It's often said that the stock market is driven by two contradictory feelings: the desire of those who invest to increase their wealth, on one hand, and their fear of losing it all, on the other. Of course, as a general rule, the potential to make profits is accompanied by increased risk. When seeking higher potential returns, we must accept the possibility of losses may also be high, at least in the short term.  

But is there no way to mitigate these two factors, aiming for a degree of growth while avoiding losses? 

If you’ve ever wondered about this, the answer you seek just might be found in an investment solution known as a principal-protected note. 

Growth potential with a safety net 

Offered by major financial institutions, principal-protected notes are investment vehicles structured around two key components.  

The first component serves to guarantee the principal at maturity. It is invested in a fixed income security that, at maturity, will equal the total amount of your initial investment. The second component provides exposure to exchange-traded funds or baskets of securities that have the potential to appreciate in value.  

Imagine, for example, that you invest $1,000 in a principal-protected note with a term of x years. Out of this amount, $800 will be used to purchase a bond with a guaranteed value of $1,000 at maturity, x years from now. Your initial $1,000 investment is now fully protected, and your risk of loss is zero if you hold your investment to maturity. The other $200 will be exposed to investments that are riskier, but also have higher growth potential. These might consist of a basket of global equities, European equities or perhaps Canadian financial equities, for example. This is the component that could generate your investment returns. 

How is that different from a traditional investment? 

This financial product differs from traditional fixed income securities such as guaranteed investment certificates (GICs), and from investments such as mutual funds*.  

In the case of GICs, your principal is protected and your return is known in advance, but the price of this certainty is that your return will usually be modest. In the case of mutual funds, your principal is not protected and your return is not guaranteed; however, your reward for this uncertainty is the potential for much higher growth. 

The principal-protected note bridges these two options: it gives you the certainty that you will get your principal back at maturity, while offering the potential of a return that, although not guaranteed, could be higher than that offered by a GIC. 

A broad and relatively complex range of products 

There are various types of principal-protected notes that may differ in a number of ways, including: 

• term to maturity 

• how they are structured to expose your investment to the financial markets and the choice of these markets 

• the formula(s) used to calculate notes’  return versus the return on the underlying reference basket 

• liquidity, i.e., whether or not you can sell the notes before maturity 

• the fees that apply 

That’s why, as with any investment, it’s important to explore the features, advantages and disadvantages of these notes, and to get informed advice in order to make the right decisions. 

*Mutual funds are offered by group savings representatives at SFL Investments, a financial services firm.