While it has been over a year since share prices picked up, interest rates are still languishing at record lows (0.5% for Sterling, 1% for the Euro). In the UK, the Office for National Statistics
While it has been over a year since share prices picked up, interest rates are still languishing at record lows (0.5% for Sterling, 1% for the Euro). In the UK, the Office for National Statistics has confirmed that last year British savers earned over 50% less than they did in 2008. The way things are looking, there will not be much, if any, improvement this year.
When asking us for investment recommendations, people often enquire about low risk investments, ideally ones with very little capital risk. With the current interest rate situation, more people are looking for alternatives to cash but without the attendant risks of equity investment.
One investment you could consider is a capital protected fund, particularly one which offers a 100% capital protection.
These funds are designed to provide investors with both 100% capital security and a return linked to stockmarket performance (usually to a major stockmarket index). Provided you hold it for the full term, your investment cannot fall below the original capital investment value and you still have exposure to rising equity markets.
The roles of a capital protected investment
– As an alternative to cash
While a capital protected fund is not an option for those who need income (they could consider a bond fund instead), if you are looking to protect your capital from inflation over the longer term this type of fund is certainly an option to consider. They are suitable for low risk, medium term investors who are seeking improved returns above those available from cash deposit accounts.
– To reduce portfolio risk
Holding a diversified portfolio helps to lower risk. The asset allocation of your portfolio should be structured to suit your investment objectives, time horizon, circumstances and risk tolerance. If you can include a 100% capital protected fund you will lower the overall risk further since that capital will be protected whatever happens in the markets. At the same time the investment has the potential to grow over the longer term.
– To secure your profits
Stockmarkets have been on an upward trend for over a year. Many investors are wondering whether they should leave their profits invested to increase future growth potential or to move the profits into cash. With the first option there is the risk that markets will fall and you will lose your profits, but with the cash option you are restricting growth to the very low interest rates available at the moment.
A capital protected fund can be a useful alternative. By moving your profits into a fund with a 100% capital protection you will give them a similar level of protection to cash, but at the same time they will continue to benefit from stockmarket rises, with the potential to provide higher returns at the end of the term then you would have made from a bank deposit.
– As a defensive measure
On the same principle of protecting your profits, if you find yourself spending too much time worrying about where stockmarkets will move in future you can switch some of your capital from shares into a capital protected fund. This will reduce the amount of money you have exposed to market risk, while retaining the potential to earn you stockmarket linked returns, depending on performance over the investment term.
Key considerations
? Capital Protected investments are often for a set period of time, for example, for five years, so you need to be confident you can leave your capital invested for the whole term. They do not provide income over the term. The funds can usually be fully or partially encashed at any time, but this could affect the amount received and the capital protection. This is an important consideration if you are considering these investments as an alternative to cash.
? When considering a capital protected fund as an alternative to cash, bear in mind that while you will receive all your capital back, if the stockmarket index the fund is linked to falls over the investment term, you will lose out on any interest the money would have earned if you had left it in the bank. If you think that interest rates will remain low for some years, this may not be a significant risk.
? Your money is protected from market falls, but the capital protection is dependent on the guarantor meeting their obligations. You should therefore check out the institution which provides the capital protection. A ?too big to fail? bank is likely to be suitable, given that they are in effect guaranteed by their respective governments.
? Capital Protected investments can look similar at a glance, but the way the returns are calculated can vary considerably. Make sure you understand how the fund you are considering will work and that it is designed in favour of the investor rather than the provider.
? While returns are based on stockmarket performance, the returns received will be lower than if you had invested directly in equities.
When considering any new investment, you should read the small print and make sure you understand the level of risk. It should not be viewed in isolation, but rather on how it fits in with your other investment assets and what effect it will have on your overall portfolio strategy in terms of meeting your investment objectives. Ask a wealth management adviser like Blevins Franks for advice on what opportunities would be suitable for you.
By Bill Blevins, Managing Director, Blevins Franks
27th April 2010
