As I watched my son learn how to bowl, I vividly recall the trepidation in his eyes as he stared down the pins at the end of the lane. He stood frozen, paralyzed by fear. I encouraged him to roll the ball, promising that he could knock down the pins. What held him back was the uncertainty of what the ball would do once released—would it end up in the gutter, yielding no pins knocked down? To overcome his fear, I pressed the little red button on the scorer’s table, causing the bumpers to rise along the gutter. This simple act virtually guaranteed that, with the courage to release the ball, at least some pins would fall as it reached the end of the lane. To my surprise, he bowled a remarkable 149 and even bested me. That memorable day made me reflect on the parallels between this experience and investing, particularly when guiding clients through the inherent risks of investments.

In most investment scenarios, risk is inherent. When we invest, we essentially buy into an asset or financial instrument, with the expectation of receiving returns commensurate with the risks we assume over time. However, this also means that there’s a possibility of unfavorable outcomes, such as the investment performing below expectations or underperforming during the intended investment horizon. These apprehensions have deterred many from taking the vital step of assuming the appropriate level of risk to achieve their short- or long-term financial goals. Nevertheless, what many investors may not be aware of is that there exists a way to invest money with some level of downside protection, a predefined outcome, and a known investment period. This method, analogous to “bowling with bumpers,” is found in the realm of Structured Investments, previously accessible only to ultra-high-net-worth individuals and institutional investors.

Structured Investments can help us attain various financial objectives, whether for immediate income or future growth. These investments do not involve placing money directly into the market but are instead linked to the market indices we wish to track, which may include the S&P 500, Russell 2000, Dow Jones Industrial Average, or even individual stocks and securities, including international indices. When structured notes are created, they represent senior secured debt issued by the bank underwriting the note. The bank acquires options to engineer the desired investment outcomes, affording investors the opportunity to generate income monthly, quarterly, or annually over a defined period, or to amplify potential long-term growth without receiving any immediate income. The investment horizon can be tailored to the investor’s needs, with built-in protections that can mitigate market losses at the expense of potential returns.

However, it is important to recognize that all investments come with risks, and one significant risk in structured notes is the creditworthiness of the bank issuing the note. Once the parameters are established, the investment’s performance hinges on the underlying indices and how they perform over the predetermined investment period. For instance, an investor seeking 8% annual income paid monthly could potentially have a 15% or 20% downside buffer, protecting them from the initial market losses during the investment period. Increasing the downside protection typically results in sacrificing some of the potential return. Income notes usually track two or three highly correlated indices, and the note matures based on the worst-performing index on the designated day.

On the other hand, growth notes typically track one or two indices and offer higher upside potential when the market performs well while featuring a downside buffer if the market experiences declines. For instance, if the S&P 500 is the tracked index and the note has a 120% participation rate, you would receive 24% at maturity if the market surges by 20%. In case the market is down by up to 20% at maturity (within the downside buffer), you would not incur any principal loss and would have the opportunity to reinvest in a market that you did not previously participate in. What makes structured notes exceptional is their flexibility in managing risks and outcomes, increasing the likelihood of achieving desired investment goals compared to investing directly in underlying assets.

It’s crucial to thoroughly discuss the risks and rewards when considering structured notes, as they may not be suitable for all investors. They are often more suitable for short- to medium-term investments due to liquidity needs, and they do not trade at market values but at an intrinsic value with a time value component. For investors concerned about the future and looking to safeguard their portfolios, structured notes can be a valuable tool for creating a portfolio with built-in bumpers.

By: Jonathan Jordan