Smart Thinking... The price of protection
What price protection? [excerpt from Personal Finance and Savings online]
According to a recent survey, the majority of investors are looking for a significant level of security when making an investment. The two key requirements are a guaranteed return and capital protection. So if these are your requirements, what sort of products should you be looking at? And at what ‘price’ the guarantee? Is it worth paying? Alicia Wyllie does the sums.If there’s one thing every investor wants, it is to make the maximum possible return with an absolute minimum of risk. In the past you had little or no hope of achieving such an aim: you either stuck with the poor returns available in your bank or building society account or trusted your luck with the stock market. But in the past decade the old rules of investing have been thrown out of the window, as a new breed of investment schemes that aim to provide a decent return and protect your capital have entered the market. Most of these products, such as high-income bonds and escalator funds, seek to achieve these laudable aims by using derivatives – a financial instrument that provides insurance against market declines – to give you exposure to stock market returns without the risks.
In a world where investors are still reeling from the savage bear market of 2000–2003 when they lost an average 42 per cent of their money, it is not surprising that protected products have become extremely popular. Low interest rates have also increased the attractions of protected investments. Throughout the 1980s and early 1990s, interest rates were high enough to give cautious investors a decent return. But, as interest rates started to tumble, returns dropped, forcing even the most guarded of investors – including those who relied on their savings to supplement their retirement income – to look elsewhere. Traditionally savers looking for a better return than they could get from the building society would opt for a with-profits bond. But, in the late 1990s, returns from these products – which invest in a mixture of equities, bonds, property and cash – started to fall too. Against this background, protected products, to many cautious investors, seem like manna from heaven. But are these products all they are cracked up to be? And is the price of the protection you get worth
paying?
“Capital guarantees sound like a fantastic deal in theory,” says Mark Dampier, head of research at IFA and broker Hargreaves Lansdown. “But many people don’t really realise what they’re getting. They think that if they invest £10,000 and get that money back after five years they’ve done well. But the effects of inflation will mean they have, in reality, lost money.
“Their investment would also have underperformed the return they could have achieved from the building society,” adds Dampier. “This should be the real test for investors – not how their fund has performed against the stock market.”
Other experts do, however, feel that protected investments have their place in investors’ portfolios. “There’s a tremendous demand for products that provide an element of capital protection and, with deposit rates so low, it’s hardly surprising,” says Kerry Nelson of Willis Owen, an independent adviser. “There’s nothing wrong with protected products per se and they do have their uses in some investors’ portfolios. These products are, however, extremely complicated, and there’s always a danger investors will buy a product that simply is not suitable for them. Capital-protected products come in many shapes and sizes, so investors should tread very carefully and, in most cases, should probably seek professional advice before handing over their money.” So, which protected products are worth considering?