If you’re someone who’s hesitant to invest due to fear of market volatility and often find yourself hoarding your money under your mattress, then this episode is tailor-made for you.
In this week’s episode of Retire in Texas, Darryl Lyons delves into the world of structured products, offering a comprehensive overview of their potential benefits and considerations for investors seeking a middle ground between traditional investments and safer options.
Show highlights include:
*Why many investors are apprehensive with the current state of the market, and why structured products may be the ideal solution for those who feel this way.
*A breakdown of what a structured product is, and how it can be a useful alternative investment tool if utilized correctly.
*An outline of five key points about structured products, including their construction by banks or institutions, their returns based on the performance of underlying assets, and their varied terms and features.
*The importance of understanding the risks and fees associated with structured products, including the potential for limited liquidity, varying costs, and the importance of working with reputable financial institutions.
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Transcript:
Hey, this is Darryl Lyons, CEO, co-founder of PAX Financial Group. Thanks for tuning in. This information is general in nature only. It’s not intended to provide specific investment, tax or legal advice. Visit PAXFinancialGroup.com for more information. And also, I want to remind you, go to the PAX website if you haven’t already. And if you want to meet with an advisor, just hit the button on there. There’s a call to action button and you’ll meet with an advisor. 15 minutes. Heart of a teacher. No pressure.
We just want to make sure it’s a good fit. But it’s probably a good idea as you are thinking deeply about your money, to have somebody walk alongside of you. And I don’t think there’s anybody better in the industry to walk alongside of you than somebody at PAX. That’s of course, my biased opinion, but I have conviction there.
So, I’m going to talk to you today about something that you may at first glance seem like it’s a little bit more complex and nerdy, but hang with me. I think you’re going to appreciate this content, especially if you fall under this description of an investor or an individual or whoever that’s just thinking about like, I really, really want to invest. I really do. But man, I just don’t feel comfortable.
And the markets just going up so much. And I know as soon as I put money in, it’s going to crash. It’s just like these all time highs. And then you’ve got 33 trillion in government debt and immigration and this country’s going to hell. There’s no way I could invest. If that is you, then this is the right episode for you. Because I get it.
There is something wrong. And you know this too. Putting it in the mattress. Can there be a place in-between the mattress and the stock market that behaves like a child with a yo-yo going up an escalator? Is there something in between the mattress and the escalator?
Now, of course, I-you know me. You’ve heard me over the years. I have conviction in the escalator long term, but I also respect where you’re at, where you’re coming from. The concerns that you have are very real. So, I don’t discount them. So ,what’s in between the mattress and the escalator? That’s the question. Is there something in between the mattress and the escalator?
I mean, if I were to say bonds, you’d say that kind of sounds more like the escalator. Stocks and bonds. They’re kind of married, aren’t they? What about annuities? Are they between? But then you say, well, you have heard annuities are bad, CDs feel more like the mattress. In long term that’s not really what I need. Maybe now is fine. So you scratch your head and go, I’m really struggling with what’s in between the mattress and the escalator.
And so I’ve got you. And I actually, I really, really like this investment tool, but it’s not for everyone. And make sure you read any of the show notes, because I’ll have some links to disclosures and information because I’m going to give you a brief rundown of a tool that is very effective for the right people under the right circumstances.
And not everyone qualifies for it. There’s certain disclosures that have to be provided,because it’s nuanced, it’s not exactly the everyday layman stocks and bonds kind of stuff for CDs. But it does fit that category of in-between. So, if somebody has their money in their mattress and I’m looking at their retirement plan and saying, “I really need your money to grow” and I can’t convince them that the escalator is safe, then I need an in-between tool.
And so this would be an in-between tool. For golfers, this would be kind of the in-between club, right? And this one is called structured products. Structured products. What is structured products? Okay, let me try to unpack it. This is a definition of structured products. Structured products are investments which provide a return based on the performance of an asset.
So what did I just say? So the returns are not necessarily based on the structured product itself, but the returns are based on another asset. So, let me unpack this. I’ll give you five points that will help give you an idea of how structured products work.
So point number one, think about the word structure in itself. That’s important to know. And when you think of structure, it’s not a huge leap to think about construction. And so, construction in the financial world, constructing a building is easy to think about, but constructing in the financial world happens all the time too. They structure loans. They structure health care products, they structure disability plans. There’s construction that happens in the financial world all of the time.
And so this is an element of that structured products. It’s constructed by who? So this is the second point, who constructed these structured products? They’re banks, usually big banks or investment institutions. So that’s number two. I just want you to know they’re constructed by banks and institutions. And so the quality of the bank is important, right? Because you don’t want to have somebody not be able to fulfill a promise that they’ve made.
So, making sure that it’s a good financial institution. So that’s the second point. I want to make sure that you know about is financial institutions responsible for this construction. Number three, how do they perform? You say you get a return based on an asset, but tell me a little bit more. How do they work? I’m still not clear.
So the construction of these structured products, they get their returns from another asset. They get their returns from another asset. So they might get the returns from the stock market, they might get the returns from the bond market, they might get returns from small company stocks or large company stocks. Interestingly enough, the construction can be done on nearly any type of investment in the marketplace.
So you say, well, I just told you, Darryl, I’m not confident in this child with Yo-Yo in an elevator thing going on. So you told me, you’re telling me that I can construct an investment that’s linked to the stock market. So basically, why don’t I just get the stock market? That’s where the difference is at. And so I’m going to give you one example, because the construction, these structured products, yes, they’re tied to the stock market in many ways they are.
But here’s where they’re different. And I’m going to talk about a subcategory of structure products because they followed different categories. And I’m going to talk about the ones called principle protection. Principle protection. So it’s like saying, okay, cars are a big category and underneath cars is SUVs. And so structured products are a big category, and underneath structured product is principle protection.
Now, I’m going to help you bridge this intellectual gap. So these structured products are connected in many ways to the stock market, not all the time. They can be done various ways, but in this example, the stock market. And let me give you a couple examples that might help. So, this is the fourth piece is for me to give you some examples so you can grasp this concept.
So, we constructed these working with a third party. They’re no longer available. These structured products aren’t always available. They’re not what we consider perpetual. We have offerings that we do each quarter, and these are two that we’ve done in the past for our clients. Now we do it for our clients. So if you’re not a client, we won’t do them for you just can’t come off the street and say, I want a structured product. We have to know you. We have to know how they fit into your financial life.
I don’t think people generally understand when we know our clients and we have new tools in the marketplace, we’re able to reach out and implement these tools. Now, the two that we’ve done in the past, one was working with Morgan Stanley. And so there’s three elements of this particularly constructed, structured product.
Hear me, it’s interesting. You have to hold this structured product for two years. This is one done in the past. It has the maximum that you can get on the upside of the stock market linked to the S&P 500 specifically. The maximum you can get is 18%. So if the stock market goes 50%, the most you can get is 18%.
The downside, 100% downside protection. 100% downside protection. That’s one example. Let me go to another example. We did one with Goldman Sachs. Offered 22% upside. So that would be 11% a year to your hold, but not a 100% downside protection. They had something called a 20% buffer. That means Goldman Sachs would essentially absorb 20% of losses. But if your stocks went down, if your stocks went down 25%, you would have to absorb that 5% loss.
So they have a buffer on the first 20% of losses of your portfolio. So two examples, three terms that are worthy of digesting. One is something called point to point. They look at the day of the agreement and then the end of the term and see from point A to point B, did the stock market go up in this case represented by the S&P 500?
If it did, then you get to participate in that up to the terms. In the first example, up to 18%. In the second example, up to 22%. That’s the first point. Point to point. The next one is buffer. Some of them have buffers, that when they say a buffer, that means that’s the max that the institution will absorb in losses. And anything beyond that you have to take on. Sometimes they have buffer, sometimes they have 100% principal protection. And then of course, you have to pay attention to the holding period. They all have holding periods. Those are two examples. Now please understand that the markets for these change all the time. So they could be totally different. Different institutions do these in different ways.
So you may come to your advisor and say, “Hey, I heard that Structured Product podcast from Darryl and I want one of those 22 percenters.” And they change all the time, so don’t anchor to the numbers. This is more of an example of how they work, and there’s thousands of variations of them. We’ve even worked on customizing some of them in the past, using biblical responsible investments in the construction.
So we’ve been able to really work with some institutions on designing these to fit our clients needs. But the fifth piece that I think is important is to understand the fees and the risks associated with these. Now, the fees are really hard to understand because they’re not as fluid. First of all, the banks are betting against you. Just to be clear, they’re not betting that you somehow lose on this deal. That is absolutely not the case.
They’re making money on the risk management that they’re doing and they’re making money on. Not to be too granular, but some of the spreads of some of the products that they’re using to make this work. But the main thing I want you to know is, first of all, the fees vary and I don’t even think you won;y consider them fees necessarily. The cost of doing this varies. It’s hard to tell because their spreads on how they manage risk.
One thing to know is that there’s no commissions, at least in the tax environment. We’re fiduciaries. So if we’re recommending a structured product, it’s not because we’re getting paid a commission. No, no, we want to make that very clear. If anything, it’s more work for us. And so when we recommend a structured product, we believe it’s in our client’s best interests. So that’s very clear.
There might be advisors still out there selling these in a commission relationship. I’d be careful there when we do it, we do it in a fiduciary relationship. So there’s no commission. Very important to know when you work with a fiduciary, at PAX and then the costs of the products do vary.
There’s a third party and again, I’ll put the link in the show notes. There’s a third party that said that the average expected margin by these structured products is 0.3% per year. But I still think that’s probably difficult to digest because of the construction of these. The main thing that I look for, certainly the cost, but the main thing I’m looking for is the terms. What’s my upside, what’s my downside protection and how does that work?
So I’m really looking and I think all of us are just kind of looking at the bottom line. Okay, I understand that everyone needs to get paid in this thing, but what do I get, bottom line? And so that’s a lot of times what we’re looking at. Keep in mind, though, that these generally aren’t liquid. So you got to keep it to the term to make it work. So that’s important.
The other thing is working. I mentioned this to you before, working with a good bank. There’s some of them that have FDIC insurance. FDIC insurance doesn’t mean that you don’t have any loss of principal. Just means like if Wells Fargo goes bankrupt, you have some insurance there. So check and make sure that the structured product has FDIC insurance. Some of them do, some of them don’t. I think it’s just a judgment call. You don’t have to have it on every single transaction. But if it’s a smaller bank, I think having the FDIC coverage is helpful.
And then don’t put a big chunk of money in here. Work with your advisor on making sure it’s an appropriate amount. We do a lot at PAX where it’s a core satellite, so you have your core investment strategy and then periodically you satellite the investment strategy with kind of a thesis or ideas that you might have and the structured product would fit into that satellite idea. So there you go. That is a very complex conversation hashed out in 15 minutes.
I hope you digested some of it. It’s a type of strategy. That’s the in-between strategy. The in between the mattress and the child with the yo-yo on the escalator. And you have to consider all the risk reward profiles and the institution. And then, of course, making sure it’s a good fit for you.
That was fun. I actually watched a lot of YouTube videos on this one here because I wanted to get some language right. And I’ll mention this real quick. There’s some videos out there that hate structured products. And I’ll leave you with this. There’s a couple of guys that hate structure products and I’m just watching just because I want to pick up some phrases. You go to the comment section, people say, “Well, gosh, now that you’ve explained it and you hate it so much, I actually want one.”
And that’s kind of how I feel. I think for a long time I wasn’t a big fan of structure products, and the more I’ve got into them, the more I can appreciate them. So, do your due diligence, work with your advisor and as always, you think different when you think long term. Have a great day.
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