Who wins on no-lose bonds?

Protection can come at a price. Anthony Bailey looks at the prospects for both capital growth (left) and income generation
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The Independent Online
Conventional wisdom has it that taking a risk is an unavoidable part of investing on the stock market.Yet the plethora of guaranteed stock market investments in recent years seems to stand this notion on its head.

The lure of the guaranteed stock market bond is the promise that you will get back at least your original capital (or in some cases, most of it) if the stock market fails to perform.

These bonds also promise a guaranteed return linked to the stock market if, as is usually the case, share prices rise over the life of the investment - which is typically five to six years.

But could investors do better elsewhere? "Quite honestly these products are being churned out by the banks and building societies who mailshot customers. In our opinion they are in most cases not what people want and are a load of rubbish," says Jamie Ware, of financial advisers Churchill Investments.

Harsh words indeed. But what can be wrong with a guarantee? Quite simply, you don't get something for nothing. The guarantee has to be paid for in the form of a lower return than you would get with a more conventional stock market investment.

"The first question an investor must ask is: do I need a guarantee?" says Mr Ware. He thinks not. If you take all five-year periods since 1945 beginning on 1 January each year, in only one of those periods would the total return from the stock market have produced a loss - a period that included the 1974 oil crisis. Paying for a guarantee could be a waste of money.

The key lies in the phrase "total return". This is made up of the rise in value of shares and the dividend income they pay. A guaranteed bond's promise of a stock market-linked return takes account only of the rise in share values. Investors lose out on the all-important dividend income.

But supposing you were unlucky enough to invest over a five-year period that failed to show a profit (or at least return your original money). Would you then regret not going for a guarantee?

Not necessarily. For another important aspect of stock market investment is that you have to get your timing right. If the market is down at the time you want to cash in, you will, ideally, keep your money invested until the market picks up. But with a fixed-life guaranteed investment you have to withdraw from the market at a fixed date.

If you are pathologically risk-averse and feel you need a guarantee, read the small print carefully. You may do better going for a plan that guarantees only 98 or 95 per cent of your money back. The guarantee costs less and more of your money can be put to work to get a positive return.

The marketing material may have headline "capture" rates - how much of the market's rise in value you'll get assuming a positive return. Are you getting, say, 100 per cent of the rise in the market on the day the investment comes to an end? Or is it based on the average level of the FT-SE index (over perhaps the past six months)? If the latter, you may get a poorer return if markets are rising. And is there a cap on how much stock market growth you will benefit from?

Check how much of your investment gets the promised rise in the market. After charges, the growth may be limited to, say, 95 per cent or less of your capital.

But if you take a modest risk over a longer period, you may get a much better return from one of the many index-tracking unit trusts. These invest directly in companies that make up an index and aim to mirror the rise in that index. You will benefit from dividend income, which can be tax-free if you use a PEP. And you will be able to cash in your investment when you choose.

q For a guide to guaranteed investments send pounds 2 to Churchill Investments, Oakridge Hall, Oakridge Lane, Sidcot, Winscombe, Somerset BS25 ILZ.