the time?''

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