Gyroscopic Investing

I'm curious if anyone has considered using Market Linked CDs for the cash component of PP.  FDIC insurance and principal loss protection if held to term seem to make it ideal for cash, if constructed like a traditional CD ladder, while still allowing you to participate in some ways in positive market movement of the S&P 500.  On the other hand, you don't get dividend income (as it is linked to the value of the index only) and the tax implications are horrendous (all gains are taxed as normal income even prior to maturity).

Pros:

• Linked to market performance.
• Principal protection in the event of a market downturn, if held to maturity.
• FDIC insured.
• Many have a death benefit which pays the current value to heirs.

Cons:

• In high interest rate environments, might underperform traditional cash/short term treasuries.
• Taxed as normal income.  Tax is especially bad because you have to pay tax on annual gains even though you have not even realized that income.
• Tied to the S&P 500 Index (or bond/commodity indexes) and doesn't participate in dividend income.
• FDIC insurance limits the amount of protection to $250,000 per named account at an institution.  You can be creative with this by using joint accounts, spousal accounts, trust accounts, etc.
• Cash is not liquid and can't be used as an emergency fund.

Are there any that I have missed?  It seems that given all of the above, MLCDs might be very nice to hold in an IRA, and might even make sense to hold in a taxable account in a zero or negative interest rate environment like we currently have.

More info:

http://moneyning.com/investing/is-marke ... t-for-you/

From the comments in the linked article:

A MLCD is no riskier than opening a CD and purchasing call options on SPY (for example) separately. To reconstruct a MLCD myself, say I place $100,000 in a 9-month ING CD @ 2.25%. This amounts to about $250 per month of interest. Then I buy 10 nearest at-the-money call option contracts for SPY (09 Sep 89.00 for $10.40 apiece, $104.00 total). Now I have $146 leftover and I’ll receive any upside of the S&P 500. In the absences of arbitrage, a retail MLCD and my DIY approach should have the same yield.

Note: Because of the limited upside mentioned above, I suspect that a bull call spread is used rather than just simple call options. But that’s a whole other ball of wax.

I believe this might also be a good cash strategy, however, it falls pretty firmly outside of the PP principals of keeping it simple and easy to manage.  In a lot of ways MLCDs are the same product but more simple, and I'm sure the bank is charging you some pretty high fees for essentially purchasing the call options on your behalf.

There is something to be said for doing it yourself and tweaking the implementation to match your tolerance for risk, however, there is also something to be said for a CD that sits at the bank and is redeemable by anyone, even your family in case you have a medical emergency and are unable to execute or sell your options.

Some people like cash in the PP because of its steady NAV (you can't nominally lose money). It appears that is what you like about it, and this alternative you proposed maintains that trait.

For me, that is not the point of cash. Cash is important in the PP because occasionally the Fed tightens short term interest rates to a level where NO asset class is attractive. Every asset class does poorly, except for cash. In this environment, cash doesn't just sit there maintaining its value. The Fed directly intervened using short term interest rates, so your cash component is going to have a very high interest rate which helps offset losses in your other asset classes. I think your proposed tweak entirely removes this dynamic.

EDIT: I imagine this product is somewhat complicated, so if I am wrong and it does hedge against rising rates than please let me know.