Principal protection - Financial definition
Concise definition of the term principal protection
Principal protection is a financial feature that guarantees the original investment amount will not be lost, even if the investment's value decreases. This protection is often seen in structured products or certain types of annuities.
Comprehensive definition of the term principal protection
Principal protection is a critical feature in certain investment vehicles that aims to safeguard an investor's initial capital from losses. This feature is commonly embedded in structured products, principal-protected notes, and some types of fixed or indexed annuities. Typically, principal protection is achieved through the combination of fixed-income securities, which ensure the return of the initial investment, and riskier assets like equities, which offer growth potential.
For example, a principal-protected note might invest predominantly in zero-coupon bonds, which mature at the face value equal to the initial investment, while a smaller portion is allocated to stocks or options for potential growth. This strategy appeals to conservative investors who seek exposure to higher returns without the risk of losing their initial investment.
However, these products may come with trade-offs, such as lower potential returns compared to non-protected investments, higher fees, or longer lock-in periods. Principal protection is particularly attractive during volatile market conditions or for investors nearing retirement who cannot afford significant losses in their portfolios.