Nothing is risk free.
The credit crunch has probably made this a lot clearer to a lot of people lately. Savings accounts which are generally considered the least risky investments have been buffeted by wave after wave of bank collapse. Investment funds have been going down in value rather than up. Big financial organisations including household names have gone under.
Almost every investment advert in the UK that you’ll ever see includes something like the phrase:
the value of your investment may go down as well as up
Plenty of people are pretty risk averse, and this kind of thing gives them the jitters. Now, whatever I might think about the level of risk I am willing to take on, I think it’s very important that your finances don’t keep you awake at night. You should only take on as much risk as you understand and are comfortable with.
One sort of product that attracts conservative investors is one that promises a guaranteed capital return after 5 years, and a share of any profit if the stock market increases. I can see why people like this idea. Of course, at the moment, there’s an excellent chance that you could be relying on the guarantee to get your money back.
In so many ways we are all fortunate people. In the nineteenth and early twentieth century, a bank collapse meant depositors – and they really were people like you and I – lost their money. That’s no longer the case. Savings accounts and investment accounts belonging to private individuals are insured by the Financial Services Compensation Scheme (FSCS). Which means that in the event of a default we can claim a good portion of our money back.
However, this only applies if they company that adminsters the product is unable to meet its obligations.
guaranteed equity bonds
The problem with guaranteed equity bonds, aside from their not that exciting performance, is that it would seem that the guarantee is insured by a third party.The way that the third party manages to make the money is through the use of derivatives. Even if your plan adminstrator is solvent you are dependent on the third party remaining in business to ensure that you get your money back.
The name should be ringing alarm bells already. Some guaranteed equity bonds had Lehmans Brothers as a third party insurer. And now, Lehmans is no longer in business. Those guarantees, it turns out, aren’t quite as rock solid as they first stand. Aside from potential mis-selling issues there is pretty much nothing that anyone can do about it.
if you’ve been caught out
If you have one of these investments and the risk involved wasn’t made clear to you, you might want to investigate whether you can make a claim against whoever sold you the plan for mis-selling.
lessons for everyone
The real issue is that people shouldn’t be investing in something if they don’t understand how it makes money. This is how you avoid pyramid schemes, and other scams.
Guaranteed equity bonds are not intrinsically bad products. But if you can’t tell me how they work, and you don’t understand the risk involved then you shouldn’t be buying them. Sensible personal finance is not that difficult – if I can understand it, anyone can.
- understanding of inflation rising?
- the magic money cupboard
- basic guide to Stocks and Shares ISAs part 3: all about investments