Are Barrier Notes Right for Your Retirement?

Now, again, can private credit, because it is higher risk, use the word junk often, could those go down on a year-to-year basis? They could.

But you look at high-yield bonds, go out and look at a high-yield bond ETF, what it did during Great Recession, COVID. You're talking 20% down before it comes back. And again, if you're diversified. So if your goal is to get that extra yield, to get something that's in between the bonds and the equities, Why not these other options where things are more predictable?

Welcome to the Healthy and Wealthy Retirement, where your certified retirement counselor, Mark Struthers, takes a holistic approach to retirement. Going beyond finances and embracing holistic well-being, this YouTube channel will address not just the financial part of retirement, but also the social, the physical, and the emotional parts of retirement. Everything you need for healthier, a wealthier, and a happier retirement.

Welcome to the Healthy and Wealthy Retirement. My name is Mark Struthers, and thank you for joining us. We use this office for other things than recording, so I'm always adjusting this mic. Thank you for joining us. Today we are coming here from Minnesota. You can tell by the Timberwolves. Sure, Timberwolves are playing tonight. It's been an exciting year. Love having the two Knicks players on our team. And it's a beautiful day here in Minnesota, in case you don't know. Our winters can be awful.

Our summers can even be hot and maybe a little muggy and mosquito-y, but... Our spring and our fall are fantastic this morning. It was 50 degrees, and I went for a run with my little cockapoo pebbles. We did about four miles, four and a half. It was gorgeous. So we have some cool mornings, some really great sunrises and sunsets, and even some warmer afternoons. It gets up to 70 or 80.

The only thing I like better than a morning cool run with my dog is talking about barrier notes and structured products.

And you were probably going to guess that, weren't you? I often pick topics of things that I see from clients, and I've seen a lot of these come across my desk. And if you don't know the term, you've probably seen them if you looked into investing very long. These structured notes, products, structured CDs, you could even include index annuities. These are things that are complex. And at times, I think they're designed, the complexity is often designed just to honestly kind of confuse people.

But there's something that some people seem to like. And sometimes there's a promise of you can't lose any money, so to speak. Now, again, that's a nuanced statement. And I will pause. I know we always have disclaimers. Please do not consider this investment advice. Do your own research. consult your own advisor. But I do think, especially if you are going into, if you're close to retirement or in retirement. Making sure these are a good fit for you are critical.

So we're going to give a real life example. This is one that just came across my desk. It was just issued by this particular bank, not going to say the name, of a barrier note. So we're going to talk, what are they and why you might have them, when and why. And give you some pros and cons. So a barrier note is a debt instrument. So a note is often a debt, treasury notes, treasury bonds, treasury bills, but it has an embedded derivative.

And if you were to just bottom line it, it gives you a higher than normal return, but it has some downside. And it's often tied to the derivative piece, often it's tied to an index. I often see S&P 500 as a common one. That's not the only one, but that's one that you often see. So when you think about buying a normal bond issued by the U.S.

Government or Apple or whomever, you may say you buy it for $1,000, say it pays a 4% coupon each year, and if you hold it to maturity, you get your par value, in this case, say $1,000 back. Now when you buy it initially, it can be more or less, but you get the idea. You know what to expect. And based on the creditworthiness and interest rates at the time, and you can even say the creditworthiness of the U.S. I mean, U.S.

Is service-free, but as we move along through our debt and deficit and fiscal journey, that's slowly changing. Conversation for another day. But it's based on credit worthiness, going interest rates, and so on. Maturities, length of time. But this one is different. So this is a very common one. And we'll flash up kind of particulars. I hate putting this much verbiage up here. But this potential return you see here is 7.9% annual.

That is the most. So when you look at these things, whether it is a structured CD, any sort of artificial product, ask yourself, what is my max upside? In this case, it's 7.9% per year. And it's a four-year, and for some reason, four years seems to be what these things are. And so you could take four times 7.8, thinking just under 32% total. It's not compounded. It's a little bit of a negative as well. That is not compounded. And this one was issued a couple months ago, back in early March.

And the index level at the time was 5,770, 50, 70, 70.

And this is where things start kind of getting complicated i work with a lot of bright people smarter than me it's just i happen to love this industry and i've worked very hard to have some of the best credentials but i'll work with people a lot smarter than me they have a tough time with me very almost never have i have someone come in and have something like this where they completely understood it whether it's an index annuity whether it's a barrier note whether it's a structured CD.

But in this case, they start off with this initial level. And after one year, they start looking at the index. And if it's above the index, initial level, you get your 7.9% or whatever. And in this case, it actually snowballs, which adds some complexity. It could be a nice feature. So there's no consistent payment like we talked about with a normal bond. So after one year, if you look at this, March 2026, it's above 57.70. You get your 7.9% and you take your money and go home.

Now, on the surface, when you hear that, you say, well, that's not bad. Well, but what were your alternatives? And what risks did you have? You're assuming the S&P was higher. Over time, it generally goes higher, but not always. We've seen that. You think about 7.9% is higher. That's a higher yield. But what are the risks? Well, the risks are, one, this thing's not very liquid. At the very end, we'll go through the pros and cons.

So if I had a U.S. Treasury bond and I wanted to resell it and rates kind of remain where they are, I could get what I paid for. If rates drop, I could get more. If rates rise, I could get less. And with these as well, quite often it looks at the index quarterly to see if it could be called. So as you might guess, these are often called, and there's nothing wrong with that, but you also have reinvestment risk. And you don't know. That is really crucial in retirement.

There is a value to having some predictability as far as, especially for your bond portion. The bond is often the ballast. It's there for income, but also as a ballast during bad times, which is another. This is kind of in between, which for some people, it's a value. They say it's a diversified, this isn't a debt, really a debt. It's not really equity. It's kind of in between. I get a higher yield than even kind of high-grade corporates.

And actually they get a higher yield than most high yield bonds, but not much. We'll mention that in a second. So this thing could be called. Now, a bond being called is not unusual. Their callable features are there all the time. And that's if a company issues a bond at 5% and all of a sudden, two years later, it could issue the same bond for 2%, it costs it less money. It could say, well, I've reserved the right to give you your money back and reissue the bond to save money.

So it's not the end of the world, but again, that's where if you have too many of these callable bonds in your retirement portfolio, that's where it's problematic. Can we predict that we're going to get a certain rate of these bonds act as a ballast or a source of return? There's nothing wrong with having an asset class in your portfolio that's kind of in between bonds and stocks. Corporate bonds are riskier than U.S. Treasuries. Just a fact, at least for now.

High yield bonds are kind of in between too. This is where you start looking at the alternatives. Well, if it's not this, what do high yield bonds return? Well, they can easily return 7%. You go to high yield bond ETFs. You have a diversified basket of issuers, so if one defaults, the impact isn't as large. And that's where you start to dive into, is this thing, do I really need this complexity and all the illiquidity and downside? Why not just buy a high-yield bond? And that's a valid question.

You should be asking why. Because chances are you did not choose this yourself. Chances are this was someone selling it to you. What I have seen a lot from one particular bank is their advisors will charge an advisory fee, generally not cheap, but they'll also put these in. I will say I've never seen more than, I think, kind of 10% of the value of the portfolio. But when I see a 70% equity, 30% bond portfolio, and this makes up 10% third of the 30%, that's where it's a little concerning.

Now, there are some folks who like these, and that's just fine. But as you can tell, just like with insurance products, this company is double dipping. It's making money off of this barrier note because it issued it. When they structure, by definition, they structure these products so they make money. There are brilliant people. Again, that's a lot smarter than me. Actuaries who sit down and they structure these things so they know that they're going to make money.

That's why the bond is callable. And that's why it also has kind of a severe downside. So we talked about this particular note is looked at every so often, and if it's above the initial level, it's called and you get your interest payment. Well, this bond has a principal protection down to 30% of the S&P 500 from that initial level. So that means if we look at this bond at maturity, in this case, it's just at maturity, which makes the odds of this happening very low.

Again, all these are different. There are certainly styles and structures where just going below a trigger level, all of a sudden you could lose principal. In this case, the only way you can lose principal is if this thing is more than, if S&P 500 is down more than 30% at maturity. But if it is, if it's 40% down, you lose 40% and no dividend payments. So is it worth that 7.9% to have that kind of risk? And how does it fit in your portfolio? Your equity piece, that's the primary driver.

Your bond piece is a ballast. Again, it is valuable to have some other things in between. The question is, what are your alternatives? Why not high yield bonds? Now, on a general month-to-month, year-to-year basis, high-yield bonds are going to be riskier than this because these are going to be called away.

They don't have necessarily the reinvestment risk. But as far as the extreme tail risk, the hardcore recessions, think the Great Depression, think the oil crisis, Black Monday, the dot-com bubble, the Great Recession, COVID, the odds of that maturity date landing on those particular down months, days, especially given it's not, we're talking about not off the high, we're talking off the issue value, is very low. This is a very low tail risk event for this to happen. But it's still there.

So the question I always ask, and I try to keep an open mind, and again, I believe in diversification, I believe in low cost. There's value into having some other asset classes for diversification. Private credit comes to mind when I see these. Private credit, there's private credit funds that are very well managed that return 8% to 10%.

They're easily returned more than these have. Now, again, can private credit, because it is higher risk, use the word junk often, could those go down on a year-to-year basis? They could. But you look at high-yield bonds, go out and look at a high-yield bond ETF, what it did during Great Recession, COVID. You're talking 20% down before it comes back, and again, if you're diversified.

So if your goal is to get that extra yield, to get something that's in between the bonds and the equities, why not these other options where things are more predictable? So those are the things that you should be asking. So when we think about pros, it is a diversified source of return, but you can probably get it someplace else. And it is much higher than other things. And on a year-to-year basis, it's probably lower risk than those things that yield the same way.

But it does have very severe tail risk that there's other debt instruments that most often do not if it's diversified. So there's a couple of good pros there. What are the cons? Reinvestment risk. Because most of the time, the scenario with these things, they're going to be called away. The idea that the S&P 500 from an initial issue level is not going to be up from that level after two or three years. Now, again, think of the Great Recession and so forth.

But the idea that it's not at least somewhat higher within that four years, it's probably going to be called. But again, not guaranteed. Credit risk?

The credit risk is these are backed by the bank that issues it not gonna name the name of the bank that i see a lot but that's that's a risk so again that's a risk you have to take into account when you're if you had diversified basket if you had some private credit where it's a diversified basket of issuers or high yield bonds your your risk risk is you have risks of all those companies not paying. Your risk is that this company pays it. Liquidity risk.

High-yield bonds aren't the most liquid, but you can sell them. And then you can buy and sell the ETFs, the mutual funds. You think private credit, you know, has liquidity issues too, but you can at least most often, you know, it's not guaranteed, but you can meet at least every quarter you can, you can try to redeem your shares and you should, you know, and this is where you do your research before you get it. You're able to do that without too much issue. But here, there's really no market.

The market is the bank that issues. Well, if the S&P 500 is down, anytime something's illiquid, you're at the mercy of whoever issued it. You're probably going to have to sell it for a discount. I will say we have sold these and haven't had any issues, but they've also been in kind of calm times. Also, taxability. I see these in taxable accounts and I'm just blown away. You know, that's a high yield. You know, these aren't muni bonds.

They're not U.S. treasuries that all have some tax beneficial benefit to them. And the compounding often makes it even worse. You know, not for all clients, especially if they're always in the highest tax brackets. But if it's a snowball effect where all of a sudden you do get one big 30% payment at the end of four years, it could push up another tax bracket.

So I try to keep an open mind. When I look at the alternatives that you have for these, when I think about what their role in their portfolio, I often just think in the complexity and just know I've run into very few people or even advisors that seem to understand them. So I'm always at a loss as to why these are there. Do they create a great harm given the odds of maturity date falling on a really bad down market?

And if you do, and I will say I've always seen them diversify where they stagger the issuance to where, again, the odds of it are very low. Yeah, it's a very low probability of that. But why take on that risk at all for bond-type returns that you can get other places? So we often will leave these. The clients will like them or we don't want to deal with the liquidity risk. But I do encourage you just to make an informed choice.

Always ask yourself, why is this in my portfolio? And what are the alternatives? Because financial planning and investing is all about making informed decisions. And if you do that, you're probably going to have a healthier, a wealthier and happier retirement. Go Timberwolves and subscribe. Timberwolves and subscribe.

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