Be Cautious Over Guaranteed Stockmarket ISA Products
February 2006
The ISA deadline is coming and people who want to take up their maximum allowance have until 5th April to do so. A total of £7,000 can be invested, all £7,000 in stocks/bonds/funds etc or £4,000 in those investments and £3,000 in cash. There is also the option to invest just £3,000 in a cash savings account and forget about the stocks. All profits and interest on ISAs are 100% tax-free.
Many Banks Are Trying To Market Guaranteed Equity Bonds
One thing that scares investors the most about the stockmarket is that it can go down as well as up. So if you're a bank trying to sell these kinds of products why not eliminate the downside potential? This has been done with so called Guaranteed Equity Bonds which promise to guarantee 100% of your investment (say over a period of 5 years) while letting you enjoy 100% or even more of any upside. For example -
- Invest £1,000 in a 5 year guaranteed equity bond and if the stockmarket (usually the FTSE 100 index) has risen by say 175% over that time period your gain will be £1,750 + the original investment of £1,000 = £2,750
- But if the index were to fall 30% over the 5 years then you wouldn't lose a penny and still get your original investment of £1,000 back
BUT, there are two critical points your bank won't tell you when they try and sell these bonds to you -
- You'll receive no dividend income which equates to about 2%-4% per year (compounded over 5 years this can be a tidy sum)
- Inflation will naturally erode the value of the original £1,000. With inflation say at 2% per year the £1,000 will have the equivalent purchasing power of just £900 in today's money
So what looks like such a good deal now must have a serious question mark hovering over it.
Who's Taking The Other Side of The Trade
For every buyer there is a seller for a product so potential investors must ask themselves just who is taking the other side of the trade when they invest in the guaranteed bonds? The answer is the bank that's pushing them and you can bet that they've really done their homework as to how they can get the best deal while blinding the client with marketing so as they think they're getting a great deal, ie you cannot lose!
In fact some people argue that these bonds are a licence to print money with virtually no risk to the bank selling them.
The other problem with these bonds is that there are now about 250+ of them in existence, all with different specifications so it's very hard to compare like with like.
Summary
Expect these bonds to be pushed aggressively on ISA investors over the next few months. Our advice is the same as the majority of Independent Financial Advisors (IFAs), stay well clear of them unless you really understand what you're buying.
If you do want to invest an ISA allowance of either £7,000 or £4,000 in the stockmarket but have little experience it's better to invest a small amount in a tracker fund. These have the added bonus of having low costs, often less than a 0.5% management fee - see this article. But matters such as these are a personal choice.
Good luck with investing your ISA money
See Also
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