'Stock Market Growth of 25% in perfect safety' discussion area.

deemy2004 wrote:

Holding a high yield shares portfolio would generate about 23% dividend income, with the added bonus of being able to exit your position at your choosing where any gain would be set against CAPITAIL GAINS ALLOWANCES rather then INCOME TAX

Right on Deemy.This is an excellent strategy IMHO.

Note also that dividend income is tax free to basic rate taxpayers, 23% (IIRC) for higher rate taxpayers.

In the table, shouldn't the Tracker show a loss, -£970, rather than a positive £970 for the case of the stock market falling 25%?

Judge

These are really really poor investments in my opinion, and I wouldn't touch them with the proverbial bargepole. The problems are broadly as follows:

- If the stock market rises, you have a gain roughly equivalent to the gain of a tracker plus dividend returns. So these two types of product are equivalent on the upside.

- If the stock market falls, you get your cash back. This appears better on the downside projection, BUT (massive BUT) you are locked in to the full 5 year term. So whereas you can cut your losses on a tracker, you are stuck in the guaranteed equity product for the full term.

- But surely this is fine, because I get my money back? Well NO, it isn't. Because you are losing the 5% compounded interest you can get on a cash based investment. So you are actually down considerably on where you would be if you just plonked your cash in a savings account.

So on the upside you can't really get much of an advantage, and in fact depending on what the tax treatment of the investment is (capital gains v. income tax, ISA wrapper), a tracker may well return more, noting also that the comparison table in the article doesn't appear to compensate for tax (I may be wrong about this, having not checked the numbers carefully).

And on the downside, you have all the inflexibility of a fixed rate bond without the security of a known return rate - would anyone put 5 grand into a bond with a headline rate of, say, 7%, when the T&C stated that the effective interest rate over the term might in fact be 0%, we'll just have to see what happens? I can't see this sort of a product figuring in Martin's best buy table somehow!

And you can't get out of the deal under any circumstances, and if the stockmarket rises for two years then falls for three, you can't lock in a profit.

To be fair, Martin has pointed out these flaws in the article, but somehow is still managing to come out recommending these products, which I find astonishing. The comparison table in the article is also extremely skewed, because it does not allow the possibility of hopping out of a more flexible investment product if the market falls.

You might say that these are a good bet for an unsophisticated, lazy investor, not prepared to manage his or her portfolio or risk his or her capital, and of course this is the target market for the products. So can anyone tell me just when did the financial services ever aim a good value product at this sector of the market? "Simple risk free" financial products are almost never good value. If you want risk free, go for cash. If you want good returns, look carefully at equities. But don't choose something combining the worst characteristics of the two...

A great deal of effort is made to sell these products, because I suspect they are highly profitable, and this in itself speaks volumes. As I say, I wouldn't go anywhere near them personally.

As I said, the fact that this sort of product is aimed at the financially unsophisticated does raise a big red flag for me (this is not financial snobbery, just a statement of fact). It's in the same category as 2.5% interest building society accounts in my view, a poor value product flogged mercilessly to consumers because it's profitable for the issuer.

I do think it's the worst of the alternatives, and come back to the question of whether you'd recommend a 5 year cash bond that returned either 7% annually or 0%, depending on what is essentially a blind gamble. Given that anyone can get longish term 5% bonds, these have to be a better bet for anyone not prepared to risk their cash.

Some of the alternatives are:

1) Tracker. May go down, but you can cut your losses by selling out at a point less than the loss you would make on interest over the 5 year term if the investment falls early. If it rises early you can cash out if it looks like the stockmarket is wobbling. Alternatively you can just stay in long term (there is no 5 year limit) if you believe equities are generally a better performing investment than cash. Most people can pay very little tax on the profits, and can also drip feed cash in rather than making a risky one off lump sum investment.

2) Cash - long term bonds at decent rates are available. The disadvantage is the tax treatment, but to some extent this can be removed with Cash ISAs run as bonds. If you want to lock money up long term and are risk averse, this has to be the best option.

3) Guaranteed Equity investment: the accused that stands before us in the dock. Fine if you believe the stock market is going to rise over 5 years (but then so is a tracker). Very very poor if you don't. Extremely inflexible. You are vulnerable to any fall in the stock market at any point in the cycle, and can't even ride out a blip at the end of the term by taking a longer term view. Substantial potential losses are disguised as a capital guarantee.

4) With profits endowment style policy. These are hardly fashionable, but they do lock in any gains via bonuses and provide fairly risk free exposure to the equities market as well as some life insurance (though not necessarily for you if you buy a second hand one). You do get a guaranteed amount back at the end of the term too, so there is capital protection of a sort.

5) Additional pension contributions. These are very tax efficient for long term savings, can be lodged in both equities and cash, you will need the money at some point (or else it will pass to your dependants), your pot is not taken into account when calculating benefits if you are made redundant (and is removed from the calculation when working out entitlement to tax credits), and there are some very interesting developments coming next year that may bring additional benefits. The downside, obviously, is that you can't get at the money until you retire, so you need to be clear that you are saving for retirement.

There are some more esoteric alternatives, including things like spreadbetting with a stop loss, but the point is that the guaranteed equity products really don't get past the first round of the beauty contest (the bit where they say they're in favour of world peace and want to work with children). This sort of contestant is undoubtably superficially attractive and will turn the heads of many, but not really the kind of partner you would want for a long term relationship.

You really can't get something for nothing when it comes to financial products. You can't have the rewards of risk without risk, and IMHO it's unrealistic to say you can. Recommending these products to the financially unsophisticated is effectively asking them to take a bet on a coin toss of a substantial (but unknown) gain, or a large loss (of compounded interest), while giving the impression there is no loss (which is where the issuers are employing a very misleading sleight of hand - in fact they are using the interest on the money to insure themselves against the costs of providing the returns if the market rises). Far better to take 5% over 5 years guaranteed which you can get in cash.