Balancing The Need For Returns With The Need For Security


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Have you watched your bank interest earnings plummet over the last year? Although the Bank of England base interest rate stopped just short of zero, 0.5% is so negligible it may as well be zero f

Have you watched your bank interest earnings plummet over the last year? Although the Bank of England base interest rate stopped just short of zero, 0.5% is so negligible it may as well be zero for savers. The 1% European Central Bank rate is not much better. Depending on what type of savings/deposit account you have, you could be earning a pittance even if you have over ?100,000 on deposit. Some offshore savings account charge a small monthly fee which may currently be higher than the interest earned on the account! Is there anything you can do to improve returns?

If you do not normally use your bank interest earnings to provide an income, and instead just roll it up in the account, the low rates are not such an issue at the moment. It does however mean that your capital is not growing, or only minimally, and over the longer term its spending power will diminish. When you do come to use it some years down the line you will find it does not go as far as it does today. If inflation does resurface over the coming years as predicted, this could impact on your wealth and possibly on your standard of living in your later years.

It is generally accepted that over the longer term equities provide the best opportunities to outpace inflation. With many shares still undervalued, this is a good time to invest in this asset class if you are a long term investor and adopt a strategy to suit your investment objectives and risk tolerance.

But what if you do not want to invest directly in equities, or if you have enough shares in your portfolio already?

One alternative is a bond fund. This investment pays interest, usually suitably higher than a bank account, as well as offering the potential for capital growth over the longer-term. If you do not need the income you can accumulate it in the fund, thus increasing your capital growth.

Bonds can be less risky than equities, but capital value can rise and fall according to prevailing conditions. The income levels, however, will not necessarily be impacted in the same way ? over the current financial crisis, for example, the income held up well.

If you are seeking capital protection for your capital, then an option for you to consider is a guaranteed fund, one where the returns are linked to stockmarket performance and where your capital is protected from turbulent markets.

These investments are suitable for lower risk, medium term investors, who are seeking the potential for improved returns above those available on cash deposit.

Note that you will need to tie your money up for a fixed period, normally five or six years, so this is only suitable for money you are saving for the future and should not be used for capital you may need to access.

There are a number of such opportunities around whereby you can invest in a guaranteed investment fund, but make sure you choose one which provides a 100% capital guarantee and where you understand how the returns will be generated.

Returns are linked to a major world stockmarket index or a basket of indices, often the FTSE 100, S&P 500, Dow Jones Euro Stoxx 50 and Nikkei 225. Such a mix gives you diversification across countries.

So while you will earn a return linked to stockmarket performance over the period (and with today?s stockmarket levels this is a particularly attractive time to invest in one of these funds), provided the fund offers a 100% capital protection, your original capital will be as safe as it is in a bank account. Your capital cannot fall below the original value, but you will have the potential for higher returns than a bank account.

Returns are added to your capital on maturity and how much you earn depends on how your particular fund works. You would ideally find a fund that will pay a return even if only one index outperforms over the period (though in this case the returns would be lower). If all stockmarkets underperform over the period, you will not receive any returns ? but with a 100% guarantee you will receive the full return of your original investment. Your capital is protected even in falling markets.

The risk on such an investment is the loss of any bank interest you would have made had you left the money on deposit, but with interest rates likely to remain low for some time, this risk is lower than it would normally be.

Choose a fund where each stockmarket index is ?ring-fenced?. This means that a negative performance of one of the indices will not affect the returns generated from the others. In effect, the loss in one index will be subject to a guarantee independent of the other indices and will not offset any gains made in any other index.

Some guaranteed funds offer a bonus if all four indices outperform over the period, giving you increased potential for capital growth.

These investments are not suitable for those looking to earn regular income from their capital or for those who need access to their savings, so you need to be confident that you can lock your capital for the full investment term.

You are usually able to withdraw money should you find you unexpectedly need it, but returns may be compromised and you may lose the capital guarantee. These are important issues to consider before you make such an investment.

You also need to bear in mind that if equities perform well over the period, the returns from a guaranteed fund are unlikely to be as good as direct investment into equity markets – but the capital guarantee makes this an acceptable compromise for many. You could of course invest some capital directly into equity funds and some into a guaranteed account, to balance out the risk and return element.

There are various types of structured products on the market, and although at a glance they can appear similar, some are more risky than others and you may be better advised to leave your money in the bank. It depends on how they work and the guarantees offered. Ask a reputable financial adviser like Blevins Franks to explain the product to you, including all the risks, and establish whether it will be appropriate for your objectives.


By Bill Blevins, Managing Director, Blevins Franks


17th July 2009

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.