Equity-Indexed Power CDs

[scfr]

Looking for opinions on Equity-Indexed Power CDs. Anyone have experience with them? Anyone think this is something they'd be interested in right now, given the current state of the US stock market and the economy in general?

Compass Bank is offering one; here are a few of the details (I saw this in a newspaper ad ... Tried to find a link with the specifics but it is not on the web):
Term = 5 years
Principal is Insured up to FDIC limits
Interest: 6% APY in years when the S&P 500 is the same or up for the year (from anniversary date of the CD); ZERO in years the S&P 500 is down
Minimum Deposit $10K

This is not something I would have considered in past years, but I'll admit it's tempting now that the stock market is down so much. I wouldn't be pulling money out of the stock market to put in to this CD. I've been seriously tempted to put some of our liquid savings in the stock market recently, but other than one stock trade, and having any new additions to our tax-deferred savings going to an S&P 500 Index Fund instead of our usual conservative mixed stock/bond funds, have lacked the guts. I thought that something like this CD would be a safe way to bet that the stock market is going to go up. (No need to explain that if I might miss out on some gains if the market soars 30% over the next 5 years. I get that.)

The huge advantage is that your principal is protected.

Here are a couple possible negatives that I have come up with; all are things I would check on before deciding whether or not to get this CD:
- Principal is probably NOT protected if the CD is not held until maturity (in other words, this is not an appropriate savings vehicle for an emergency fund)
- It may be callable
- Looks like it's reported as interest income (as opposed to capital gains) and therefore taxed at regular income tax rates

If you'd like to read more about this type of CD in general, here's a write-up by the SEC:
EQUITY-LINKED CDS

[noppenbd]

If someone would consider this I would offer an alternative path for a $10K investment:

The highest 5 yr CD I could find offers 3.9% APY. Putting $8200 in such a CD for 5 years would guarantee $10K at CD expiration. Simultaneously, invest the remaining $1800 in an S&P500 index ETF. Even if the S&P500 goes to 0, you are guaranteed not to lose money. On the other hand, you don't have the upside limitation that the Equity-Index CD product has.

[scfr]

Thanks noppenbd. I should have clarified that, for the sake of marital harmony, this is money that will be in a CD, MMA, or Treasury one way or another.

[noppenbd]

Thanks noppenbd. I should have clarified that, for the sake of marital harmony, this is money that will be in a CD, MMA, or Treasury one way or another.

Does that mean you would not be open to putting a small portion (less than 20%) in an S&P500 fund? Remember, considering the interest on the CD, you could not end up with less than $10K after 5 years (which is exactly how much the Equity-Index CD is guaranteeing). That seems like exclusionary thinking.

[scfr]

Here are additional details:
CD is NOT callable
Principal is NOT protected if not held to maturity
Earnings are interest income (not capital gains)

Any opinions on which is better, this Equity-Indexed Power CD or a plain ol' regular CD, MMA, or Treasury?

[jIM_Ohio]

If someone would consider this I would offer an alternative path for a $10K investment:

The highest 5 yr CD I could find offers 3.9% APY. Putting $8200 in such a CD for 5 years would guarantee $10K at CD expiration. Simultaneously, invest the remaining $1800 in an S&P500 index ETF. Even if the S&P500 goes to 0, you are guaranteed not to lose money. On the other hand, you don't have the upside limitation that the Equity-Index CD product has.

This is along lines of what I was thinking.

Buy a CD which matured to "present value"-
Meaning if you want to invest $10,000 total, find the term of CD which when invested at x% returns all $10k.

Invest the remaining balance in any of the following:

• An option to buy an S&P 500 index at 6% above current values (use an ETF)
• An ETF or mutual fund which invests in the S&P 500
• Some type of futures contract on S&P 500

[noppenbd]

Here are additional details:
CD is NOT callable
Principal is NOT protected if not held to maturity
Earnings are interest income (not capital gains)

Any opinions on which is better, this Equity-Indexed Power CD or a plain ol' regular CD, MMA, or Treasury?

No, I would not do this. If you figure the S&P500 has about equal odds of being up or down over a given year, your expected return on the Equity-Indexed CD is going to be about 1/2 of the 6% (meaning half the time you will get 6%, half the time 0). This gives you an overall expected return of around 3%. You can probably beat that with a plain-vanilla 5-yr CD, and without all the nasty insurance stuff (surrender penalties, no FDIC insurance, etc).

If you are trying to beat the 5-yr CD without a risk of losing money your best bet is a combination of a plain CD for the majority of the money and a small amount of risky investment on the rest (as outlined above).

[simpletron]

compare to almost 4% CDs out there, this product's returns would be about even if 3 of 5 years up and better if 4 or 5 years were up. I would take the bet that 3 or more of the next 5 years are up.

noppenbd's idea about 8200 cd and 1800 sp500 is interesting comparsion to the equity cd.
if the sp 500 is up 1 of 5 years, then you'll need the 1800 to return -67% or ~-19%/year.
if the sp 500 is up 3 of 5 years, then you'll need the 1800 to return -31% or ~-7%/year.
if the sp 500 is up 3 of 5 years, then you'll need the 1800 to return 6% or ~1%/year.
if the sp 500 is up 4 of 5 years, then you'll need the 1800 to return 46% or ~8%/year.
if the sp 500 is up 5 of 5 years, then you'll need the 1800 to return 88% or ~13.5%/year.

given the the sp 500 is up the X of 5 years, I would say the corresponding return is below average. meaning most of the time, noppenbd's idea would do better. also this is before taxes, which helps noppenbd's idea because capital gains taxes are less the income taxes.

edit: those returns are to match the equity cd. if the sp 500 return is higher, noppenbd's idea wins; if the return is lower, the equity cd wins.

[scfr]

I would take the bet that 3 or more of the next 5 years are up.

That's how I'm leaning right now.

As far as the other idea, I get it, and I think it's a terrific idea for someone else. As I said, marital harmony is in play here, which for me is more important than ROR. I've learned when it's not worth talking myself blue in the face ... I have no desire to be an Oompah-Loompah lookalike!