Are the risks of structured income notes too great for a conservative investor in today's conditions?

Question

The high returns and possible principal protection (e.g., 30%) of these notes are tempting, but they seem very complicated. Are they a good choice for a new investor needing a low-risk investment and rapid recovery in a downturn?

Answer 1

I would strongly suggest that if something seems complicated to you, it is very much not low-risk. Things that are actually low risk are and should be very easy for you to understand. Because a large part of "risk" is the risk of not understanding how an investment might behave in different market conditions.

If you do a lot of research to understand the risks and benefits of structured securities, you might conclude that they have a place in your portfolio. But not if you are new investor.

Personally, if I look at a basic overview of a product and see something like

Because of this, regulators have expressed concerns that retail investors, particularly the less sophisticated ones, may not appreciate the risks associated with the purchase of a note. Regulators such as the National Association of Securities Dealers (NASD) and Canadian Securities Administrators have also emphasized the need for due diligence, both on the part of the seller and the purchaser of a note.

I would run for the hills if I considered myself a "less sophisticated investor". Even more so if this was something I was being pitched by a non-fiduciary financial advisor. Structured products generate a lot of fees which is great if you're a salesperson paid on commission.

Answer 2

"Structured Income" notes is a very broad category, so it's not possible to consider them all as "low risk", or to say that they are good for new investors in general. They have a wide range of risks and returns, such as limiting downside but taking a cut of the upside, which would not make them suitable for a "rapid recovery". Or they limit downside up to a point, making you vulnerable to large losses unexpectedly.

The main point is that if they look "low risk", then either they are also relatively low return, or you just don't know where the risks are. Generally new investors should only invest in things that they understand fully, which is one reason why 401(k)s and other broad plans limit the investments available to simple mutual funds, usually linked to an index of some sort.