Bank interest rates in both the UK and Europe remain at record lows, where they been since spring 2009, and where it looks they will stay for the foreseeable future. There was a brief glimmer of
Bank interest rates in both the UK and Europe remain at record lows, where they been since spring 2009, and where it looks they will stay for the foreseeable future. There was a brief glimmer of hope that the Bank of England would lift its base rate sooner rather than later, but that was dashed by the publication of worse than expected economic growth data. Many economists now do not expect a rise until late in the year, if this year at all. In both the UK and Europe, a premature rise could hamper already delicate economic growth.
In the UK, Bank of England governor, Mervyn King, did say that he ?sympathise[d] completely? with savers, who are among the ?biggest losers? from this crisis, but could not offer them any words of encouragement other than that ?a return to economic stability from our fragile condition will require careful and well-judged steps looking beyond the next few months?.
Most investors wish to, or need to, earn greater levels of return than is currently available from cash on deposit. Even if you do not need your savings to generate income, the low interest rates mean that your capital is not growing in real terms, or only minimally. Over the longer term its spending power will diminish, more so if inflation continues to increase.
It is generally accepted that over the long term equities provide the best opportunities to outpace inflation. If you do require your capital to generate income, you could invest in a high dividend equity fund. They provide both regular income and the potential for capital growth over the medium to longer term.
If you do not want to invest directly in equities, either because you are a lower risk investor or have enough exposure to equities in your portfolio already, one alternative is a bond fund. They also pay regular interest, usually higher than a bank account, as well as offering the potential for capital growth over the medium to longer-term. The income can be accumulated in the fund to increase capital growth potential.
If you do not need income and do not want any investment risk for your capital, you could consider a capital protected investment fund. These funds allow exposure to rising equity markets but without investment risk to capital.
The key is to select a fund that offers a 100% capital protection. Even if markets fall over the term of your investment, you will not lose any of your original capital. You will receive your entire investment back at the end of the term (provided you hold it till the closing date). If markets rise over the term, the fund will provide a return linked to a major world stockmarket index or indices.
Capital protected funds can therefore be an attractive alternative to cash for medium term investors seeking the potential for improved returns above those available on cash deposit.
They also work well as a risk reduction strategy in an investment portfolio. Holding a diversified portfolio always helps to lower risk. Including a 100% capital protected fund as part of the diversification lowers risk further.
These funds can also be used to secure investment profits or as a defensive measure.
Note that with capital protected funds you will need to tie your capital up for a fixed period, normally five or six years, so this is only suitable for money you are saving for the future and do not need to access. The funds do not provide income either. You can usually make a withdrawal or encash it if necessary, but this would affect the amount received and the capital protection so you should plan to hold it full-term.
A risk on such an investment is the loss of any bank interest you would have made had you left the money on deposit, but if you expect interest rates to remain low for some years this may not be a significant risk.
Also bear in mind that if equities perform well over the period, the returns are unlikely to be as good as direct investment into equity markets – but the capital protection makes this an acceptable compromise for many. You could of course invest some capital directly into equity funds and some into a capital protected account, to balance out the risk and return element.
It is important that you understand that the capital protection is dependent on the guarantor meeting its 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 they are in effect guaranteed by their respective governments.
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 protection offered. A reputable financial adviser like Blevins Franks will guide you through your options and establish whether a capital protected investment fund would be appropriate for your objectives.
By Bill Blevins, Managing Director, Blevins Franks
28th January 2011