Risk takers: start here
Saturday 11 May 1996
Just what are these attractive but dangerous vehicles? They are a species of guaranteed bond with complicated built-in rules, tied to stock market performances and which aim to give high income plus, all being well, some or all of your original capital back.
Such bonds have a cut-off date for investment, and a minimum input of up to pounds 5,000. The exact terms for these bonds vary, so it is essential to understand the small print of each bond thoroughly.
A bond currently on offer from Financial Assurance/Johnson Fry offers a potential 10 per cent return over five years. A Financial Assurance bond launching in mid-May promises 10.25 per cent. An issue from a large UK insurer is expectd in June with a yield of 10.5 per cent. These are far higher yields than a bank or building society can offer, so how do they do it?
A typical bond works like this. Let's say you make a pounds 10,000 investment. During the life of the bond (usually five or five-and-half years) you will get an annual income of 10 per cent - that's pounds 1,000 a year in this case. The minimum guarantee, according to the brochure, is that you will get your original investment back.
But what may not be understood by investors is this means that if either the FT-SE 100 or the S&P 500 is lower at the end of the period than at the start, you get back your original capital less the income you have received meanwhile. So with a 10 per cent five-year bond you will have received pounds 5,000 in income and then if the relevant index is downwhen time is up you would only get pounds 5,000 capital back.
Over every five-year period since the FT-SE index began in 1984, claims the literature from Financial Assurance, the two indices have achieved an average growth rate of more than 50 per cent. So if the future resembles the recent past you should get your income and your start capital back.
But intermediaries are more cautious. BEST Investment, which has done a god deal of research into guaranteed investments, points out that looking back further than 1984 there have been periods when markets were indeed down over five years.
These bonds, it says, represent an interesting gamble on the future level of stock markets but we question whether the person who needs to maximise his or her income should be gambling capital on the stock market.
On the bright side, if the indices are the same as or above their starting point at the end of the term, you get income and your original capital back with no deductions. So these bands are a simple bet between the investor and the companies offering them on how the markets will do.
The risk of both stock markets being down over the period is thought to be minimal and daily index levels are averaged over the last year of the bond's life to reduce vulnerability to last-minute fluctuations.
It is worth remembering that there is usually an up-front charge on these bonds so that not all of your money will be invested. However, Baronworth and a number of other intermediaries offer a discount on the 3 per cent adviser's commission they earn.
Elsewhere good returns can still currently be made on secure investments that do not depend so crucially on stock market movements.
National Savings offer a range of fixed returns, many of them tax-free. It is also possible to get a running yield of 8 per cent on a 10-year gilt, without any loss of capital or with only a small loss when the stock matures.
National permanent-interest bearing shares (PIBs) are another source of high-income returns - typically yielding around 9.5 per cent at the start of this month - with a number of issues from substantial building societies offering minimal risk. Yields on both gilts and PIBs vary daily.
Such products are not sold aggressively to investors because they lack an up-front commission, but a local stockbroker should be prepared to advise you.
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