Have you made your move? All week, we’ve shown you why you need to stay invested in this dizzying stock market. Alex even showed you when to make your move.
But we get it. Investing when markets are falling is hard. It’s scary. We know readers still jumped in.
That’s dangerous. There’s no doubt it will cost them money. Cash attracts only dust. Stocks always rise over the long term.
We won’t try to convince you to make your move any more. We’ve given plenty of reasons “why” you should invest. Instead, we’ll show “how.”
We’ll show you a unique, yet quite controversial way to put that cash to use.
Structured products - in their many shapes and forms - get a lot scrutiny. They deserve it. They’re expensive. They’ve been at the heart of a couple of scandals. And they don’t offer the best shot at a return.
So why in the world are we telling you about them?
Despite their flaws, in the case of an investor who’s paralyzed by the fear of losing money, we believe they have their place. After all, if your doc can’t get you to exercise 30 minutes a day... he’ll surely be happy if you started by eating less, right?
Structured products allow you to take advantage of the stock market’s upside... without exposing you to its downside. That’s what makes them an ideal “first move” for investors frozen by fear.
Here’s how they work.
Although they may call them something different, most banks and brokerage firms offer structured products of some sort. Citibank, for example, offers several types of “Structured Notes.” HSBC calls them “Structured Investments.” And UBS sells “Return Optimization Securities.” They’re all quite similar.
In varying forms, your principal is protected from the market’s downside. In the most popular versions, the only way you’d lose your principal is if the issuer can’t pay its bills (the FDIC isn’t there to backstop these products).
But what makes these investments appealing to fearful investors is the upside. Depending on the bank you work with, you can buy structured products that track the value of many types of assets - i.e. gold or currencies or, commonly, a specific stock index.
In other words, you can easily buy a product that lets you participate in the upside of the S&P 500, without the downside.
Of course, there are no free lunches on Wall Street. With most of these products the gains are capped, the costs are high and you must hold the asset until it matures. Those reasons are why we don’t often talk about these sorts of products. They’re only for folks otherwise paralyzed with fear.
If you’re one of our many readers who aren’t paralyzed by market volatility and the fear of losing money, you can create your own structured products - without the expense of working with a bank. In fact, if you’re paying attention, you likely already have. They aren’t all that different from the strategy The Oxford Club touts in our popular Wealth Pyramid.
Again, most structured products offer a return of your principal if you hold the product to maturity. From there, they offer an upside based on some sort of index.
The principal protection simply comes from a bond and the upside comes from sort of derivatives contract - in most cases, a call option.
For example, let’s say you have $10,000 you want to invest for the next five years. You might put it into a structured product that promises to protect the principal and offers 90% of the return of the S&P 500.
The bank will likely buy 10 zero-coupon bonds that will mature in five years at $10,000. It might pay $8,000 for those bonds. It will then take the other $2,000 and buy a set of call options that offer the appropriate exposure to the S&P 500. (Unfortunately, it’s not quite that simple, but those are the essentials of the deal).
As long as the bonds don’t default, they’ll hand the investor $10,000 in five years. If the stock market doesn’t rise, the calls will expire worthless. And if stocks rise, the investor will reap the rewards.
It’s vital to know these sorts of products are quite lucrative for banks. The bank makes its money through fees and by capturing excess returns. There is no doubt you’re far better off investing in a diversified portfolio of stocks and bonds (the results will likely be the same, if not better). But, again, if you’re too paralyzed by the market’s recent volatility, structured products are an option.
As we said last week... do something. Sitting on a pile of cash is the quickest path to mediocrity.
By no means are structured products the right choice for everybody. But they do offer a solution for the timid investor looking to make a first step. Talk to somebody you trust about your unique situation.
But no matter what, do something. Don’t stand for mediocrity. - investmentu
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