Money Matters

Not all structured investment products are the same

January 26, 2013 

Q. My broker wants me to invest in something that is tied to the performance of the S&P 500. It has limited upside potential of a 7 percent annual rate of return, but he said my principal is guaranteed as long as I hold the investment until it comes due, which is seven years from the issue date. He assures me that this is not an annuity (I even have that in writing), but either he isn’t explaining it well or I’m just dense because I still don’t understand the investment after meeting with him numerous times. He talked about a kick-out that could make the maturity less than seven years, and a bunch of other terms that confused me. Do you know about these types of investments and, if so, could you please explain what they are and the pros and cons in plain English?

I’m quite sure you are talking about Structured Investment Products. They are a bit complex, and you need either to trust your broker, to read the prospectus and know exactly what he is recommending you buy, hire someone else to read it, or read it and understand it yourself. They can have a lot of different features. The product features will determine for which type of investor the product is suitable. They can be an excellent way for a cautious investor to participate in potential market returns while desiring capital protection.

Some, but not all, SIPs offer 100 percent capital protection if it is held to maturity. If the SIP assures return of principal regardless of the performance of the underlying asset (in your example, the S&P 500), you have a SIP with “hard protection.” Since there is lower risk of loss with this type of SIP, the maximum return is lower than with others. A SIP with “soft protection,” where the initial investment may be reduced if the underlying asset performs poorly, will have a higher maximum potential rate of return. Some SIPs have the additional benefit of deposit insurance from the FDIC. You get the features of the product, and your money is insured for as much as $250,000 per the issuing bank or institution.

One determination of the maximum return is the participation rate. Example: If the underlying asset has an annualized return of 12 percent and the participation rate is 80 percent, your maximum return will be limited to 9.60 percent (80 percent of 12 percent).

In addition to the participation rate, you need to know the cap rate. Some SIPs are uncapped, meaning they have no upper limit, and if combined with a high participation rate, can even offer the potential for a higher return than the underlying asset. Others are capped. In the above example, if you had a cap of 7 percent in addition to the 80 percent participation rate, your maximum return will be limited to 7 percent.

As you indicated, some SIPs will also have a kick-out provision. This simply means that if a target rate of return is reached prior to maturity, the SIP will mature early. You get your investment back sooner than anticipated. Not a bad thing to happen; you receive the targeted return in less time. The biggest problem with this is that now you have to decide where else to invest the money sooner than anticipated.

The above doesn’t cover all you need to know before investing in a SIP, but now you should have a general understanding of the most common features.

Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at or P.O. Box 97128, Raleigh, NC 27624

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