Guaranteed returns – we love ’em. Or to be more accurate: investors love ’em. It’s the very nature of investment which means that people will pay a premium for the promise of a “certain” return. But research shows these supposed guarantees often come with hidden costs and risks attached.

Imagine an investment product that is sold as lifting your chances of meeting your retirement needs from 60% to 65%. A second product proposes to increase your chances from 95% to 100%. Which is more valuable?

It seems clear that while both products offer a 5 percentage point increase in the probabilities of success, the second option is much more enticing. This is known as “the certainty effect” and is well documented among behavioural scientists.

We can’t help it. According to this effect, we are predisposed to overweight small risks and will pay far more than the expected value to eliminate them altogether.

It should come as no surprise that an entire industry has evolved to exploit this innate desire among consumers for perceived certainty in investment outcomes.

The industry produces what are known as “structured” products. These instruments are often marketed to consumers as “capital guaranteed” or “capital protected” and offer the prospect of a certain payoff in the future.

Aware of the popularity of these investments, the Australian version of the Financial Conduct Authority – the Securities and Investments Commission – recently released the results of a study of unlisted retail structured products that offer guarantees or protection of capital. It concluded that these products can entail complexities, conditions and risks which are not always well understood and which can deliver unintended outcomes.

While the products are sold as ‘guaranteed’, there are often mitigating phrases such as ‘qualified’, ‘limited’, ‘conditional’ or ‘contingent’ – all of which hold out the possibility that the whole of the investor’s capital may be at risk.

“Some investors may consider structured products to be equivalent, or a near equivalent, to cash or deposit accounts, when the risks of structured products are usually considerably higher,” the Australian regulator warned.

In my view problems with structured products abound. Top of the list is an opaque structure. The issues are two fold. Firstly the likelihood of payoff is exaggerated. Secondly the level of charges and fees are underestimated.

Some product issuers, while notionally being associated with a major financial institution, may in fact be separate entities with little financial substance. Some products, through the use of internal gearing, also carry significant potential for investors to lose money beyond their initial investment. Others carry conditions that link the payoff to the performance of an underlying asset.

“The attractions of these products for investors may include the ability to participate in the upside of market performance, while having protection on the downside as well as potential tax advantages in some cases,” ASIC said.

A lack of liquidity–ease of access to your money–is another frequently cited problem with structured products.

And even if none of these risks are present, the guarantee of a payoff has to be weighed against the lower return than might be secured otherwise and the often higher fees than incurred by investing in a low cost, globally diversified portfolio of stocks and bonds.

It is understandable that people would prefer to eliminate risk altogether than merely reduce it. But the perception of certainty and the reality are often poles apart. And the cost of seeking a guarantee can be much higher than we anticipate.

As always, beyond diversification, there are no free lunches in investment.