Structured Notes Part 1: What are they and how it works

Without getting into the technical details, the typical structured note sold in Asia is a financial asset (like a bond or stock) whereby the risk & return behaviour may mimic a bond when the product is performing well and conversely, it behaves like a stock when the product is performing poorly. Structured notes are commonly sold in banks in Asia, especially to service affluent and high net worth investors. In the retail or consumer banking space, it’s usually termed as “Structured Deposits.”

A structured note can be customisable in many different ways depending on the investor’s preference and risk profile. Think of it like a do-it-yourself pizza where you can put whatever components (called the underlying) you fancy. Depending on what your taste preference may be and who the pizza chef is, the pizza will be priced (the strike price or the coupon) differently.

The final payout of your structured product investment is dependent on the performance of some underlying instruments. Below is an illustrative example.

If you were to buy $10,000 worth of the following structured product:

Tenor: 3 months
Underlying: Stock ABC
Reference Price: Stock ABC $10
Strike Price: $8
Coupon: 12% p.a.

There’s a lot of jargon here, but this means at the end of 3 months:

Scenario 1: If ABC falls below the Strike Price of $8, you have to buy $10,000 worth of that stock at 8$ regardless of where the stock is trading at.

Scenario 2: If ABC closes above the Strike Price of $8, you will get your $10,000 back plus a coupon of 12% p.a. (resulting to 3% a Tenor of 3 months) of $10,000, totaling $10,300.


In this case, the risk here is in Scenario 1 where the stock falls way below $8. Generally, you should only buy this structured product if you have the following view:

  1. You take the view that stock ABC will not fall by more than $2 in 3 months.

  2. You fundamentally like the stocks and believe that they are potentially long term assets you want to hold on to. Such that, even if scenario 1 were to happen, it would not change your long term view on this product and are okay with a short term loss.

The details of a structured note can vary in its underlyings, terms and pricing levels. It is important that you know the details and risks of the product well, and the various scenarios that might play out. Structured notes are typically sold via financial advisors in banks, so be sure that your advisor is clear in explaining them to you.

If there’s one thing to know about structured products (or investments in general) is that there is no such thing as a free lunch. For every seemingly good “benefit” that you are receiving, know that there’s also an equal amount of risk you are taking at any particular given point of time.

At the end of the day, it’s never a question of whether this structured product is good or bad, but whether the risk/reward factors are aligned with you and your views.

In Part 2 of our Structured Note series, we’ll talk a little more about the risks associated with structured products and when might be a good time to have them in your portfolio.

Financial Wisdom in Delayed Gratification – Part 2

Delay, Gratification, Investment, Investing, Privetech

Does choosing between instant or delayed gratification have an impact on our finances? In our previous article, we introduced the definitions and what factors may cause us to lean towards one or the other (click here to read).

Today, we will be diving deeper into the financial implications of instant versus delayed gratification, and learn more if it directly affects our decisions in the areas of loans and investments. But just before we do that, let’s take a look at the results of the quiz in Part 1. Which category did you fall under?

Delay, Gratification, Investing, Investment, Privetech

It seems that a good number of us came under the balanced category, and more of us lean towards delayed gratification over instant gratification. The question now would be, would our decisions be similar when applied to finances? Let’s find out later.

Loans & Debt

Instant gratification can make us want things immediately, even when we can’t afford it. When we decide we cannot wait for the day we can finally afford it, we choose to take on loans and by doing so, enter the world of consumer debt.

The Federal Reserve Bank of New York reported a total household debt of $13.29 trillion in the second quarter of 2018. That is a lot of debt. Granted, there are some loans that are legitimate and can be useful and timely when used wisely. A study loan might enable one to get the correct qualifications and skills to kickstart a career with a higher starting income.

But loans also can be a double-edged sword if we are careless with them. We need to understand the effect of interest rates, and should strive to benefit from it with savings plans and investments, rather than struggling to pay back the loans we take (and the interest with it!)

When we get into debt, we are taking our money that we earn in the future, to pay for our expenses today. Is that wise in a financial sense? Can we justify with good reason, the purchases we make and the difference it makes to our credit scores?

We should take a step back, and reflect on the loans we currently have or are considering to take on. Are they truly necessary? Most loan providers spend good money on clever marketing, because they know humans are emotional and impulsive, so hence may give in to instant gratification. In order to overcome that, here are 3 areas we need to reflect on when considering loans

1. Wants vs Needs:

Do we really need to make this buying decision? Is it always about getting the bigger house, a nicer car, and more luxurious vacations to top our experiences? Extrapolate, and visualise ourselves having all these things and ask, when is enough, truly enough? How long would these things make us really happy for? A year? Maybe 5? Maybe 20? How certain are we?

2. The Time Factor:

Cognitive psychology tells us that when most people take a narrow view in making decisions, it might be because we tend to give more weight to the situation or problem, when it presents itself as the only problem at that point in time. But if we were to step back a little, and look at the problem in its recurrence and effect over the course of time, our attitude and the way we think about the problem could be fairly different.

Ask ourselves, do we really need this now? Could we wait for a better deal and allow our money to continue accruing interest while we wait? Is this the correct time to buy or are we being peer-pressured to follow a hype?

3. Alternatives and True motives:

What alternatives can we have that are less costly? Are there emotional or cognitive alternatives to replace our wants? Learning a new language or picking up a musical instrument might be much more prudent than the lifestyles or hobbies that we want to associate with being wealthy and famous. What are our true motives? Do we really love that $50,000 watch or do we just want others to perceive we are successful? Can we honestly admit to ourselves we are in no way affected by consumerism?

Investing

A key factor in mastering delayed gratification is the ability to be patient. Charlie Munger, a key business partner of Warren Buffett, once remarked “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”

This is indeed true in the world of investing. Most seasoned veterans would advise that the lack of patience causes many an investor to make mistakes. It is needed especially in sticking to the wisely calculated and planned strategy, instead of being over-reactive to market movements and news chatter.

The lure of instant profit is something not easy to deal with. We live in a world where we are conditioned to get things at the snap of our fingers. This is especially so when our society today is one with conveniences never possible a mere decade or two ago. From the food we eat, the services we use, and the multimedia we can command at demand, the norm of getting what we want, when we want it, has changed drastically by the power available at our fingertips today.

Every product shouts “Better! Faster! Now!” We are bombarded with the lure of rare and time-limited discounts, and investment opportunities that try to make you feel privileged and lucky. There are even some robo-advisories that claim they can beat the market. Are they really telling the truth, or could they be traps that take advantage of our impulsive tendencies to instant gratification? If we were to conscientiously take a step back and wisely consider, the math and statistics might tell a very different story. We need to do our research and investigate the facts, especially when some financial products promise returns that are too good to be true.

QUIZ TIME!

Before we go on, let’s give this quiz a go. They are of course hypothetical scenarios, so don’t try to think too much about them. Instead, go with your most natural choice and let’s see where that goes.


Were you surprised at your results? When you were attempting the quiz, did you consciously think about how much savings you could have accrued? Or was it more of an afterthought when you saw the results of the quiz? Now that you’ve taken to mind the power of compounding interest, would that be something that will affect your purchasing decisions henceforth?

Be sure to look out for our final part of this mini series as we tie everything together and discuss practical solutions to improving our financial decision making. This content was brought to you by our partners, Hive Up. Do remember to sign up for their mailing list if you haven’t already, so you won’t miss out on new content!