There are a LOT of different ways that you can invest your money. But you must remember that there is no one-size-fits-all approach to investing. Just like there is no one-size-fits-all diet or exercise routine. So let’s go over another investing vehicle that is available to you if you were to choose it and let’s answer the question, “What is an ETN?”
What is an ETN?
An ETN is an abbreviation for an Exchange Traded Note.
Whenever you see the word “note”, think of bonds. In the investing world, the two words are often used to describe the same thing.
A bond is a debt instrument where you essentially loan out your money to a municipality, government entity, or business for a specified period of time. In exchange they give you periodic payments (called coupons) and then give you your money back at a later specified date.
I won’t go into all of the details of bonds here. But there is a really good article on bonds that I wrote through this link.
If you were to buy an ETN, you are buying a debt instrument that tracks a particular index for a period of time. For example, you could buy a $1,000, three-year ETN that tracks the S&P 500.
If you were to do that then you would give $1,000 to the investment company. They would keep the money and invest it in bonds in the S&P 500 for three years. And at the end of the three years, the investment company would take any fees that they incur from you, give you back your original $1,000 as well as any growth and/or dividends from that period.
It’s kind of like buying an ETF (also called an Exchange Traded Fund). But there are a couple important differences.
Differences Between ETNs and ETFs
We have answered the question, “What is an ETN?”. Now let me show you the differences between investing in ETNs, ETFs, and bonds.
When you invest in an ETF, you invest directly in those stocks within the ETF. For example, if you invest in an S&P 500 ETF, that ETF has purchased shares in all 500 of the companies in the S&P 500.
But if you were to buy an ETN instead, you would not be investing directly in the companies in the S&P 500. You will be investing in the finance company and they will be investing your money (as well as a bunch of other people’s money) into bonds in the S&P 500. At the end of the period that you are investing, you will get your money back (less any fees) as well as any gain on the S&P 500 and/or dividends accrued during the time.
Since you are investing in the financial firm and not directly into the S&P 500, the bond price and interest is largely depended on the financial security, credit rating, and default risk, of that particular financial institution and less on the financial security, credit rating, and default risk of the companies within the ETN.
This isn’t necessarily a good thing or a bad thing. It is just an important differentiator in investing in ETFs and ETNs.
Differences Between ETNs and Bonds
The biggest difference between investing in bonds and investing in ETNs is that when investing in a bond, you invest in a single bond at a time. But when investing in an ETN, you invest in a whole bucket of bonds at the same time which can give you some added default protection.
But the biggest difference in investing directly in bonds and into ETNs is that ETNs do not pay coupon payments or dividends until maturity while regular bonds do.
Here is an example:
You have the option of investing in a 5 year bond or a 5 year ETN. For the sake of simplicity, they both have the same credit risk, coupon payments, and maturity date.
You have $5,000 to invest and the coupon payments are paid annually at 10% ($500 per year).
If you invest directly into the bond your payment schedule will look like this:
| Investment | Year 1 Coupon | Year 2 Coupon | Year 3 Coupon | Year 4 Coupon | Year 5 Coupon and Principal Return | Total Gain |
| ($5,000) | $500 | $500 | $500 | $500 | $5,500 | $2,500 |
If you invested into the ETN, here is what your payment schedule would look like:
| Investment | Year 1 Coupon | Year 2 Coupon | Year 3 Coupon | Year 4 Coupon | Year 5 Coupon and Principal Return | Total Gain |
| ($5,000) | $0 | $0 | $0 | $0 | $7,500 | $2,500 |
There will, of course, be fees taken out of these investments also.
The biggest difference is how these investments are treated for taxes.
If this person would invest directly in the bond, then they would have to pay ordinary income tax on the coupon payments. But if the person were to invest in the ETN, then they would get to pay capital gains tax (which is usually a lot lower).
BUT they would have to wait 5 years to see any of their money again. So depending on the person’s situation and needs they may want to choose one over the other.
Final Thoughts
ETNs are not for everyone. Most people would be much better off investing into their company sponsored retirement plan first and/or into a Roth IRA or traditional IRA.
However, just like food, there is a specific flavor out there for anyone. And in the case of answering the question what are ETNs, this is what they are and how they work.
I am here for you!
You can do this!
Until next time!
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