Guaranteed savings schemes sound like an ideal solution for those wary about losing their cash in a dodgy investment or bankrupt bank. And there's a huge demand for them, as witnessed by the launch of two new deals from major savings institutions this week.
However, anyone tempted by the guarantee offered needs to take a second look. Experts warn that savers could actually lose out by putting their cash into the schemes.
The two new deals introduced on Tuesday – by Abbey/Alliance & Leicester and Nationwide – are typical of the kinds of schemes banks and building societies like to offer. They are linked to the stock market which, despite its recent volatility, still looks set to offer better returns in the long term. But unlike direct stock market returns, savers are guaranteed to get their money back, even if the Footsie falls over the term of the investment.
So what could be wrong with that? According to Ed Bowsher of lovemoney.com, they're too complicated and probably unnecessary at the moment.
"I'm not a fan of guaranteed investment products and neither Abbey nor Nationwide have done anything to change my mind," he says. "Both providers have launched complex products that many will struggle to understand. Sure, you'll get some return from rising stock markets, but the return is capped and you won't receive any dividends. And at a time when stock market valuations are low by historical standards, I don't think there's much need for capital protection. I strongly suspect that share prices will be higher in five or six years' time than they are now."
Of course, Bowsher has no greater knowledge than you, I or any other expert about what will happen to share prices in the future. Historically, stock market investments have done better than simple savings accounts but, as anyone heavily into shares in 2008 can attest, invest at the wrong time and your nest egg can shrink – or almost vanish. But with markets up around 40 per cent since March, tapping into future gains can sound attractive, especially if there's no chance of losing your cash.
"Our range of guaranteed investment products are designed to appeal to investors looking for potentially attractive returns, but without risk to their capital," says Simon Taylor, head of investments at Abbey. "Guaranteed investments rely less on the judgement of the investor or fund manager. Therefore, they generally appeal to more risk-averse investors that want greater returns that they may get on cash savings. They are less risky than direct investments into the stock market or within a fund as they often cap any potential capital loss."
The bank's new Guaranteed Growth Plan promises a minimum return of five per cent gross if you invest for three years and nine months. The return rises to 11 per cent gross if you invest for five years and six months. But the figures quoted are for the whole length of the term, not annual interest rates. Also, you must stay invested for the whole term, or risk losing some of your savings.
"With fixed rate cash savings offering 5.3 per cent at best, the temptation to plump for a product advertising a possible double-digit return with a guarantee can prove too much for some," says Andrew Hagger of Moneynet.co.uk. "But no investment product is ever guaranteed, it's always a case of risk versus return. If you need access to your funds before maturity of the investment plan you could face significant losses. Also there are often better returns to be had by building a balanced portfolio of investments with the guidance of a qualified investment adviser."
One major drawback of choosing an investment scheme with a guarantee is that you will be limiting your returns. With the Abbey/Alliance & Leicester bonds there is a maximum return, either 50 per cent of the growth of the Halifax House Price Index or 50 per cent of the growth of the FTSE 100 index.
Even then the return could prove to be not as favourable as you expect, as the growth figure is based on the average of the last seven months of the respective indices. That's supposed to smooth out the risk of a sudden dip in the index as the bonds reach maturity, which is a sensible approach. But it can mean that if either the property or stock market reaches record highs when you are due to get your cash back, you won't be in line for record returns.
Nationwide Building Society's Capital Guaranteed Multi-Index Equity Bond (12th issue) launched on Tuesday is actually run by Legal & General. It's a guaranteed equity bond which must be held for six years and promises a minimum 12 per cent gross. Added to that is 50 per cent of the growth of the FTSE-100, EuroSTOXX 50 and S&P 500 indices, subject to final year averaging.
"Guaranteed equity bonds are ideal for savers who are looking for potentially higher returns on part of their savings portfolio," says Robin Bailey, Nationwide's divisional director for investments.
"They provide the potential for stock market-linked growth, without the risk of capital loss associated with direct stocks and shares investments. The typical GEB investor could therefore be described as a cautious investor who wants to increase their potential returns, particularly at a time when savings rates are historically low."
But knowing what you are getting into is essential, says Hagger. "The trick is understanding the 'what if' questions, so if the stock market or property index fails to grow or falls over the term of the investment, what is the worst-case scenario for the consumer? It's essential that consumers obtain professional advice before considering these investment products, so that they fully appreciate the risks involved."
There are some key questions that you should consider before investing in any guaranteed investment scheme. The most crucial is whether the capital is actually guaranteed. Both the Nationwide's and Abbey new scheme promise the return of your cash, but not all of these types of schemes do. The guarantee may refer to the percentage return you're promised or may only apply if the stock market doesn't collapse.
Next, do you understand the scheme? If not, don't buy it. The danger could be that you need to get at your cash before the end of the term and get heavily penalised for doing so. Or the returns could be much lower than you expected if you haven't actually understood what is being offered, such as only half the growth of the Footsie, rather than the full amount.
If you're not worried about missing out on the potential of the stock market and only want to guarantee the return you get on your savings, then you may be better off with a fixed-rate savings bond, suggests Gemma Stanbury, head of savings, loans and debt at confused.com, although even then there is the risk of tieing yourself to rates that then rise further down the line.
"Fixed-rate savings bonds are simple, guaranteed products as they offer a fixed interest rate for a fixed investment term," points out Stanbury. "But it's important for savers to be sure that the money invested can be tied up for the fixed term, as there is unlikely to be penalty free access, if any access at all.
"Also, although you can currently get 5.3 per cent gross from the Yorkshire Building Society, five years is a long time and a lot could happen to interest rates and inflation during that time. The danger of fixed-rate bonds is that interest rates and inflation rise higher than expected which could leave you stuck in an uncompetitive product."