I’m going to guess that you haven’t heard much about auto-callable yield notes (ACYNs), sometimes called barrier notes, and the role they might play in expanding your portfolio and buttressing your income plan. So what are ACYNs?
Financial planners have long advised investors to keep an appropriate mix of stocks and bonds in their retirement portfolios. The stocks are mostly meant to provide long-term growth, and the bonds are there for reliability and income.
But what if neither investment is living up to expectations — at least for the time being? Shouldn’t there be other options for investors who want to diversify their holdings and fortify their income in retirement?
There are other options, of course. Even if you’re not using them, you’ve probably heard about some, including investing in real estate and real estate investment trusts (REITs) and/or purchasing annuities, CDs or dividend stocks.
But why haven’t you heard much, or anything, about ACYNs? Probably because ACYNs are more nuanced than more traditional strategies and, therefore, can be hard to explain to the average investor. But just because an investment strategy is more advanced or nontraditional doesn’t mean it doesn’t deserve a little research and an in-depth conversation about risk vs. reward with a financial adviser you trust.
What Are Auto-Callable Yield Notes?
ACYNs are short- to mid-term (usually one to five years) market-linked investments designed to offer a higher yield than what a fixed-income bond with a similar credit rating and maturity generally can provide. ACYNs are typically linked to the performance of an underlying index (such as the S&P 500), a stock or some other reference asset. And as long as that underlier remains at or above a predetermined threshold, an ACYN can provide income in the form of monthly, quarterly, semiannual or annual payments.
That’s the reward. So, what’s the risk?
If the underlier falls below the predetermined coupon contingency level on any of its observation or “call” dates, those payments could stop. They would remain halted unless and until the underlier rebounds and, on a future observation date, rises back above the threshold. If, at maturity, the underlier is substantially lower than it was at the start of the note’s term — and below the note’s preset “barrier protection level” — the safety net disappears, and the principal could be exposed to the full loss of the underlier.
Here’s an example. Let’s say you’re looking to invest in an ACYN that:
- Is linked to the S&P 500.
- Has a three-year term.
- Pays a semiannual coupon of 10% per year as long as the S&P is at or above 70% of its initial level on its quarterly observation dates.
- Has a one-year non-callable period and can be automatically redeemed by the issuer for par if the S&P is at or above 100% of its initial level on any observation date after the non-callable period.
- Has a 30% “protection barrier,” which means the note holder will receive their full principal back so long as the S&P 500 is at least 70% of the initial level when the note reaches the end of its term.
Here’s what could happen to your investment under three different scenarios:
- The index remains between the coupon contingency level (70%) and the call contingency level (100%) for its entire term. You’d get six coupon payments at 10% per year plus 100% principal return at the end of the term.
- The index remains between the coupon and call contingency levels during the non-call period, then exceeds the call contingency level on the second observation date after the one-year non-call period ends. You’d get three coupon payments at 10% per year before the note was called by the issuer plus 100% principal return.
- The index moves below the coupon contingency level after the first year and continues to fall so that it is, for example, 40% below its initial level at maturity. You’d get two coupon payments at 10% during the non-call period, while the S&P was above the coupon contingency level. But then, as the market dropped below the contingency level, your payments would stop. And at maturity, because the index dropped so far that the barrier protection went away, only 60% of the principal would be returned.
Of course, these are hypothetical scenarios — they aren’t based on past market movements or predictions for the future. But you can see the benefits and risks pretty clearly in these equations.
Is an ACYN Right for You?
ACYNs can offer a higher income potential than some other income-producing investments, which can make these market-linked debt instruments a strong option for retirees. They also offer some downside protection, depending on the barrier that’s offered.
It’s important to note, however, that the scheduled payments may not be as reliable as some other income-producers — either because the market is way up or way down.
Liquidity also can be a factor. Though ACYNs are typically short- to mid-term investments, in order for the principal to be returned, the note must be held to maturity. (Unless, of course, it’s called before it matures.)
To protect your investment, you’ll want to be sure to work with a reputable financial adviser who has experience with this particular strategy. It’s also critical to be confident you’re dealing with a credible, highly rated issuer.
ACYNs aren’t for everyone. But they might be a good fit for you. If you decide to consider this investment, be sure to work with a credible source that brings ample knowledge and experience to the table. Our firm, for example, has chosen to connect our clients directly to the teams at First Trust Portfolios.
If you’re looking to add another income stream to your plan, or you want to diversify your portfolio beyond the basic age-appropriate stock-bond mix, an ACYN may be a strategy worth considering.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Adam Bruno is the founder and president of Evolution Retirement Services in Fort Myers, Florida. A former teacher, his goal is to provide a one-stop shop where individuals can receive education and holistic guidance in all aspects of financial planning. Adam is a regular contributor to Fox 4 News in Fort Myers, host of the Retirement Evolved podcast, and author of They Lied: The Real Cost of Your Retirement. Adam is married and has four children.
Amazon To Offer Students $25 Flights For The Holidays — But You Must Act Fast
Amazon Prime Student members will have a chance to score one of 3,000 tickets for a limited time, starting December 5.
By Jamie Feldman Published
Walt Disney's Dividend Is Back. Will DIS Stock Follow?
Disney reinstated its dividend after a three-year suspension as shares remain depressed.
By Dan Burrows Published
Year-End Tax Planning for a Financially Healthier Retirement
Getting your tax ducks in a row for the end of the year can decrease your tax liability and make the most of your income, now and in retirement.
By Ryan Marston, Investment Adviser Representative Published
Where to Start Financially After a Life-Changing Diagnosis
Dealing with an illness, yours or your child’s or that of another loved one, is hard enough without adding financial duress. Here are some considerations and suggestions for covering expenses.
By Stephen B. Dunbar III, JD, CLU Published
Stock Market Today: Dow Jumps 520 Points After Salesforce Earnings
The enterprise network software firm reported impressive Q3 results, sending the blue chip stock soaring.
By Karee Venema Published
Six Ways to Prepare for Widowhood and Protect the Surviving Spouse
No one wants to have to plan for losing their spouse, but having plans in place and knowing what to do when the time comes can alleviate at least some of the stress.
By Tyler Hill, Investment Adviser Representative Published
Creating a Blended Family? Three Key Steps to Consider
Blended families can make your finances and estate extra complicated, but you can head off some of those issues with careful planning.
By Adam Frank Published
Do You Need Disability Insurance?
If you work for a living, the answer is yes, so don’t overlook protecting your biggest asset. Open enrollment season is the perfect time to assess your options.
By Frank J. Legan Published
Stock Market Today: Stocks Give Back GDP Gains After Beige Book
The latest GDP report showed the U.S. economy grew at a rapid-fire rate in the third quarter, but the Fed's Beige Book sparked concerns.
By Karee Venema Published
Retirement Planning in a Time of Inflation and High Interest Rates
Today’s challenges make retirement planning even more complicated than usual, but it’s not all doom and gloom.
By Ken Moraif, MBA, CFP®, CRPC® Published