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Structured Products

We’ve talked before about chocolate covered hand grenades – the too-good-to-be-true investment. Time and again, the market has expanded rapidly as investors get caught up in opportunities based on stories and ideas rather than facts.

Most of us are familiar with the explosion of Sub Prime Mortgages and how they played a major role in the Great Recession. Another seemingly tasty investment blew up as a result of the Great Recession. Structured products cost numerous investors big time.

What are structured products?
The term “structured product” is financial industry jargon referring to a product which allows you to participate in the stock market while guaranteeing your principal.

How do they work?
Originally, structured products were made up of two different elements: stocks and zero coupon treasuries. By spending half of your principal on zero coupon treasuries and holding onto them until they reached their full maturity, an investor would be able to, at a minimum, get their initial investment back.

Over time, investment advisors set up structures which reflected zero coupon treasuries and stock market investments. In theory, this was great. In reality, these structures were just paper. They weren’t based on facts.

What happened?
Lehman Brothers, a major brokerage house, created a variety of complex structured products which were sold by third parties. When they filed for bankruptcy in September of 2008, investors discovered the company’s collapse could cause them to lose most, if not all, their money. Why? They weren’t invested in real securities. They were invested in reflective securities. When they wanted their money, most investors ended up selling for $0.10 on the $1.00.

What’s the moral of the story?
Smart investments are made based on facts. If you invest based on stories and ideas, you most likely will get a blast of reality.

 

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