Introduction
Are you getting overwhelmed with how investment products work? You may be wondering which is the right product you must choose. You have equities, stocks, deposits, structured notes, and derivative components. You may be thinking which investment objective is the best bet to receive stable returns of investment without losing your capital money.
To help you get clarity on two such investment products is what we will be learning about in today’s blog titled ‘Structured Notes Vs CDs’.
CDs refer to Certificate of Deposits. These are fixed deposits that may belong to public entities or are issued by larger financial corporations. They carry fixed rates of return on the principal amount. The investor can then take away his initial investment with returns added by the term of the maturity period.
Structured notes are investment notes wherein you have a mix of debt and equity. The debt is linked to an underlying asset like a stock, share, futures, or options. Although fixed rates of return cannot be promised for structured notes, you get your return on investments based on the performance of an underlying asset.
Structured Notes Vs CDs- Key Differences Explained
Structural Outlay
The CDs are Certificates of Deposits and financial institutions provide a fixed rate of returns on the Principal amount. CDs are therefore fixed income debt instruments that allow the investor to invest a specified sum of money on the same. Fixed rates of returns are calculated on the deposit amount and the final amount is given away to investors at the term of the maturity of the Fixed Deposit or Structured deposit.
In the case of a structured note, every note has a debt instrument that is linked to the underlying value of an asset. The asset can be shares, equities, stocks, futures or options.
Therefore, the note has a two-structured component while CDs only have a single component added to their structure.
Term Of Maturity
CDs have a fixed rate of returns over the investor’s initial capital investment. The lock-in period is decided by the product issuing firms. In the case of a structured note, the terms of the investment get customized based on the independent requirements of the investor.
For instance, a CD that sells for $25,000 with a fixed annual return of 10% cannot be altered. In the case of structured notes, the investor can choose his portfolio as a short-term, medium-term, or long-term investment plan.
In a nutshell, the plan is tailormade for the investor in the case of structured notes as compared to fixed terms on CDs or fixed deposits
Liquidity
CDs are characterized by a lack of liquidity. The investors must maintain their debt securities until the term of their maturity. Only then, are they assured of their capital sum and fixed rates of return.
Whereas, in structured notes, you do have a buy-back option on the commodity, stocks, shares or securities of the asset allocation the notes are linked to. You can sell these shares in the secondary markets at going rates. Although the returns are higher, you also may have an investment risk of losing your initial sum.
Therefore, the liquidity factor is better with notes as compared to CDs.
Principal Protection
CDs are meant for traditional or conservative investors who do not want to fall into the risk of incurring a loss of principal. Mostly, investors get their principal amount with fixed interest rates and keep their credit risk at a minimum.
Whereas, in the case of structured notes, you are not assured of 100% principal protection. If you have specifically opted for 100 percent capital protection, you can get your principal money back irrespective of how the underlying or linked assets perform in the market. As you have the option to diversify investments and these are not like traditional options, you can also have your returns optimized on notes.
Some of the investors have a higher degree of risk-handling potential. They link a higher proportion of the notes to equities or debt components. In this case, the investors might a part of their investment amount if the underlying assets fare badly in the equity markets.
Flexibility
CDs comprise three elements a. Capital amount b. Rate of Returns and c. Period of term of maturity.
Here, the principal money is also referred to as debt money. Fixed rates of return are decided by the issuing company and the returns are added to your initial investment once the term reaches its maturity period. Therefore, these are standardized forms of investments.
Whereas, structured notes offer a greater deal of flexibility and customization for investors. The investor can choose debt instruments that can be linked to a single security or a basket of securities. You can choose between shares, stocks, derivatives, currencies, options, futures, and other trading instruments.
The financial advisor does a risk profiling for you and you can choose your customized set of notes.
Tax Implications
In the case of term deposits or CDs, the interest earnings would be taxed year after year. However, the investors receive their principal amount and interest earnings only by the term of maturity or when the tenure of the deposits ends!
Whereas in the case of structured notes like exchange-traded funds, the investor receives different types of earnings in the form of potential returns. These are coupon payments, earnings of underlying assets the notes are linked to, and interest payments. The variable payouts are deemed to be taxed as regular income.
For instance, investors get taxed for recurring coupon payments even before they receive the amount in their actual accounts.
In a nutshell, the tax implications work quite differently for CDs as compared to structured products.
Creditworthiness Of The Issuing Company
The CDs are given away as bonds mortgages or fixed deposits and these belong to Govt treasuries on the whole.
On the contrary, the product issuing firms for structured notes can be investment bankers or large stock-holding corporations for primary investors. In the secondary market, you have banks and middle-class corporations that cater to issuing notes for the middle-class retail segment.
Key Takeaways
Look for one of the two after determining which suits you the best. As structured CDs are more applicable for investors who do not want to risk losses from the fluctuations arising from equity markets, these are more conservative. In other words, CDs protect investors against downside risk factors as these instruments are principal-protected.
Structured notes may have soft buffers or downside protection while CDs have fixed terms and conditions for the term, value of repayment, and interest earnings. The creditworthiness of the issuer plays a vital role that deciding if the investor can receive his principal investment back or not. The fees and costs differ for etfs, mutual funds, or structured notes.
Tax implications on whether an investment is treated as capital gains or as regular income also differ from one investment product to another. Market risks may impact how much the portfolio earns through the term of the investment.
On the other hand, investors who link a structured product to a larger proportion of equity want to look for higher rates of returns from the performance of underlying assets the notes are linked to.
While CDs belong to the asset class of ordinary income citizens and structured notes are meant for high net-worth individuals, still both forms of investments have their own pros and cons, one must read through market volatility terms of initial offer documents carefully before signing on the dotted lines. This way, the investor can aim for downside protection from his/her initial investment.
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