Guaranteed equity bonds issued by National Savings & Investments as well as most High Street banks are a lousy investment. I’ve been saying this for years but here are figures that prove it.
The figures were produced by the Investment Management Association and they compare what investors got from three different issued of NSI’s Guaranteed Equity Bond with what they would have got from an investment in an index-tracker fund.
Investors in the NSI bonds ended up with between 15% and 20% less cash than if they’d bought an index-tracker. For example, someone who invested £10,000 in the NSI GEB in April 2002 received a maturity payout five years later of £11,559, which represents an annual return of just 2.9% on their money.
The same investment in an index tracker produced £13,311 - or 15% more. For each of the three NSI GEBs that have matured, the index tracker provided a similar uplift in encashment value.
How NSI’s bonds have failed investors
| | Initial investment | Annual growth rate | Value after five years | Extra return from Index trackers |
| NSI GEB issue 1, April 2002 | £10,000 | £11,559 | 2.94% | |
| Index tracker funds | £10,000 | £13,311 | 5.89% | £1,752 |
| | | | | |
| NSI GEB issue 2, August 2002 | £10,000 | £14,431 | 7.61% | |
| Index tracker funds | £10,000 | £17,271 | 11.55% | £2,840 |
| | | | |
| NSI GEB issue 3, November 2002 | £10,000 | £14,579 | 7.83% | |
| Index tracker funds | £10,000 | £17,444 | 11.77% | £2,865 |
Source: IMA
Over-priced insurance against loss
The key difference between the NSI GEB and an index tracker is that the GEB guarantees you cannot lose money when your investment matures after five years. With the index-tracker, the value of your investment fluctuates up and down in line with the stock market.
NSI makes a big selling point of the risk factor: it says “thousands of investors are playing the stock market without risking a penny" by buying these products. But as these figures show, this security blanket is a very expensive form of insurance.
What investors need to ask is how much risk is involved in a 5-year investment in the stock market. The answer is not a lot. The UK stock market has ended lower at the end of about one-in-five 5 year periods since 1945.
Staying in and hanging on normally pays eventually
But in only one in four of those loss-making periods has the loss been serious, like 20%. And even on those loss-making occasions, if you just hold on instead of cashing in at the end of year five, you normally end up even or ahead by the end of year 7 or 8.
These figures are from Barclays’ Annual Equity-Gilt Study, which provides the definitive figures on long-term returns from the UK stock market.
Richard Saunders, the IMA’s Chief Executive, said: “These GEB products have been widely promoted in recent years as a risk-free way of getting a stock market-related return. Instead, they appear to be simply a complicated and opaque way of delivering the same returns over time as a good deposit account. It is quite wrong that consumers should be misled in this way.”
Even better index tracker
If anything I think Mr Saunders is being too kind to these products, which escape the detailed disclosure of costs and charges that apply to investment funds like unit trusts, open-ended investment companies and investment trusts.
With these funds, WYSIWYG, but this is certainly not the case with GEBs.
A key point that novice investors overlook is the effect of dividends. At the moment, if you invest in an index tracker, you get dividends of 3.3% a year. Over a 5-year period that adds up to nearly 18% of your initial investment, but with growth in dividends it will probably be over 20%.
That means that if you buy an index tracker and reinvest the dividends, the index can fall by about 15% before you start to lose money. With GEBs, you don’t get dividends- all you get is a capital payment linked to the level of the stock market index (with most GEBs this is the FTSE 100 Index).
The comparison in the table also understates the return you can get because the IMA assumed the tracker fund has an annual charge of 1%. In fact, our own index tracker Best Buy has an annual cost of just 0.3%, which would have increased the index tracker fund’s return by about another 4-5% over a 5-year term.
Most GEBs are bad
Most of the High Street banks also sell lots of GEBs to their customers, usually over-emphasising the fact that ‘there is no risk’ and skating over the costs, the lack of dividends, the inflexibility and, in many cases, a poor tax position.
With many GEBs sold by banks, you pay tax on any profit, whereas with index-tracker funds, profits are potentially subject to capital gains tax but you won’t pay tax unless you make profits of over £9,200 during the year.
When you invest in a fund, it’s clear how much the managers will earn in charges. With GEBs, there’s no disclosure of costs or charges. But the figures I have seen suggest that these bonds include a big profit margin for their managers and that banks are earning far more by selling these bonds to their customers than they would by selling funds.
Do they dare criticise NS&I?
How often do you read a word of criticism of NS&I in the newspapers? Not often. It’s one of the biggest spenders on financial advertising and also spends a fortune smooching journalists.
As we’ve said before, most NS&I products are very poor value. In fact, with every single NS&I product you can easily get a better return elsewhere. My advice is don’t be suckered into buying one of these GEBs from NS&I or a bank.
If you really, really, really can’t afford or face any risk, then stick to fixed-rate bonds, where you can easily collect 6% a year at the moment. But if you can afford to take some risk with some of your capital, use our Model Portfolios to create a portfolio of funds of different types to earn better returns while managing the risk.
Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
