Principal-protected investments: What they are and how they work

Principal-protected investments guarantee the return of the amount you initially deposited, even if the markets they’re linked to don’t do well. Learn more about what these products are, how they work, and how they compare to alternatives like annuities and bonds.

What are principal-protected investments?

A principal-protected investment combines safety with some market upside. Options like principal-protected notes (PPNs) guarantee a return of your initial investment at maturity and let you earn additional returns based on an underlying asset. Just keep in mind that if you sell before maturity, that protection may no longer apply.

The protection itself is a contractual promise, meaning you’re relying on the issuer to make good on it. This is different from federal deposit insurance (FDIC in the U.S.), which protects eligible deposits even if a bank fails. With principal protection, your money’s security depends on the issuer’s financial strength.

Along with that, principal-guaranteed investments can also have explicit and embedded fees:

• Structuring fees: Paid to the issuer who creates the PPN
• Distribution commission: Paid to the advisor or broker who sells it
• Management fees: Paid to keep the investment active
• Embedded option cost: For a chance to earn more if the market goes up
• Early redemption charge: For selling the PPN before maturity

Who should consider principal-protected investments?

Principal-protected investments aren’t for everyone, but they can be a good fit for investors with specific goals and risk profiles:

• Conservative investors: Want some market exposure but won’t risk losing their principal. PPNs can offer peace of mind by guaranteeing return of the initial investment and allowing participation in potential upside.
• Legacy investors: Want a clear time horizon, like planning for a future gift or estate objective. They want principal protection but still appreciate the possibility of growth during the investment period.
• Sophisticated investors: Use principal-protected notes as a diversification tool. For them, PPNs can play a tactical role in a broader strategy, but only when they understand all the possible fees and risks.

2 principal-protected investment examples

There’s no single best principal-protected investment. The right choice has to do with your goals, investment horizon, and the issuer’s credit quality. Here are two options that offer a different mix of safety and market participation.

Principal-protected notes (PPNs)

A PPN is an investment where you’re guaranteed to get your original investment back at a set date. You might also earn a portion of gains based on how a market index or other benchmark performs. If the market does well, you can earn more. But if it does poorly, you still get your investment at maturity as long as the issuer is financially sound.

Example: A five-year note linked to the S&P 500 could return your principal at maturity plus a portion of index gains.

Structured securities

Structured securities combine a bond (to protect your principal) with derivatives (to provide potential gains). They often have features like caps, participation rates, or performance triggers, which can make the payout formulas complicated. Your final return hinges on both the market’s performance and how the product calculates gains.

Example: A three-year structured security that guarantees 100% of your principal and provides 60% participation in the Nasdaq’s upside, up to maximum return. 

How are protected investments regulated?

PPNs fall under multiple layers of regulation to promote transparency, proper disclosure, and fair sales practices. Oversight varies by issuer and product structure, but typically includes the following. 

Securities and Exchange Commission

The Securities and Exchange Commission (SEC) typically regulates PPNs as securities. Issuers typically must comply with federal securities laws, including registration, disclosure, and anti-fraud requirements. Investors need information on the note’s risks and fees so they know what might affect their returns.

Financial Industry Regulatory Authority

The Financial Industry Regulatory Authority (FINRA) typically oversee brokers who sell PPNs, enforcing rules on product suitability, advertising standards, and sales practices. Advisors should make sure the investment is appropriate for the client’s risk tolerance and financial goals.

Banking regulators (for bank-issued notes)

When a bank issues principal-protected investments, agencies such as the Federal Reserve, OCC, or FDIC monitor that bank’s capital standards and issuing practices. This supervision ensures the bank can meet its obligations at maturity.

Issuer creditworthiness requirements

The safety of a principal-protected investment is tied to the issuer’s financial health. Regulators check the issuer has enough capital and overall stability, but investors should also look at credit ratings and financial statements. Unlike FDIC-insured deposits, PPN finance depends on the issuer’s ability to pay.

Prospectus and offering document rules

Issuers must provide detailed documents, like a prospectus, that explain how the investment works, the risks and fees involved, and what your returns could look like in different scenarios. These disclosures are required to help you make informed decisions before investing.

Principal-protected investment risks to consider

While PPNs offer downside protection, they have certain risks you need to be aware of.

No clear issuer credit rating or shell issuer

The principal guarantee depends entirely on the issuer’s financial health. If the issuer lacks a clear credit rating, it’s hard to know your principal is secure. In a worst-case scenario like bankruptcy or restructuring, the guarantee may not be honored at all.

No secondary market or wide bid/ask spreads

Principal-protected investments are difficult to sell before they reach maturity. Even if there’s a secondary market, the gap between buying and selling prices can be sizable, which could mean a loss if you sell early. And because the issuer controls liquidity, the price you get may not be in your favor.

Complex payoff formulas without examples

Some PPNs use complex formulas to calculate your payout. This may include averaging periods, caps that limit gains, and participation rates that reduce exposure to index growth. 

Without clear examples of these formulas, you won’t know how returns could change under different market conditions. Even small details like caps and participation rates can affect your final return.

Early redemption penalties may not be clearly stated

Redeeming a PPN early can trigger hefty fees or reduce your return. It’s easy for investors to get caught off guard when those sorts of penalties aren’t clearly explained. On top of that, payouts are usually based on secondary market prices — which could be far lower if interest rates or market conditions change.

Prospectus doesn’t show scenario tables

Scenario tables can help investors understand how participation rates and averaging periods play out in real numbers. Without them, it can be harder to gauge how the PPN behaves in flat, moderately positive, and sharply negative markets. This lack of insight can  increase the risk of surprises at maturity.

How principal-protected investments compare to annuities 

Annuities are a strong alternative to principal-protected investments, especially when you want long-term security rather than a single payout at maturity. With annuities, you work with an insurance company and have the option to convert your balance into guaranteed lifetime income (something PPNs usually don’t offer).

In addition, annuities have different types of guarantees:

• Fixed annuities: Give you stable, predictable interest growth with no market volatility. 
• Fixed index annuities: Provide downside protection with interest growth linked to a market index.
• Variable annuities: Offer market exposure and optional add-on riders — at a cost.
  

PPNs can be simpler, single-maturity products. You invest, wait out the term, and receive back your principal plus any market-linked gains the structure allows.

If you want longevity and predictable income, annuities may be the better fit. But if you prefer principal protection and some market participation, a PPN may be more appropriate.

Start growing your money with Gainbridge

Principal-protected products help safeguard your investment, but they often come with a lot of complexities and risks. For more transparent, reliable solutions, consider the direct-to-consumer annuities from Gainbridge. 

Our online platform gets rid of broker commissions and planner fees and puts potentially higher interest rates into your hands. You can purchase a Gainbridge annuity in typically under 10 minutes, and start growing your money immediately. Explore Gainbridge today and take control of your financial future.

FAQs

What is the safest investment with high returns?

Products like principal-protected notes can protect your investment while offering some market-linked upside. Higher returns typically have higher risk. 

What is a low-risk investment?

Low-risk investments, such as government bonds can help protect your principal. In general, they can provide modest returns but give you stability and predictable income.

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This article is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. For advice concerning your own situation please contact the appropriate professional. The Gainbridge® digital platform provides informational and educational resources intended only for self-directed purposes. Guarantees are backed by the financial strength and claims-paying ability of the issuer.

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