These "Safe" Investments Have a Catch
Stock market volatility has become a fact of life that investors have to deal with. Yet one thing that's even more volatile than the market is the marketing approach that Wall Street firms take in trying to get you to invest in their financial products.
Most of the time, financial services companies focus on how much money you can make with the right investment. But when big threats to the market's future prospects rear their ugly head, you can count on a shift in that focus, with Wall Street's finest coming out with products that promise safety rather than limitless profit potential.
The return of principal-protected stock market investments
The latest new product to appeal to investors' sense of fear comes from Eaton Vance (NYS: EV) . As a Wall Street Journal article noted over the weekend, Eaton Vance has now come out with two new investments called eUnit Trusts that are designed with conservative investors in mind.
The concept behind an eUnit Trust is simple. For the most part, the product tries to generate returns that are tied to the value of the S&P 500 (INDEX: ^GSPC) . But it also offers a trade-off: If the index rises more than a certain amount, then your gains are capped to that amount; if the index drops, then you don't lose anything unless the loss is greater than another set amount. For the first eUnit Trust, which went public in January, the relevant limits are a maximum gain of 17.85% over the two-year period of the trust, with a 15% limit on protection from losses.
A smart bet?
Eaton Vance isn't the first company to offer investments with similar properties to nervous investors. Four years ago, Bank of America (NYS: BAC) and other banks sold a total of almost $100 billion in structured notes with similar terms, with one of the issuers, Lehman Brothers, eventually going bankrupt and leaving noteholders with big losses. More recently, market-linked CDs from issuers including Wells Fargo (NYS: WFC) and Banco Santander's (NYS: SAN) Sovereign Bank subsidiary fixed the credit-risk issue by putting a similarly structured investment in the form of an FDIC-insured certificate of deposit.
At first, these investments seem to offer a reasonable deal to investors. Because they help limit losses -- even though they don't eliminate them entirely -- they appeal to risk-averse investors who tend to avoid the stock market. And given the relatively weak returns on stocks lately, many would be willing to gamble that beating a roughly 8% annual return on stocks in the next couple of years is unlikely enough to give up the prospect of earning more than that.
But you really have to pay attention to the fine print on these investments. For one thing, the first thing that jumps out is that Eaton Vance "offers no assurance that the Trust will achieve its investment objective," meaning that you can't count on its strategy actually producing the desired result.
Another interesting thing about these investments is that they trade on exchanges, and their share price doesn't necessarily match up to their net asset value. For instance, of the two publicly traded trusts currently available, one trades at a 5% premium to net asset value, while the other trades at more than a 2% discount.
Finally, the trusts track the price change of the index rather than its total return. That means that you won't get any benefit from dividends paid by the S&P 500's stocks, giving the trust a roughly 2% annual handicap versus buying an index-tracking fund.
Do it yourself and save
Perhaps most important, there's nothing terribly complicated about the trust's strategy. It owns a two-year Treasury note to guarantee return of principal in the absence of extreme losses, and uses put and call options to provide the breakpoints for returns. For that, it charges 0.75% in annual fees. But with options trading available to ordinary investors, you could create a similarly hedged position yourself if it were important to you.
Looking for principal protection isn't a bad thing in itself. But with many products, you give up too much to get the benefits you want. Before you buy a product like the eUnit Trust, be sure you understand all the risks as well as the true rewards.
Sometimes, taking risks is the only way to get to your goals. But we've got some stocks that should do a better job than most of making even risk-averse investors comfortable. You'll find them in the Fool's special report "3 Stocks That Will Help You Retire Rich." Get your free copy today while it lasts!
Meanwhile, be sure to check out our premium investment report on Bank of America to learn what our senior bank analyst's thoughts are on B of A and the entire banking sector.
The article These "Safe" Investments Have a Catch originally appeared on Fool.com.Fool contributor Dan Caplinger doesn't like paying too much for safety. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services have recommended buying shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy has no catch, just great information.