The Hidden Dangers of Structured Notes: Why They May Be a Poor Fit for Most Retail Investors

Structured notes have long been marketed as a sophisticated solution for retail investors seeking yield, downside protection, or tailored market exposure. However, beneath their polished veneer lies a labyrinth of embedded risks, opaque fees, and structural complexities that often undermine their stated benefits. As the global structured notes market approaches $150 billion in 2025, it is critical to dissect why these instruments may be ill-suited for the average investor—and why the risks far outweigh the rewards for most.

1. Credit Risk: The Silent Threat

Structured notes are debt obligations of the issuing institution, meaning their value is entirely dependent on the issuer's creditworthiness. If the bank or financial institution defaults, investors face the grim reality of losing their principal, even if the underlying asset performs well. This risk has been amplified in recent years by the collapse of major institutions like Credit Suisse and the ongoing fragility of regional banks.

For example, a structured note linked to the S&P 500 with a 10% annual coupon might appear attractive, but if the issuer defaults, the investor could lose everything. Unlike traditional bonds, structured notes lack robust legal protections in insolvency proceedings, placing investors at the back of the line for recovery. In 2023, the average recovery rate for unsecured creditors in bank failures was less than 30%, according to the FDIC.

2. Hidden Fees: The Cost of Complexity

The fees embedded in structured notes are often buried in dense legal documentation, making them difficult to quantify. On average, these fees range from 1.5% to 2% annually, with some products charging as much as 4.59% in markups. For instance, Barclays' contingent coupon notes in 2024 carried an effective expense ratio of 2.3% per year for two-year terms.

These fees erode returns significantly. A $100,000 investment in a structured note with a 2% annual fee would cost $2,000 in the first year alone—before accounting for market performance. Worse, brokers and advisors often receive commissions of 2% or more, further compounding the cost. The lack of transparency in fee structures means investors may not realize they are paying more in fees than they are earning in returns, especially in volatile markets.

3. Market and Liquidity Risks: A Double-Edged Sword

Structured notes are inherently tied to the performance of underlying assets, indices, or derivatives. While this can generate attractive returns in favorable conditions, it also exposes investors to non-linear payoffs and unexpected losses. For example, a note linked to the Russell 2000 Index with a 20% participation rate and a 10% buffer might seem safe, but a 15% decline in the index would still result in a 5% loss.

Liquidity risk is another critical issue. Unlike stocks or ETFs, structured notes are rarely traded in secondary markets. Investors who need to exit before maturity often face steep discounts or are forced to hold underperforming assets. In 2024, the average discount for early redemption of structured notes was 12–15%, according to iCapital data. This illiquidity becomes a liability during market downturns when investors are most likely to want to sell.

4. Complexity and Tax Traps: A Misunderstood Proposition

The intricate structures of these instruments—such as barriers, caps, and participation rates—require a nuanced understanding of derivatives and market dynamics. Many retail investors assume they are purchasing a “principal-protected” product, only to discover that protection applies only under specific conditions. For example, a note with a 90% principal guarantee might trigger a 10% loss if the underlying index falls below a certain threshold.

Tax implications add another layer of complexity. Structured notes are typically taxed as ordinary income, even if the investor has not received cash distributions. This “phantom income” can lead to unexpected tax liabilities. For instance, a principal-protected note with a 5% annual coupon might generate taxable income of $5,000 per year, even if the investor's cash flow remains unchanged. The IRS has yet to clarify the tax treatment of many structured note features, creating uncertainty for investors.

5. A Poor Fit for Most Retail Investors

The combination of these risks makes structured notes a poor fit for the average investor. The average retail investor lacks the expertise to navigate the complexities of derivatives, the resources to conduct due diligence on issuers, and the liquidity to hold these instruments to maturity. Moreover, the high fees and tax inefficiencies often negate the benefits of yield enhancement or downside protection.

Academic studies reinforce this conclusion. A 2023 analysis by the Journal of Financial Economics found that structured notes underperformed a balanced portfolio of stocks and bonds by an average of 1.8% annually. In some cases, they even trailed risk-free Treasury bills. For investors seeking income or capital preservation, alternatives like dividend-paying ETFs, municipal bonds, or FDIC-insured certificates of deposit offer clearer, more transparent solutions.

Conclusion: Proceed with Caution

Structured notes are not inherently bad investments—but they are rarely appropriate for retail investors. The embedded risks, hidden fees, and structural complexities create a mismatch between the products' marketing and their real-world performance. For most investors, the path to safer, more predictable returns lies in simpler, more transparent alternatives.

If you are considering structured notes, ensure you:
1. Understand the issuer's creditworthiness and stress-test its ability to survive a downturn.
2. Demand full fee disclosure and compare the total cost to traditional investments.
3. Simulate worst-case scenarios using the note's payoff structure to assess potential losses.
4. Consult a fiduciary advisor who prioritizes your interests over commission-based incentives.

In a market where complexity often masquerades as sophistication, structured notes serve as a cautionary tale: the best investments are not always the most intricate. Sometimes, simplicity is the ultimate safeguard.