Dow Jones 10793.62 -58.36 5:52 am PST, February 4, 2006  NASDAQ 2262.58 -18.99 For info, visit access.smallcapnetwork.com S & P 500 1264.03 -6.81 Change your subscription status here Russell 2000 724.22 -2.03 VOLUME 06: ISSUE 10  Feature: Don't Buy Index Linked CD's. Build Your Own. Got say, $50,000 to invest? Want to put it into the market but you have the risk tolerance of a small fuzzy puppy? No matter, this idea will work for all types of investors; very low to no risk of capital and a chance to make some decent cash in the market. Intrigued? Read on... In a few decades of market watching and investing, I've concluded that most investors are more concerned with protecting their capital than making scads of money. While that attitude will limit returns, it is certainly understandable. There's a way to have the best of both worlds and it's surprisingly simple. Stay with me. Many financial institutions have come out over the last few years with products called--among other names-- index-linked Certificates of Deposits (CD's). The premise is simple: give the institution a chunk of your dough and if the market indices, say the S&P 500 for example, goes up over the term of the instrument, you'll get some of that return. If it goes down, your capital is guaranteed at the end of the fixed and non-redeemable term of 3- 5-7 years or even longer. Some of the problems with index-linked CD's: The vast majority of vendors pay no traditional interest on the principal. Even so, the IRS will require you to pay tax on the ' implied' interest annually. These CD's are non-redeemable. And substantial penalties if you try to. You're locked in big-time for the FULL term to one vehicle and one institution. To understand the various formulas as to what you will make if the market rises or falls--see below-- you'll need a degree from the either the LSE, Wharton or MIT. Interest, if any, is only paid upon maturity. Absolutely no ability to adjust your market exposure or timing. If you have an index-linked CD outside of an IRA, the tax treatment is a nightmare. Trust me that truly is an article unto itself. From one institution's explanation. Try and figure this out: All interest on the S&P index CD is credited and paid at maturity. The "stock market linked index" interest is based on the percentage increase of the Standard & Poor's 500 during the term of the CD. This is calculated by comparing the index on settlement day to the closing index on maturity day or certain averages. This gain is calculated into a percentage to come up with the rate of return. Although the index may fluctuate from time to time, your interest will be based on the gain over the entire holding period. I feel your pain. Even the grammar is bad. 'Come up with...'. I love that. I left out the institution's name for your protection. If you had bought one of these babies in 1999 for a five-year term, you'd likely have sat on the sidelines and watched the action as the markets rose and fell. You'd likely have made nothing, although your capital would remain intact, for whatever that's worth. And you're five years closer to retirement. Frankly, given the obtuse nature of the various returns formulae, I have no idea what you'd have made. Really, life's too short for this crap... So what to do? Buy a 5-year Treasury Note (or other risk-free vehicle) and invest the balance. Here are the options and details. I'm going to use 5-year US Treasury Notes as an example for the risk free component, but you could use just about any interest paying or discounted value vehicle; Municipal, Corporate (depending on the terms), Zero Coupon Bonds or even a straight, interest bearing redeemable CD. While my calculations aren't exact, you'll get the picture pretty quickly. And remember, I have $50,000 to invest. The 5-year US Treasury Note yields around 4.5 percent annually. That means that if I bought roughly $40,500 worth of that vehicle, I would have received, by maturity, sufficient interest and capital gains that when added to my initial investment would equal $50,000. My capital would have been made whole by maturity.  If you don't do this in an IRA, the interest is taxable. That's where something like a high-grade tax-free municipal bond as the risk-free component might be a good option. Next, of your original $50,000, you'd have about $9500 left after you've bought your 5-year Treasury Note.  You have several options with that $9500 which makes up the index or market linked component in our strategy. Buy one or more straight index linked Exchange Traded or Mutual Funds. There are scads out there. www.Morningstar.com can help sort them out. Buy some stocks. Buy a sector fund or perhaps an international equity fund. Buy a dividend growth fund or selection of dividend paying stocks. That's the point: you can buy whatever YOU want, not whatever THEY want. There's the main benefit: flexibility. With a standard index-linked CD you'd likely have no idea either what you're invested in or how much you'll get if the market rises.  Here are the benefits of the do-it-yourself (DIY) index linked CD: Capital intact at maturity. Enhanced tax treatment if you use tax -free munis, an IRA or other legal legerdemain to avoid tax. Maybe even inflation-linked bonds. Liquidity--a biggie. You can reverse, sell or even adjust the strategy anytime. You can lengthen your bond's term or reduce, sell or change your market component at will. If you so choose, you could reinvest the interest earned on the risk-free portion any way you wish. Or not. You get to keep all of the market gains instead of some slice after the institution gets through calculating your end using a HAL 5000 or Cray Super Computer. And, most importantly, you have virtually a risk free way to potentially make great returns without the sleepless nights that invariably follows after putting all of the $50,000 into this market. By building your own index-linked CD, you gain the three things you don't have with the fixed institutional variety: flexibility, liquidity and the ability to adjust the terms and components with lower risk than straight 'naked' stock ownership. The only thing they both have in common is that you get your principal back at the end. With our DIY version, the risk-free component is taxable just as the standard version; in our strategy, at least you're actually receiving the interest annually to pay the tax. I think that's pretty clear. Build one of your own index/market linked CD on paper first and run the numbers. I think you'll find it intriguing and a decent strategy for a portion of your capital, no matter what your risk tolerance or aversion may be.     We Value Your Feedback Got comments, questions or suggestions? Send 'em on over: Editor@smallcapnetwork.com If you wish to send a written request or inquiry, please send it to our physical address: TGR Group, LLC 4653 Carmel Mtn Rd Suite 308 #402  San Diego, CA 92130 What's a Treasury Note? A Treasury note is a Treasury security (Principal guaranteed by the full faith and credit of the US Government) with a maturity of between 2 and 10 years. The Treasury currently issues 2, 3, 5, and 10-year notes. Notes are auctioned by yield, with interest paid semi-annually. The face value of the note is paid in full upon maturity. The 2 and 5-year notes are issued once each month. The 3-year note is issued once per quarter. The 10 year note is now auctioned six times each year with auctions held at quarterly in February, May, August, and November, and two other auctions which settle on July 15 and October 15.   Market Call: Nasdaq Headed Lower Unless we get a fierce snapback and/or a major material change of events, it appears the NASDAQ is headed for lower territory. We could well see a 'seller's exhaustion' rally of some sort prior to the decline.   A rally to 2280 - 2290 level may be in the cards, and then selling should come into the market again. Ultimately, I think we may be headed for 2143 before we see any potential opportunity for a tradable rally to the upside. Interesting QQQQ puts look like the $41April 06 if you can snag them under $1 on a market pop. Or a few now and a few when the pop poops out. Here's the link: http://finance.yahoo.com/q/op?s=QQQQ&m=2006-04 Scroll across the top for expiries and strike prices. Remember, straight option purchases are for aggressive traders.   OIL Watch Have made some good calls on oil, it looks to us that the monthly chart is moving toward a potential double repo. Pretty simple, if oil stays below 70 in the coming weeks, its likely to go much MUCH lower. If it breaks above $70 timing looks good to jump on board as we see a possible whole new upleg unfolding. Adjust your exposure accordingly and we'll keep you apprised of our thoughts. Keep an eye on the Energy SPDR (AMEX: XLE). We'll look at some appropriate targets next week. It is also optionable, lest y'all forgot. Subscribe Information is power and timely information is profitable. Become informed and profit from SmallCapDigest Profiles and Trading Alerts by becoming a Preferred Member today. There is no cost associated with your email subscription. 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