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Kim Butler

Partners for Prosperity, Inc.

City:Mt. Enterprise

State: TX

I have 20+ years of handling alternative investments in cash, growth and income for clients nationwide.  I strive to help my clients with all things financial in every way possible over the phone and the web.  I own an alpaca farm which I enjoy working during my downtime.  I also enjoy gardening, writing and reading books.  I also train other advisors on Prosperity Economics.

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Regulators Grow More Concerned About Principal Protected Notes

Low interest rates are driving more investors to principal protected notes

Investors frustrated by prevailing low interest rates are enticed by the potentially higher yields offered by principal protected notes – a trend that worries federal regulators who fear retail investors will jump into the complex products without fully understanding their risks.

“Retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment,” said John Gannon, senior vice president for investor education, at the Financial Industry Regulatory Agency.

“The retail market for these notes has grown in recent years, and while these structured products have reassuring names, they are not risk-free,” said a recent FINRA press release that issued a joint warning with the U.S. Securities and Exchange Commission.

Principal protected notes typically combine a bond and a derivative product linked to an underlying investment, index or benchmark. The bonds are typically zero-coupon bonds that pay no interest until maturity, while the underlying investment can vary from a common stock market index to currencies and commodities. According to the SEC, a note might be based on the performance of an equally weighted basket composed of the Russell 2000, an exchange-traded fund tracking a real estate index, the Brazilian Real-U.S. dollar exchange rate or the price of copper.

Investors receive returns linked to the performance of the derivative, said FINRA, but they should be aware that principal can be tied up for up to a decade and may not return a profit in the end. Investors who hold PPNs to maturity typically get back at least some of their investment, even if the value of the derivative product goes down. “But protection levels vary, with some of these products guaranteeing as little as 10 percent – and any guarantee is only as good as the financial strength of the company that makes that promise,” said FINRA.

Some consumers mistakenly believe that PPNs offer complete downside protection, said Lori J. Schock, director of the SEC Office of Investor Education and Advocacy. “Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand.”

Principal guarantees depend on the soundness of the guarantor, which is typically the securities firm that creates and issues the note. Should the issuer go bankrupt, investors – who are considered unsecured creditors – would likely recover little if anything of their original investment. That was the fate of holders of PPNS issued by the now bankrupt Lehman Brothers.