Investing in the Stock Market: Protection for the jittery

But are guaranteed investments as safe as they seem? asks Caroline Laws
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The Independent Online
If you are looking for an alternative to the abysmal interest rates offered by the building societies but are nervous about stock market investment, you may be tempted by the array of guaranteed and protected investments from banks, building societies, life companies and investment companies.

These invest your money in the stock market, can give you a guaranteed income, and promise to return all, or an agreed percentage, of your original investment at the end of the term, usually five years.

You can invest in unit trusts, offshore funds, Oeics, ISAs, single-premium investment bonds and even pension funds, comfortable that all your savings will not be lost in a crash.

They sound great but are not favoured by financial advisers, because for a taking a little bit of risk you will get a much better return for less cost elsewhere.

"Guaranteed investments are for scaredy-cat investors who don't want to lose their money. Over the long term you are going to pay for the guarantee somewhere down the line and I would always advise investors to stick with a blue-chip portfolio as ultimately you will always win," says Julie Lord, a certified financial planner and managing director of Cavendish Financial Management based in Cardiff.

And with analysts predicting a fairly buoyant economy here and in the US with no crashes on the horizon, there seems little reason to go for a protected investment. However if perhaps you need an income, or are coming up for retirement and still want to invest in equities without risking all your money, then protected investments might be worth looking at. But you need to understand how much of your capital is protected, as these products achieve their guarantees in different ways and you may lose more money if the stock market falls sharply.

Some guaranteed stock market bonds, for example, will link their investment returns to stock market indices, such as the FT- SE 100, or the US Dow Jones. If these indices move up, so does your investment. With the Midland Equity Linked Income Bond, for example, the FT-SE 100 would have to move up 25 per cent over the life of the investment to guarantee the return of 100 per cent of your capital. If the investment you favour uses these benchmarks, then check the indices are not too volatile.

Some investments link their losses to stock market indices. With the HSBC Fixed Income ISA (available until 1 July) you get 7.25 per cent income each year and a return of your capital at the end of the term if the stock market has not fallen. If it has, for every 1 per cent the stock market falls, you lose 1 per cent of your capital. But Tim Cockerill, investment director at Whitechurch Securities in Bristol thinks it is worth looking at. "It's offering a good level of income and I like its five-year life because it adds to the comfort factor. With a longer time horizon you expect the markets to rise."

Other funds, such as the Edinburgh Fund Managers Safety First Fund, protects its investment for 12 months. After this it sets a floor price of 95 per cent, so the maximum amount you can lose is 5 per cent.

Floor prices are usually set annually, which makes them less sensitive to changes in the market. This is why some advisers suggest you look at investments with a quarterly lock-in period that allow you to change your investment priorities every three months. Mr Cockerill says: "I like the AIG Life investment bonds that give a choice of 100, 99, 98 and 95 per cent guarantees.

As the FT-SE 100 index has never been lower for more than two quarters in a row, they can be very attractive products. If you're feeling relatively positive and the market is going up, you can choose a 95 per cent guarantee and change your options at the end of the quarter."

If you are willing to take more risk but still balk at the thought of investing in shares, you could look at a with-profit bond. You invest a lump sum, usually between pounds 2,000 and pounds 10,000. They have been heavily criticised for being inflexible as you have to invest in them for at least five years, charges are high, and early surrender can incur stiff penalties. They invest in shares and a mixture of cash, fixed-interest investments, index-linked stock and convertibles to produce capital growth. Bonuses are not guaranteed but are paid at the end of each year. Once paid, they cannot be taken away. Some with-profits bonds also allow you to take an income.

If you want to take out a with-profit bond, it is best to go to a discount broker. Patrick Connolly, investment director at Chartwell Investment Management in Bath, explains why: "Generally there is an initial charge of 5 per cent, which means if you are investing pounds 10,000, pounds 500 comes out on the first day. The reason for this is the heavy commission that has to be paid to brokers. We waive this commission and reinvest it for you." Chartwell has just produced its latest With Profit Bond Guide, which assesses the bonds on offer. For a free copy call 01225 321 710.

The final alternative for the cautious lump sum investor is the corporate bond. Because of the way it invests (in high yielding bonds, fixed interest shares and gilts), those with more than 60 per cent of their assets in qualifying investments are still eligible for the full 20 per cent tax reclaim if they are held in an ISA. If you have other share-based investments, you can only claim 10 per cent, as some of the growth or income relies on dividends, which are now taxable. But you should not invest in a corporate bond for this reason alone. The new Barclays Optimum Income Corporate Bond ISA, for example, is offering 7.2 per cent interest and qualifies for the 20 per cent reclaim. But the value of your capital fluctuates with the bond prices so you may not get back all of your original investment.

Contacts: HSBC, 0800 299299; AIG Life, 0700 244 5433; Edinburgh Fund Managers, 0800 838 993; Whitechurch Securities, 0117 9442266; Cavendish Financial Management 01222 665588.