That's the most common reaction I get when someone first looks at a structured note we build.

A 20% annual return? For 5 years? There has to be a catch.

You're right, there's always a catch. A structured note is an engineered trade. You get a defined payout in exchange for giving up something specific. Whether that trade is worth it depends on your situation.

Let me show you what I mean.

A real note we built

Here's a note we recently built for our clients. A 20% Snowball, 5-year maturity, tied to three markets: the Russell 2000 (IWM), TOPIX (Japan), and MSCI Emerging Markets (EEM). These are actual terms.

Here's how it works.

On each anniversary date, if all 3 indices are at or above their starting level, the bank has the option to call the note. If they call, you collect 20% times the number of years elapsed. Year 1: 20%. Year 2: 40%. Year 3: 60%. All the way to 100% at year 5.

The return stacks. That's the snowball.

If, for example, three years in, all 3 indices are at or above their starting level and the bank calls the note, you collect the full 60% cumulative payout (you get the return and your money back).

If even one of the 3 indices is below its starting level on an anniversary date, no payout that year. You wait. The snowball keeps building, and if the indices recover by a later anniversary, you collect everything at once.

If they never recover and you reach maturity with one or more indices still below the starting level, you take the downside of whichever index performed worst.

Sounds compelling, as long as you like the underlying investments. So what are you giving up?

The big risk: one index underperforms

This is the risk that matters most, and it's where you need to pay the closest attention.

Your note is tied to 3 indices across 3 very different markets: U.S. small caps, Japan, and emerging markets. Your outcome is determined by whichever one performs worst.

The Russell 2000 could be up 25%. TOPIX could be up 15%. But if emerging markets are down 30% over the 5 years, that's your reference point. The worst performer drives the outcome.

You could have 2 indices performing beautifully and still lose 30% of your principal because of the third.

That's why the 20% return exists. The worst-of structure generates the premium that funds your payout. A note tied to a single index (the S&P 500, say) might pay a stacking rate of 8% or 10%. You're being paid 20% because you're taking on the risk that any one of 3 markets, across different countries and different economic cycles, could fall meaningfully while the others do fine.

That's also why who selects those indices matters. The indices in a worst-of note need to be chosen with a clear thesis: why these 3, why now, what's the correlation between them, what's the downside scenario, and do you understand and accept it.

Picking linked indices without a disciplined method is how people end up in notes that blow up. Having an advisor with a repeatable process for index selection is the difference between a well-built trade and a gamble.

The other risk: opportunity cost

Every dollar in this note is a dollar that's somewhere else: your business, real estate, a single stock, or a simple index fund.

What if all 3 indices (the Russell, TOPIX, and emerging markets) go up 40% next year? To be clear, this is highly unlikely. But in this case, you'd be capped at the 20% return regardless of how well those indices do. So if these markets are up 1% or 50% a year, you "only" get 20% per year.

Are you upset about making 20% in that scenario? Probably not. But if watching the market go up while your return is capped at 20% would keep you up at night, this note probably isn't for you. That's an ok answer. Not every trade is right for every person.

The opportunity cost goes beyond markets outperforming. It's about whatever the next best use of that capital would have been. If you'd have parked the money in a 5% treasury and slept soundly, this note looks very compelling. If you'd have deployed it into a business returning 30% annually, the math looks different.

The right question is whether 20% is a good return for this specific capital, given everything else you could do with it.

Your money could be locked up for 5 years

Your money is potentially tied up for the full term. There's no sell button. If you need the cash in year two for a business opportunity, a tax bill, or an emergency, you're stuck selling on the secondary market or back to the bank at whatever you both agree to.

Most of the time, these notes are called early. Markets usually go up over time, and remember, when all three markets are positive on an anniversary date, you automatically receive your returns and all your capital back. But, this isn’t guaranteed, as markets can go down and stay down, so you should plan on this money being tied up for the full term.

For capital you know you won't need for 5 years, this is a non-issue. For the capital you might need, it's a real constraint.

Issuer credit risk is real

When you buy a structured note, you're lending money to the bank that issued it. The bank promises to pay you based on how the indices perform. If the bank fails, your note becomes an unsecured obligation, and you're treated like other creditors.

This risk is real. Lehman Brothers issued structured notes. When they went bankrupt in 2008, note holders lost everything regardless of how the underlying indices performed.

The issuer's creditworthiness is part of the pricing, and it's a risk you're carrying for the full term.

You're giving up dividends

You own a contract that references the Russell 2000, TOPIX, and emerging markets. You don't own the indices themselves. So no dividends.

Over 5 years, the cumulative dividends on those 3 indices represent meaningful income you won't receive. The 20% stacking return more than replaces that income, but think of the dividends as part of what you traded away to make the structure possible.

So why build it?

Because for the right client, in the right situation, every one of these trade-offs is acceptable, and the resulting payout does something their existing portfolio can't.

The client we built this for had capital they didn't need for 5 years. They had a view on the 3 markets in the basket. They wanted a defined, stacking return that more than met their goals. They understood exactly what they were giving up to get it.

That's the difference between "too good to be true" and "a well-built trade."

Every investment involves trade-offs. Most of the time, those trade-offs are invisible, buried in volatility, correlation, or opportunity costs you never explicitly agreed to. A structured note makes the trade-offs visible. You see what you're getting, what you're giving up, and what has to happen for things to go wrong.

The real question

"What am I missing?" is the right instinct.

The right question to ask is whether you understand the trade-offs, and whether it's the right one for you.

-Kyle

These notes are built exclusively for Atlas Wealth Advisors clients. This is not an offer, solicitation, or recommendation to buy any security. All terms reflect actual notes built for clients in recent market conditions and will vary. Structured notes involve risk, including potential loss of principal, issuer credit risk, and limited liquidity, and are not FDIC insured. Past terms do not predict future terms.