Market Linked CDs – or MLCDs for short, are getting a lot more attention recently.  Especially after the innovative investing website Motif started offering them.

What is a Market Linked CD (an MLCD)

MLCDs are a product that combines the guaranteed return of a CD with upside participation in a market index like the S&P 500.  Each MLCD is unique, but a typical structure might be:

-Your money is committed for 5 years

-You will get all of your initial investment back at the end of the period

-You get 100% participation in the performance of the S&P during the period, up to a pre-defined limit (e.g. 40% total return)

Over time an MLCD will likely return about 2%-4% per year less than the stock market, and about 2% more than a CD.

The psychological appeal of downside protection

The 2.8% per year return we get on “safe” investments like CDs today just barely keeps pace with inflation (and for anyone with a significant tax burden, you’re likely to lose vs. inflation).  It does, however, guarantee you’ll get your money and interest back (up to $250,000 per person per bank).

An MLCD is similar to a CD in that your money is protected against nominal loss (meaning if you put in 10,000 you’ll get at least 10,000 back).

Countless studies have shown that people overvalue this kind of downside protection.  In fact, it’s been measured to be 2.5x as psychologically painful to lose a dollar as to win one.  Here’s the chart from Wikipedia on the topic:

Reality: you aren’t losing dollars, but you are losing what dollars are supposed to do

Both CDs and MLCDs are still subject to taxes, and that ever relentless destroyer of money, inflation.  So your $10,000 MLCD investment may only be “worth” what $8,700 was five years prior, even if it “looks” like you didn’t lose money.  The value of a dollar is what it can buy when you go to use it – so while you’ve avoided a psychological loss, in practical terms you did “lose”.

But MLCDs will make you behave better - and that's worth a lot

In other posts I've discussed the huge gap between the returns on stocks in general, and the returns investors typically get on their stock investments. This article claims it is about 4% per year, but I usually assume 2%. This is because investors tend to buy stocks when they are expensive, and sell them when they are cheap.

Even assuming bad behavior, a pre-packaged MLCDs is probably still a little too expensive - even if you behaved badly in the stock market you can likely do better. But a DIY MLCD may give you the best of both worlds. Read on!

MLCDs are a packaged way of engineering a specific return profile. Do it yourself!

MLCDs are really three products wrapped in one, and you pay a reasonably expensive commission (about 5%-9% as of this writing) for something you can essentially do yourself.  If you invest $10,000 in an MLCD, you are buying something that looks very similar to:


FIRST BUCKET: a 5 year CD that is worth $10,000 at the end of its life.  At today’s rates, that CD costs about $8,700.

SECOND BUCKET: $1,300 of leveraged return to the S&P.  You could replicate that by putting the money in a leveraged ETF such as SPXL

And you are selling (where the gain is capped)

THIRD BUCKET: Call options at a price above the maximum threshold return.  For simplicity, let’s say that you are writing a series of call options at 35% above today’s market price and pocketing the premiums.  I ignore this bucket due to its complexity of execution, but technically you can adjust this amount as well to get a more perfect replica of an MLCD.

Don’t think MLCDs, think of “engineering” a return profile that suits you

A more appropriate way to think about an MLCD is “what return profile do you want to create for this x year investment”.

If you have some minimum amount you need, you can then design your own strategy for each of these three parts.  And you can tailor the term and downside protection you want.

Engineer your return.

  • Decide on the nominal loss risk you are willing to take and during what time period.  This can be any number, but I’d advise something between 1% gain and 15% loss, for a period of a minimum of 3 years and up to 7 years.  This amount becomes your “guaranteed amount”.

Example 1: Willing to take up to a 10% loss in three years, in other words, end up with $9,000 of the original principal per $10,000 investment.  3 year CD rate = 2.5%.  (1 + interest rate of 2.5%)^3 = 1.0768.  $9,000/1.0768 = $8,357.  This is the amount you put in a 3 year CD.

Example 2: Willing to take 0% loss in 5 years.  5 year CD rate = 2.8%.  (1 + interest rate of 2.8%)^5 = 1.148.  $10,000/1.148 = $8,710.  This is the amount you put in a 5 year CD.

  • Put the remainder of the investment in SPXL or similar 3x leveraged ETF product.
  • Cash-out at the end of the term.

Some example results.

Back of the envelope, and with a lot of assumptions, here’s how this might have worked for 5-year MLCD replicas since 1993.  You can download this Google Sheet if you want to run your own scenarios.

Assuming no more than 2% risk of loss and a 5-year hold:

  • Stocks only would have returned an average of about 9.5%, with the worst 5 year period resulting in a loss of about 9%.
  • MLCD replica would have returned an average of about 7%, with the worst 5 year period resulting in no loss.
  • An actual MLCD would have returned an average of 5%, with the worst 5 year period resulting in no loss.
  • Just doing CDs would have returned an average of 3%, with the worst 5 year period resulting in a gain of about 10%.

My conclusion – fit for a very specific need

The MLCD or replica is probably a better bet than a regular CD or MLCD if you are willing to not touch your money for five years.  For a small bit of extra risk, you get quite a bit of upside (2%-4% per year, before tax and other complexities).

However, this isn’t the best long term strategy, nor is it a stock market alternative.  The cost of protecting your downside adds up.  A 2.5% return drag doesn’t seem like much but over the course of a working career you’ll end up with half the money you otherwise would have.

If you want your money in easily accessible cash without as much short term volatility, the ULP tends to provide better results over short term periods up to about 3 years.  But it again is not a long term strategy – for that, stick with a more plain vanilla retirement portfolio.