One question we wealth managers often get asked is if there are any risk free investments. I?m afraid the short answer is no, as all investment involves some degree of risk. Risk and reward go h
One question we wealth managers often get asked is if there are any risk free investments. I?m afraid the short answer is no, as all investment involves some degree of risk. Risk and reward go hand in hand in the investment world and you cannot have one without the other. Since different assets have different levels of risk however, allowing you to build an overall portfolio based on your risk tolerance, and there are steps you can take to manage investment risk.
Many investors only think about whether they will actually make or lose money on their investments and focus on price rises and declines, but you also need to consider whether you will make ?real? returns above inflation. You should not ignore inflation risk ? the chance that your capital will decline in value as prices rise year after year. Even 2% inflation will have a damaging effect over the longer term (10 years or more).
For this reason, keeping all your savings in the bank is not a risk free investment. True, the capital value will not decline, but there is a strong possibility that its spending power will. While ?100,000 will buy you a ?100,000 of goods at today?s prices, if inflation was 2.5% over the next five years it would only buy you approximately ?88,109 of goods in five years time and approximately ?77,632 in 10 years. Let alone if your personal rate of inflation is more than 2.5%.
While you will earn interest, once you deduct inflation and tax you may find that you are actually earning a negative real rate of return.
It is generally accepted that over the longer term equities provide the best opportunities to outpace inflation.
Many people tend to weigh up whether to invest in equities or leave their money in cash. Equities have the potential to provide some very attractive returns. Their potential for capital growth helps to protect against inflation and they can be ?wrapped? up in tax efficient structures. On the other hand, stockmarkets can be volatile and the capital invested is not protected. Looking at cash, the only returns offered are those provided by the interest rate, which can be low for long periods of time and always liable to tax, and, as discussed above, the capital value is likely to be eroded by inflation.
Of course the answer is look beyond equities to other investments like bond funds, property, real assets, commodities etc and to have a mix of assets in your portfolio including some cash.
But there is actually a way of investing in the stockmarkets and at the same time as protecting your capital from stockmarket volatility: capital protected funds.
Like cash, in a capital protected fund your capital itself cannot decline (provided you hold the investment full term), but in this case your capital has the opportunity to benefit from stockmarket rises, thus providing the potential to keep pace with inflation and quite possibly outpace it.
Capital protected funds are therefore suitable for low risk investors who are seeking the potential for improved returns above those available on cash deposit. This is achieved by providing returns linked to one or more major world stockmarket indices. So if, for example, the fund is linked to the FTSE 100 and offers a 100% capital protection, then the fund provides the investor with 100% minimum return of capital; 100% capital security and potential returns from the UK equity market.
Note that if prices rise the return will be probably be lower than if you had invested directly into UK shares or funds, but in return for this compromise you have the peace of mind of knowing that if UK share prices fall your original capital will not be affected ? it will be retuned to you in full when the investment matures.
Payment of capital and investment returns is dependent on the guarantor of the structured product meeting its obligations, so it is important to identity the guarantor. A ?too big to fail? bank is likely to be suitable, given that should they fail the potential of their respective governments bailing them out is greater than for smaller banks (however this cannot be guaranteed).
Another point to consider is that these investments are for a set term, usually a number of years, and while you can often fully or partially encash them this may affect the capital protection and returns will be subject to market conditions at the time (one must also take into consideration the fact that early encashment would likely to lead to a loss of capital) ? you would need to check the terms of your particular fund. So you would need to be reasonably confident that you would not need access to the capital during the investment term.
These investments do not provide any income either (any returns are paid out at the end of the investment term), so if you are looking for income you would need to consider alternate investments such as a bond fund which pay regular interest as well as the providing the opportunity for capital growth (though in this case the capital value can fall as well as rise).
Capital protected products can also be used for securing investment profits.
These funds are not necessarily suitable for everyone and as with all investment decisions, you need to consider your personal circumstances, objectives and the other assets you already own. A wealth manager like Blevins Franks would review your situation, portfolio and risk profile before making recommendations on what would be suitable for you.
By Bill Blevins, Managing Director, Blevins Franks
1st June 2011
