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Investors Lose $113 Billion on Complex Investments

Rob Brunhild trusted his broker when he was sold principal-protected notes underwritten by Lehman Brothers, noting that the broker implied that the notes were like Treasuries. His expectations for a solid return were dashed when Lehman went under, wiping out his investment. He said his family lost $275,000 on the notes.

"I had to tell my mother," Brunhild said. "Mom lived off of this money."

His story is one of many in the report released today on structured investment products by John Wasik. Wasik took a deep look at the investment category -- which includes products such as auction-rate securities, principal-protected notes and reverse convertibles. All told, Wasik estimates that such investments have cost investors at least $113 billion.

These instruments seem to be the answer to many investors prayers -- a way to gain an additional boost in interest while maintaining safety. However, the structures of these investments are exceptionally complex, and many investors have no idea what they're actually buying.

The paper's findings aren't surprising. We've written here a few times about how terrible these investments are. As we've noted, these products have the following characteristics:

  • The complexity will be designed in favor of the issuer.
  • Products may include some type of guaranteed downside protection.
  • The cost of the protection will be excessive, though it's likely the buyer won't be able to figure that out.
  • No institutional buyer would touch it, due to the excessive cost of the protection.
  • There will be a more efficient way to accomplish the same objective.
The next time you're tempted with an investment that sounds like you're getting a great deal, ask yourself why anyone would offer you such a deal. After all, the issuer's job is to raise capital at its lowest cost, not generate high returns for you. And if you're offered higher yields, you can be sure it comes with additional risk, even if you can't see it. And consider living by the following rule: The more complex the investment, the faster you should run away.

For more information on structured investments, see chapter 19 of my book The Only Guide to Alternative Investments You'll Ever Need, written with Jared Kizer.

More on MoneyWatch:
Bad Investments: Reverse Convertibles Bad Investments: Principal Protection Notes Principal Protection Likely Isn't Worth the Costs Municipal Bonds: Was Meredith Whitney Right? Gold and Silver, What Goes Up...
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