Guaranteed Stock Market Bonds - Are They A Good Option?
At the moment, one of the frustrations for savers is the low rates of return they are experiencing on cash deposits. This has resulted in some investors being persuaded by salespeople to put their money into a Bond that is linked to the performance of the stock market in some way or form.
There are many articles appearing in the press on this, and as usual the banks and building societies are coming in for criticism.
According to Money Mail, savers have committed £40 billion to these 'structured products', which usually have a 5 or 6 year timespan.
The patter goes something like this:
"How would you like to earn stock market-like returns without risking your capital?"
Sounds good doesn't it?
Well, yes it does. But like virtually everything that sounds too good to be true, it nearly always is! Some of the problems with these types of product can be obvious, but quite often not so.
Looking at one current offer by a leading building society, this is what the product boasts:
- half of any rise in the FTSE 100 over six years
- a minimum 10 per cent return before tax and protection of your capital
So, if the index rises by 20 per cent or less, you will see a 10% return. But this is just a yearly return of about 1.66% (simple interest, not compounded), and even if the FTSE grows by 50% the return is just 4.16% pa.
Many cash deposit accounts are offering more than this over say 5 years, and of course these don't have market risk! Other products have even more complicated rules linked to an index, and don't forget that any proceeds will be taxed. Also, if the stock market falls it is likely that you will simply receive your capital back with no interest.
One story the press picked on was an 80 year old lady who was persuaded to invest the £13,053 she had in cash into such a product. Her experience was that she made £1.02 over 5 years.
Of course, you could argue that this is the gamble, but there has also been far worse stories such as certain schemes that were backed by Lehman Brothers who went bankrupt.
The common theme here is that these customers feel cheated and say they would not have invested if it had been explained to them in full.
So what do you need to be wary of?
- which stock market index is it linked to?
- how is it taxed (income or capital gains)?
- what are the charges?
- how EXACTLY does it work?
- is the capital fully protected?
- where is it invested - how safe is the company holding it
- are dividends reinvested?
On the last point - reinvested dividends - there is a major problem. That is that while it is true that the stock market can deliver high returns, it is important to understand how this is achieved.
If you took £10,000 in the FTSE All Share Index in 1990, this would have grown to £22,220 by 2010. However, by reinvesting the dividends that the companies earn over the years, this figure would jump to £35,500!
The newspaper article crucially points out that these types of bonds EXCLUDE dividends from their calculations!
So, it is very difficult for us to see the plus side of these bonds, particularly as they could reduce your rewards for you taking a given level of risk, as well as usually paying the bank large commissions from your money.
(It is worth remembering that National Savings, backed by the Government occasionally have Guaranteed Bonds on offer, although not at present.)
There may be investors out there who are happy with them, but, in our experience, these products are very lucrative. Unfortunately, they are often lucrative for the sellers of these bonds - not you!.
The Financial Tips Bottom Line
Make sure you are FULLY aware of the potential upside and downside before you part with any of your money. Remember, it's YOUR money and the person helping you make your investment decisions (if you use someone) should be there to educate you and not simply sell you what they want.
Risk and return are related. Ensure that you have your own strategy for investments that you are comfortable with, and avoid products that seem to be too good to be true.
ACTION POINT
Do you have one of these Guaranteed Stock Market Bonds? Is it part of an overall strategy, or simply been bought ad hoc? We'd suggest you take the time to review this and find out what your options are.
About the Author
Ray Prince is a fee based Certified Financial Planner with Rutherford Wilkinson ltd, and helps UK Resident Doctors and Dentists plan to achieve their financial objectives. Just visit http://www.medicaldentalfs.com where you can request your free retirement planning guide. Rutherford Wilkinson ltd is authorised and regulated by the Financial Services Authority.
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