A short-term move with a potentially nice upside. Why are baby boomers and seniors looking into structured notes, especially those with a 2- or 3-year life? It is because these hybrid securities offer potentially greater returns than garden-variety bonds or CDs.
Banks and other financial firms issue structured notes to satisfy their investment needs. These notes come with embedded options, usually on an underlying stock or stock index. The idea is to leverage the exposure to the stock or stock index to improve an investor’s return.
A hedge when the market is down. In a bear market, a principal-protected structured note is welcome – you don’t lose what you initially invested because the assets are in a bond product. When the market improves, you are poised to benefit from the performance of the underlying index or security.
Principal-protected structured notes come in three flavors: they can be exchange-traded notes, CDs, or privately negotiated contracts.
What’s the downside? While some structured notes guarantee the return of your initially invested principal upon maturity, others don’t. Non-principal-protected structured notes lessen the degree of protection in exchange for the potential of a better return. If a structured note isn’t principal-protected, it is possible to lose some (or all) of the principal, as these investments do have derivative exposure.
Even with principal-protected structured notes, it is worth noting that a guarantee differs from a promise. Some structured note offerings “guarantee” the principal with government bonds. Others simply “promise” a return on principal based on the strength of the issuer.
Profits on non-principal-protected structured notes are commonly taxed as capital gains. As for principal-protected structured notes, payoff above the invested capital is taxed as interest income.1 If you want to sell a structured note before it matures, the financial firm that issued it will often buy it back â€“ but that is not a given.
Should you move money into structured notes? Investors looking for diversification (and ways to enter certain asset classes with less risk) might consider principal-protected structured notes. Non-principal-protected structured notes also have the potential for strong returns.