5 Reasons Why You Should Never Ever Buy A Structured Note
Image Copyright: BestCashCow

5 Reasons Why You Should Never Ever Buy A Structured Note

Morgan Stanley, Goldman Sachs and second-tier full service brokerages make a real market in structured notes. So-called "structured notes" are intricate products that carry the possibility of earning a much higher interest rate that a savings or money market account or even a certificate of deposit, but also bear the risk of earning nothing on your cash over extremely long periods of time.

The reasons why brokerages push these instruments are very clear. Their base product (access to markets, advisory) has been proven to lack any compelling characteristics for a generation. Online brokers, such as Schwab, ETrade, Ally Invest offer access at a fraction the cost (sometimes at no cost) and provide access to research that is just as compelling.

Against the backdrop of a marketplace that has become anachronistic, these full service brokers have tried to maintain their upper middle class clientele by offering them compelling debt products. Until the last decade, they managed to hang on to a rather brisk business in municipal bonds. Yields on municipal bonds have fallen dramatically over the last decade making them less sexy, and, unless Trump is soundly defeated, many municipalities face certain bankruptcy, leaving municipals neither sexy nor appropriate investments.

What did become sexy is a structured note. This is where, for example, your broker calls you and says: “I can get you into an offering from JP Morgan Chase that yields up to 10% a year. It is based on the spread between the 2-year Treasury and the 30-year Treasury and it gives you 5x that spread.” And, that sounds especially intoxicating when even the best savings and money market rates are less than one percent.

But, here is why you should hang up on your broker:

1.The maturity on these things is usually between 15 and 20 years (sometimes longer). You will be illiquid during that entire time. Whereas you can ordinarily get out of a CD for a small penalty, these instruments can and do trade well below par (sometimes as low as half of par). Brokers make a killing on controlling a secondary market for these and are counting on your need to get out before maturity.

2. No matter what your broker says or is instructed to say on the phone, these are not based on Treasury rates. They are based on some obscure measure listed on some back page of Bloomberg that can be easily manipulated for the issuer or made to go away. For many years, these were issued based on CMS and then they made CMS go away. Read the prospectus, read it carefully, and then assume someone is trying to screw with you.

3. Structured Notes are a tax nightmare. If you read the prospectus on these instruments, you will see that your broker is ordinarily getting a 3.50% commission on the sale of these notes and you may think that is harmless enough, but the problem is that your basis is 96.50% of what you think it is, and you are going to be taxed on the difference between that amount and 100% over time. That tax is called original issue discount and it shows up as on your 1099 every year that you own one of these things. And, that is just the beginning. There are all sorts of other ways that you can have imputed income and be taxed on it with these things.

4. If you die before these mature, you are creating a nightmare for your executor. To boot, your heirs are going to see a fraction of what you have invested in these things (see point 1 above).

5. Nobody should ever buy a friend. Your broker has entered into a profession that is heading towards obsolescence. A 3.50% commission on the sale of one of these instruments may enable them to meet their mortgage payment next month and you may feel good about that, but you are going to own these things long after your friendship has ended. And, your financial wellbeing is not out making friends.

The bottom line: I am speaking from experience here. Even though I was trained as a tax attorney, the multiple courses that I took in pricing of fixed income at Columbia Business School, I got roped into these things. They are a disaster.

Ari Socolow
Ari Socolow: Ari Socolow is the Chief Economist and Editor-in-Chief at BestCashCow. He is particularly interested in issues relating to bank transparency and the climate crisis. Since co-founding BestCashCow in 2005, Ari has been frequently cited in the media as an expert on local and national savings accounts, CD products, mortgage and loan products and credit card rewards products.

Your code to embed this article on your website* :

*You are allowed to change only styles on the code of this iframe.

Today's Highest Online CD Rates

Bank Product Term Interest Rate (APY)
TotalDirect, a division of City National Bank of Florida 1-Year 5.50% APY with $25,000 minimum
Bask Bank 1-Year 5.40% APY with $1,000 minimum
Modern Bank, National Association 1-Year 5.38% APY with $10,000 minimum
Banesco USA 3-Year 5.10% APY with $1,000 minimum
Dollar Savings Direct, a division of Emigrant Bank 3-Year 5.00% APY with $1,000 minimum
First Internet Bank of Indiana 3-Year 4.76% APY with $1,000 minimum
First Internet Bank of Indiana 5-Year 4.61% APY with $1,000 minimum
BMO Alto, a division of Bank of Montreal Harris 5-Year 4.60% APY with no minimum
Seattle Bank 5-Year 4.50% APY with $1,000 minimum

See More Online CD Rates →


  • SavvyInvestor

    September 17, 2020

    Zero evidence or links here. 15-20 years are extremely rare. Steepeners are rarely pushed to the retail market. No mention of returns over the past decade on index-linked or equity linked products. I suggest you read up more on the topic.

  • Ari

    September 17, 2020

    Hey SavvyInvestor, Thanks for the comment here. The article is about structured notes and not about index-linked or equity-linked products. The index-linked or equity-linked products that you describe that may be called structured products by your broker but are something very different (equity side versus debt side). These products that you describe should also be avoided as you should always be able to find an comparable ETF that will outperform and have more liquidity. Sorry for the confusion.

  • Note Guy

    July 20, 2022

    Agree with one of the past comment. Obviously this is an old article, but figured I would give updated clarity on the Structure Notes world as it is today.

    1. Notes in like 80-90s were with long term lengths, but because this is now a $7 trillion dollar marketplace(In European and Asian markets these are very common) a retail investor can buy these for as low as $1,000. Customs will require more notional, but can be created for as little as $250k. Also there is now a relatively liquid secondary market on these, so getting out of a note is fairly easy. You can also try to sell your notes to other issuers to tighten that bid-ask spread.

    2. Correct these are based on the funding levels of the banks during the time of purchase. CDS spreads also come into play. The higher the CDS spread, the more risky the credit, and therefore the better terms you would get on your note. Credit Risk is the main concern for Notes.

    3. You can buy these in a Brokerage capacity, but most RIAs nowadays purchase these in a fee based structure. For example, you could be charge 50bps and have the bonds delivered at 99.50. Agreed that taxation is difficult to calculate on structured products.

    4. That statement doesn't really make sense because we really don't see these long term notes anymore(12m-36m notes are most common now). Also if someone does pass away during the term of the note, it's very simple to go back to the issuer, get a bid, and get out of the note.

    5. BDs are falling apart left and right as this article mentions....everyone is slowly moving into the RIA space. It is true BDs charge around 3.5% in commission, but I would highly recommend purchasing these through your custodian for a much smaller fee (25bps-80bps)

    Also ETFs are getting crushed in todays market...and you can purchase a note on an ETF anyways.

  • ADR

    November 17, 2022

    As my dad always said? Figures don't lye but LIERS DO.

  • «
  • Page 1 of 1
  • »
Add your Comment

or use your BestCashCow account