Guaranteed products

During times of economic uncertainty, investors may seek a ‘safe home’ for their money. While this is a perfectly natural reaction, there are a number of reasons why it requires careful consideration.

Not everything is as safe as it seems

It is important to recognise that market fluctuations are perfectly natural; when the regulators asked financial services companies to add a ‘wealth warning’ to illustrations, many years ago, that the value of investments can go down as well as up, this was far from being meaningless.

It is, in fact the basis of most forms of investment that volatility will always occur. Even investments with guarantees, such as with profit plans, are affected by market downturns.

The investment facts of life
In fact this volatility can help, to some extent, because when investment values take a temporary dive, the number of shares – or ‘units’ in a collective investment – that you can purchase with a given sum of money will be greater than before. When prices bounce back – as they usually do – the value of your holding is therefore greater.

Where you already hold investments that have fallen in value, there can be a temptation to sell them in order to minimise your losses. But in fact, all you really achieve is to lock in the loss and forego the opportunity for a recovery. Of course in some cases, this is the right thing to do, especially in the case of an investment that will clearly never recover again. The problem is knowing which these are.

In general, however, provided you are not likely to require access to your capital, or an income from it, in the short term, it can often be better to ride out the storm and await a recovery.

Volatility is a fact of investment life

What about guaranteed products?
There are an increasing number of so-called ‘guaranteed’ investment products that appear to offer certainty over your capital as well (in some cases) as the prospect of significant upside potential. However, they do not always offer the degree of security that they may appear to.

Some are backed by special financial instruments that depend on the viability of third parties in various parts of the world, rather than the company issuing the investment – and you can be sure that there is some small print somewhere that distances the product provider from the effects of any failure by the ‘counterparty’. As events in 2008 demonstrated, it is not always safe to rely on guarantees provided by foreign institutions – and even some UK ones can look shaky, although the Financial Services Compensation Scheme can often provide a degree of protection in the latter case.

Can you really have your cake and eat it?
Even if the guarantees do work – and in today’s market it is to be hoped that they are more reliable than previously – they are invariably balanced by some significant restriction on the potential for gain. In many cases, of course, this is perfectly reasonable and something that, if approached with an open mind and a full understanding of the balance of upside potential limits and downside risk protection, investors can accept.

There is no such thing as a free lunch!
What is not acceptable is any suggestion that investments that are guaranteed when this is not the case, as has been the case with some apparently cash investments, which were actually invested in derivatives.

As ever the value of investments is not guaranteed and will fluctuate; you may get back less than you put in. You should always take individual professional advice before making any decision relating to your personal finances.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND. 

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