As I touched on briefly in part one of this series on principal protected notes, many brokers are comparing them to equity-indexed annuities. Equity-indexed annuities, which are annuities that earn interest because they are linked to a stock or other equity index. While these annuities have their own set of problems that we won’t get into here, they at least offer investors a measure of exposure to the broader stock market, which is a prudent investment for the long term.

Principal protected notes are different from equity indexed annuities in that they seem to focus instead on current hot and even speculative markets. They are often tied to indexes that have performed really well in the very recent past, instead of on proven performers. In my opinion, if you’re going to buy an investment that is based on, say, the performance of Latin American currency, you might as well plan a trip to Vegas and enjoy yourself. That is not to say that Latin American currency won’t perform well, it’s just that we have no real basis for believing that it will. Much of the current excitement surrounding currency notes is based on investors’ fears that the U.S. dollar won’t recover, and I don’t personally believe in making decisions that are fear based whenever it can be avoided!

In addition, the ‘guarantee’ attached to principal protected notes is not really as great as it may seem at first glance. For one thing, you have to tie up money for years, and all you’re really promised is a zero return. Sure, you’ll get your principal back, but so what? You could put your money in a plain old savings or money market account and outperform that!  

In my opinion, the bottom line is this: while principal protected notes may claim to be a no-lose investment, they are really a gamble in thin disguise. You are gambling on the fact that hot, speculative markets will stay that way – which they usually do not. So if you do decide to invest in a principal protected note, make sure it’s tied to an index you can believe in!