In a rising market, your gains from this ETN will be considerably lower than if you had simply bought an ETF that tracked the index. (The average will be smaller than the difference between the start and end point.) Given this snakebit market, you might think that the smaller returns are a good trade for preserving your principal. Should the market soar, however, you'll probably feel considerable buyer's remorse.
ETNs have a few other considerations:
• Counterparty risk. As we mentioned earlier, an ETN is backed by a promise. Although the issuers of these notes are large, financially strong firms, you should be aware that, at least until recently, everyone thought that investment bank Bear Stearns was financially strong, too.
• Tax risk. The IRS is reviewing the tax treatment of ETNs and may consider taxing ETN profits as interest, rather than at lower capital gains rates. Already, the IRS has ruled that single-currency ETNs will be taxed at ordinary income rates.
• Commissions and expenses. ETNs are generally cheaper than mutual funds, but you'll have to pay a commission. Your broker may tell you that you can buy an ETN on its initial offering with no commission, but that's not entirely true: The commission is part of the initial offering price.
Generally speaking, the more complex the deal, the more you should avoid it. "The structured notes are getting gimmicky," says Harold Evensky, a financial planner in Coral Gables, Fla. Gimmicks are not good investments.
Although you may well find notes that suit your overall investment outlook, bear in mind that the firms that offer ETNs aren't looking to lose money on the deal. It's a bit like betting against the house at a casino. So stick with simple ETNs, or stick with ETFs. The top-performing ETFs are in the chart.