When you’re approaching retirement, protecting what you’ve accumulated often becomes just as important as growing it.

That’s why products promising downside protection, principal protection, bonuses or guaranteed returns can sound especially attractive.

But before choosing any investment because it appears “safe,” there is another question you need to ask:

Who is actually standing behind that promise?

That issue is known as counterparty risk, and it can become particularly important when markets are under stress.

Not All Protection Works the Same Way

Different investment products rely on different structures.

For example, Leibel explains that certain options contracts can be cleared through the Options Clearing Corporation, reducing concerns about the individual party on the other side of the transaction.

Market-linked CDs have another layer of protection. Like traditional bank CDs, they may have FDIC insurance up to applicable limits, which can provide protection of principal if the issuing bank fails.

Buffered unit investment trusts, or UITs, operate differently. The trust itself owns the underlying assets and exists as a separate legal entity. That means the financial condition of the company that created or manages the trust may not create the same type of issuer risk.  

Then there are structured notes.

The Risk Behind Structured Notes

Structured notes can sound appealing because they can be designed to provide income, market participation or a degree of downside protection.

But underneath that structure is something investors need to understand: a structured note is essentially a loan to the issuing company.

If you buy a structured note issued by a major financial institution, you are depending on that institution to meet its obligations.

That may not seem particularly concerning when markets are strong and the financial system is functioning normally.

But what happens during exactly the type of crisis you bought the investment to help protect against?

Leibel points to the 2008 collapse of Lehman Brothers. Investors holding certain Lehman-issued structured notes discovered that the protection they thought they had depended on Lehman still being there to honor the obligation.  

That is the uncomfortable irony: the investment designed to provide protection during a major financial event can be exposed to additional risk during that same event.

Ask About the Worst-Case Scenario

When evaluating a retirement investment, it’s easy to focus on the best-case scenario.

What return can I earn?

What bonus will I receive?

How much downside protection do I get?

But Leibel argues that retirees should spend more time asking about the other side of the equation.

What is the worst thing that can happen?

If the issuer fails, what happens to your money?

Is your principal actually guaranteed?

Are you exposed beyond a certain level?

How long is your money committed?

What do you have to give up to receive the advertised benefit?

These questions become even more important in retirement because recovering from a major financial loss can be much more difficult than it was during your working years.

There Is No Free Lunch

The same principle applies to investments that advertise large bonuses or guaranteed returns.

A headline number may look attractive, but there is usually a tradeoff. You may be giving up liquidity, access to principal, upside potential or flexibility.

The key is understanding exactly what you’re receiving and exactly what you’re giving up in exchange.  

A retirement investment shouldn’t be chosen because the marketing sounds reassuring. It should be chosen because you understand how it works, how it could fail, and how it fits into your overall retirement strategy.

If you’re approaching retirement and want a second look at the investments you’re relying on for income and protection, schedule a consultation with Leibel Sternbach.

Schedule your consultation at:
https://www.yields4u.com/pages/book