I understand you can invest in the stock market but reduce your risk. A plan I saw advertised in the window said this was possible. Given the stock market volatility, is this a good idea?
I am not a lover of opacity and products that are ‘easy money’ for the financial services industry, all of this leaves me with a cold sweat when I see ‘protected’ or ‘guaranteed’ next to a financial services product. Take it from me, what is displayed, as a simple poster in a bank or building society window, is more complicated than most financial advisers would be able to understand.
Here are some tips for you to avoid making mistakes with structured or ‘protected, guaranteed’ products. Firstly there are five new products per month launched. To date I have never felt any of them were value for money. That is a message in itself.
If you do use one, never use a structured product with less than a five-year term – the risk is propelled skyward and suits only the providers not you. Most companies have now abandoned this idea.
Secondly, avoid any product with a dump out (kick out) option. This option is generally used to dump you out of the plan if the market performs very well in the short term. You’ll see it marketed as ‘receive 110% of the stock market return and benefit from 35% return if the stock market grows by more than 35% in the first three years’. Whilst marketed as a good thing, it is actually only there to protect the company providing the plan and is one of the worst features of an investment product.
Avoid like a 2 day old prawn sandwich.
You will also see a ‘benefit’ sold to you stating the plan will calculate the return of the stock market over the five years. They then say that the final stock market value is calculated by using the average value over the last year. Whilst a year or the last six months is about fair, some companies use an average over longer periods, which can be disastrous to the final value you will receive. Once again it’s sold as a benefit but is actually no more than a protection for the provider of the plan.
Without going into the deep mechanics of these plans, have a quick check who provides the backing. Typically, a large ‘credible’ institution may market the plan but the backing will be elsewhere. Avoid products backed by those counterparties with an S&P (Standard and Poor) rating of less than A-. If there is a default by these counterparties your protection could be worthless.
Some contracts will also offer an enhanced (geared) upside if the market performs at a certain level. They can often however offer a geared downside. If there is any level of geared downside to a plan avoid it like an actuary at a party.
You’ll normally see a product linked to the FTSE 100 which is a fairly well understood market. Be very careful (if not avoid) any product linked to a basket of shares rather than an index. Once again the risk is propelled.
Lastly, be careful of products that offer ‘worst of’ scenarios at all costs.
I have always believed that structured contracts are for customers who don’t truly understand the potential for return versus the potential for loss. Consider that a spread of investments in the FTSE could fall by nearly 25% and still provide the same capital return as a structured plan, as they would have benefited from the dividends. In any event there are few six year terms where the FTSE is down and the structured plan only provides the security if the contract is held to the end of the term. Another reason why we don’t use them.
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