New Hybrid Investments: Balance of Safety and Higher Returns
In the vast market of financial vehicles available to the average consumer, there is often a gap between safe options, such as savings accounts and certificates of deposit (CDs), and riskier instruments, such as stocks and mutual funds.
Innovative hybrid investments can fill that gap by offering a high level of safety with the potential for higher returns.
What Are Hybrid Investments?
Generally, hybrid investments blend elements of complete principal protection, guaranteed income, and market-linked performance.
One common format resembles a certificate of deposit, where you’ll earn a fixed interest rate every year and this rate isn’t as competitive as some of the top CD rates. However, the structure links a portion of the funds to a stock market index. So, if this particular stock market index does well, higher returns are offered–possibly offering better returns than the best available CD rates.
An example of such a hybrid investment is the Save Market+ program. It guarantees an annual return of 4.20% (as of June 11, 2024) for a maturity term of three (3) years with an additional average variable market linked return of 4.00% (as of June 11, 2024, based on the historical performance of the S&P 500 Risk-Controlled Portfolio from 2009 to present and reflects the potential growth.)
It’s important to note that “market-linked returns” do not equate to “market returns” in the way that a hypothetical 50% increase in the underlying index means the hybrid investment will generate an additional 50% return. Rather, you get a percentage of those returns–a tradeoff for the safety component of the investment product.
Compared to Traditional Options
Certificates of Deposit (CDs)
CDs tend to offer fixed APYs that are excellent for risk-averse savers. Typically, you lock in funds for a pre-determined period of time (commonly called the “maturity term”) and earn an interest rate that tends to be higher than a savings account. They are very safe because those funds are not at risk. And, if opened with an FDIC-insured institution (such as a bank), the funds are also covered by deposit insurance (up to the applicable limits) in case of bank failure.
Compared to a CD, a product like Save Market+ guarantees the initial investment like a CD with a maturity, albeit at a lower APY. However, there is a much greater opportunity to boost returns due to the market-linked aspect of the product. Additionally, due to how hybrid investments are designed, they may be covered by SIPC insurance, which protects against loss of cash and securities held in SIPC member brokerages.
Index Funds and ETFs
Index funds and ETFs are diversified fund options for investors who want broad exposure through a single investment. They are often recommended for the average investor who doesn’t want to select individual stocks. Your returns can significantly outperform any fixed-income product if the index does well.
However, they still carry a significant amount of risk. If the index falls, so does the value of funds and your holdings.
Hybrid investments offer part of the upside potential from stocks with absolutely no risk to your original investment. A product may go above and beyond, like Save Market+, by guaranteeing a minimum APY so that you’re not just promised your original investment.
Pros
Principal safety
For most investors, loss of capital is the biggest concern. One of the major advantages of hybrid investments like Save Market+ is protecting the original principal. Regardless of how the market behaves, you’ll at least get all your original money back.
Potential for higher returns
Unlike traditional fixed-income products, hybrid investments can yield higher returns if the underlying index performs well. Save Market+ not only guarantees a 4.20% return but also the potential for more based on an S&P 500-linked portfolio, offering an attractive proposition for growth-oriented savers.
Minimum guaranteed returns
While it isn’t offered by all hybrid investments, a minimum guaranteed return from a product like Save Market+ is certainly a very attractive incentive. Even if the market doesn’t perform well, your money is still growing.
Cons
Early withdrawal penalties apply
Like a CD, there will likely be an early withdrawal penalty or surrender charge if you need to access all or part of the funds before reaching the maturity term.
Investment costs
Administration fees and/or portfolio management fees may apply. These fees are typically a percentage of the assets under management.
Market dependent returns
The market-linked returns on hybrid investments like Save Market+ depend significantly on market performance. If the linked index underperforms, the extra earnings might be lower than expected, although the principal and base return remain secure. In such cases, opening a high-yield CD may have been the better option. But that conclusion is valid only in hindsight.
How Hybrid Investments Fit in Your Overall Portfolio
In the risk spectrum, hybrid investments lean close to the safe side due to the principal guarantee.
They are particularly suitable for more established investors who are close to or already at retirement age. With capital preservation, these investors won’t be at risk of losing a portion of their nest egg during major market downturns. Meanwhile, the added upside potential helps to increase the financial buffer during retirement.
As always, it’s worth checking in with a fee-only financial professional to see how you can add hybrid investments to your portfolio.
FAQs
How are market-linked investments taxed?
Unless the hybrid investment is held in a tax-advantaged account (e.g., a Roth IRA or Roth 401(k) plan), yes, capital gains or interest earnings are subject to taxes.
Can funds in market-linked investments be withdrawn at any time?
Withdrawal terms depend on the specific investment. Products like Save Market+ may have restrictions or penalties for early withdrawal, aligning with their term commitments.
Are all market-linked investments protected by the FDIC or SIPC?
Investments in Save Market+ are protected by the SIPC. However, investors should always review the specific protection details of each hybrid product. Principal protection in hybrid investments is not always covered by the FDIC or the SIPC.
