Since 2012, I’ve been using equity structured notes as a strategy to protect against market downturns. While structured notes can sometimes be misunderstood due to their complexity and cost, they can be quite beneficial. These tools can offer peace of mind for those hesitant to invest due to fear of loss. Over the years, I’ve seen many people hoard cash in savings accounts out of a similar fear, missing out on investment growth.
In retrospect, the protective measures I took may not have been necessary given the strong performance of the S&P 500 since I stopped working. However, without a regular income, investing significant amounts in the stock market seemed daunting. Structured notes offered a safer alternative, encouraging me not to sit on cash or excessively buy real estate.
The trade-off with structured notes usually involves giving up dividends or capping potential gains. Although this might lead to underperformance in a bull market, my experience has been positive. For instance, a structured note I invested in five years ago just matured, outperforming my expectations.
This particular note was tied to the S&P 500, set up with terms that provided 30% downside protection in exchange for forfeiting dividends. The upside was leveraged, meaning for any positive performance of the S&P 500, my returns were amplified by 50%. When this note matured, it delivered a 21% internal rate of return (IRR), compared to a 16% IRR I would have achieved with a direct investment in an S&P 500 index fund.
Investing in this structured note not only protected my downside but also provided substantial upside during a period of market fluctuations. It gave me the confidence to invest $52,000 during uncertain times, significantly contributing to my financial growth.
However, there are downsides to consider. The influx of cash from the matured note means deciding between reinvesting in the market at potentially overvalued prices or paying down debt. This decision-making can be burdensome. Additionally, every matured note creates a tax liability, which can be substantial depending on the investment’s success and the timing of its maturity.
Another limitation is the lack of control over the exit timing. Market conditions can dramatically change near the maturity date, potentially turning a profitable investment into a loss. If it were up to me, I’d prefer extending the investment period during market highs to safeguard against last-minute downturns.
Structured notes are not just financial instruments; they require active management and a strategic approach, especially when considering tax implications and reinvestment strategies. If you’re considering structured notes, it’s crucial to understand their structure and terms fully and to assess whether they align with your financial goals and risk tolerance.
For anyone interested in exploring structured notes, I recommend discussing options with your financial institution. Understanding the full scope of potential scenarios through the prospectus can prevent unwanted surprises and ensure that these investments fit within your broader financial plan.
