’Men who won’t take risks won’t drink champagne’, say the Russians. If you insist on 100% security guarantees, the stock market will only deliver lousy returns on your money.
The promoters of ’no loss’ stock market investments know they’re onto a good thing. Most people fear losing money more than they enjoy making profits, so they are attracted by the proposition that ’you can’t lose money’.
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This means the promoters can charge them more for no-loss insurance than the insurance is actually worth. That’s why I recommend that you avoid these investments and go for better value elsewhere.
How to pay £239 for a £50 guarantee
Here’s a simple demonstration. Close Escalator 100 is a fund that guarantees that the cash-in value will never be below your original investment. Unlike the products flogged by banks and building societies, it has daily dealing and you can cash in at any time.
Over the past three years the return has been 15.1%, turning an initial £1,000 into £1,151. But Close also runs Escalator 95, which guarantees a minimum of 95% of your original investment - so you could lose 5%. Over the past three years Escalator 95’s return was 39%, turning an initial £1,000 into £1,390. So with Escalator 100, you ended up paying £239 (£1,390 minus £1,151) to guarantee not losing £50 (the difference between the guarantees on the 100 and 95 products).
Clearly the Escalator 95 fund was a far better value proposition over the three-year term. But even the Close Escalator 100 was a better proposition than almost every product of this type sold by a bank or a building society, because the high street products impose five or six year lock-ins, have less advantageous tax treatment, and dilute your possible gains by ’averaging’ the stock market index over the final year of the term.
Invest in a tracker fund and get much more upside
Complicated always costs you more
’Guaranteed Equity Bonds’ - the generic name for five or six-year fixed term products of this type - have got more complicated in recent years. As I always say, there is only one reason why financial products get more complicated and it is not, whatever the promoters say, for your benefit. It is so that they can conceal higher charges without you understanding what is going on.
So try the new Abbey Guaranteed Growth Plan 5 for size. It guarantees that at the end of five-and-a-half years you get back at least 120% of your money. That sounds all right but again, the promoters take advantage of people’s inability to work out compound interest - that’s a (taxable) return of just 3.3% a year.
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Shabby Abbey guarantees to pay you less
OK, it’s better than a kick in the teeth (just), and if the stock market goes up you can get up to 44%, a return of £1,440 for every £1,000 invested. But hang on a minute- that’s at the end of five and half years, so it works out at a return of under 7% a year, and you can’t get any more even if the market doubles or triples.
So to sum up, Abbey’s guarantee is that over five and a half years you will get 2.2% a year LESS than you could easily get today with a fixed-rate bond. Giving up that 2.2% annual return- which amounts to £128 or almost 13% of an initial £1,000 investment - earns you the right to earn a MAXIMUM of 1.5% a year more than the same fixed-rate bond. Does it sound like you are getting the better end of this deal? Or is it perhaps Abbey that is trousering more?
Investment trusts can be ideal for regular savings
Tin hats and rollercoasters
If you really do want perfect safety of your capital, there are some decent
fixed-rate savings account offers around of up to 5.5% over five years. If you are prepared to take some risk with some of your money, then put some into one of these secure fixed-rate accounts and some into a unit trust investing in the UK.
Choose one of our best buy
UK Equity Income Funds or
UK Index Tracker funds. An alternative giving you a ’two-in-one’ investment is to buy one of our
best buy Cautious Managed funds, which have around 60% of their money in shares and 40% in fixed-rate investments.
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Shares beat cash in the long-term
In the long run, investing in shares has always produced far higher returns than cash or fixed rate investments. Guaranteed Equity Bonds are really closer to fixed rate investments than shares, so I predict that many of the people buying them will be disappointed when their bonds mature.
If you can leave it there for five years or more, I suggest you invest at least some of your capital in stock market funds. You’ll have to accept that when the rollercoaster dips you may get butterflies in the stomach - but you should be able to afford the champagne afterwards.
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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.
