Stock market returns without the risk
Investment products offering both deposit protection and growth provide too little of either.
There's a group of investment products called “structured products”.
Some of these have been partly blamed for causing the financial crisis, mostly because the large banks buying them knew even less about them than the large banks selling them.
It’s a similar situation when we buy a protected equity bond, which is just one variation of structured products that individuals are sold by their banks and elsewhere.
The issue is not simply that some structured products aren't protected by the Financial Services Compensation Scheme. We're just not given the information and tools we need to analyse them thoroughly.
However, we can get a pretty good picture by comparing them to alternative savings and investment products. Here are two examples.
The Investec FTSE 100 3 Year Deposit Plan 34 - Option 1
This mouthful is available as a direct investment, or in a cash ISA or pension, and you can invest between £3,000 and £1m for three years.
Let's say you invest £5,000 into the cash ISA version. It will return your £5,000 if the FTSE 100 is lower after three years and it will pay you 17% extra – £850 – if the FTSE is higher, even if it's just 1% higher. It sounds too good to be true, as all these products do.
Let's consider it a bit more:
* The £5,000 deposit is protected – but your wealth isn't. Assuming 3% inflation per year, £5,000 in three years will be worth just £4,575, or nearly 10% less. So much for the “protection” if the FTSE 100 is lower!
* Today, you can get three-year fixed-rate cash ISAs paying 4%. These guarantee you'll turn your £5,000 into £5,625. That's protection! (Adjusting for inflation, you have £5,150 with the fixed-rate ISA compared to Investec's £4,575.)
* If the FTSE rises, your 17% gain equals £850, which means you're taking all that extra investing risk over just three years (the more briefly you're investing, the riskier it is) for a maximum extra gain of £225 over the fixed-rate ISA.
* Investec's 17% gain in three years is the same as 5.4% per year when compounded. This means, if the FTSE 100 is higher after three years, you'd get just 1.4% per year above the risk-free ISA returning 4%.
* If you invest directly in FTSE 100 companies through a cheap index tracker, and the stock-market falls, you'll still receive perhaps 12% in dividends based on today's rates (according to the Financial Times and the Institute and Faculty of Actuaries). This gives you protection against the downside, but with no 17% cap on the upside.
* Dividends, if you don't know, are regular payments that many companies pay and all shareholders are entitled to. If you invest in Investec's product or similar ones, you probably don't know about dividends – because you won't receive them.
* If you invest in a FTSE 100 tracker and the stock-market rises, it might need only rise by a couple of percentage points per year, after costs, in order for you to beat Investec, thanks to the dividends you get on top.
Legal & General 6 Year Growth Deposit Bond 14
Tie up your money for six years in Legal & General's product and you'll get a minimum return of 9% in total, even if the FTSE 100 falls. If the FTSE rises more than 9%, you'll get the increase in the stock market, capped at a maximum 50% gain.
* 9% is a meagre return of just 1.45% per year, so you'll probably be trounced by inflation at that rate. In comparison, a long-term fixed-rate cash ISA paying 4.25% would give you a risk-free return of 28.35%.
* The reward of Legal & General's product is capped at 50%. Considering you can get 28.35% risk free, a maximum 50% return – that could be as low as 9% – is not much extra for the bigger risks you're taking. There have got to be better investments.
* If the stock-market performs between -99% to +28%, you'll have done worse with the structured product than the cash ISA.
* Considering it from an investing angle, if you were to invest directly in the shares in a cheap FTSE 100 tracker instead, you might get close to a 26% return from dividends alone. This not only gives you lots of protection in case of a falling market, but it's a fantastic base to build on if the FTSE rises.
* With a cheap tracker, if the FTSE rises you'll get uncapped gains, minus the costs of the tracking fund, plus the big dividends.
* If the FTSE rises, you will get far, far more through the tracker than with Legal & General's product.
Other products seem to be better value for money
These products neither give your wealth solid short-term protection, nor allow you the full benefits of rising stock markets.
If you want protection in the short-term, you use savings accounts and cash ISAs.
For those of you wanting to take advantage of bigger gains, your lowest cost option is likely to be index trackers, such as those I've been using in my comparison today. You can read more on them in Two simple ways to invest better in shares.
For those of you who are interested in a middle ground that these structured products unconvincingly profess to offer, you could consider social lending or inflation-beating savings.
Alternatively, you could get a mix of all of these.
If you invest for the long term as cheaply as possible, pay money in regularly, hold on through the highs and lows of the market, and stick to simple products like trackers, I think you're likely to do very well, and better than by buying structured products.