Balancing the need for returns  with the need for security.jpg

Balancing the need for returns  with the need for security

By BILL BLEVINS features@algarveresident.com

Bill Blevins is the Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK

Have you watched your bank interest earnings plummet over the last year?  

Although the Bank of England base interest rate stopped just short of zero, 0.5 per cent is so negligible it may as well be zero for savers.  The one per cent European Central Bank rate is not much better.  Depending on what type of savings/deposit account you have, you could be earning a pittance even if you have over 100,000 Pounds Sterling on deposit.  Is there anything you can do to improve returns?

If you do not normally use your bank interest earnings to provide an income, and instead just roll it up in the account, the low rates are not such an issue at the moment.  However, your capital is not growing, or only minimally, and over the longer term its spending power will diminish.  When you do come to use it some years down the line, you will find it does not go as far as it does today.  If inflation does resurface as predicted, this could impact on your wealth and possibly on your standard of living in your later years.

It is generally accepted that over the longer term, equities provide the best opportunities to outpace inflation.  With many shares still undervalued, this is a good time to invest in this asset class if you are a long term investor and adopt a strategy to suit your investment objectives and risk tolerance.

But what if you do not want to invest directly in equities, or if you have enough shares in your portfolio already?

One alternative is a bond fund.  This investment pays interest, usually suitably higher than a bank account, as well as offering the potential for capital growth over the longer-term.  If you do not need the income, you can accumulate it in the fund, thus increasing your capital growth.

Bonds can be less risky than equities, but capital value can rise and fall according to prevailing conditions.  The income levels, however, will not necessarily be impacted in the same way – over the current financial crisis, for example, the income held up well.

If you are seeking capital protection for your capital, then an option for you to consider is a guaranteed fund, one where the returns are linked to stockmarket performance and where your capital is protected from turbulent markets.

These investments are suitable for lower risk, medium term investors, who are seeking the potential for improved returns above those available on cash deposit.  

Note that you will need to tie your money up for a fixed period, normally five or six years, so this is only suitable for money you are saving for the future and should not be used for capital you may need to access over the term or if you need to earn an income from your capital. You are usually able to withdraw money if necessary, but returns may be compromised and you may lose the capital guarantee.  These are important issues to consider before you make such an investment.

There are a number of such opportunities around whereby you can invest in a guaranteed investment fund, but make sure you choose one which provides a 100 per cent capital guarantee and where you understand how the returns will be generated.

Returns are linked to a major world stockmarket index or a basket of indices, often the FTSE 100, S&P 500, Dow Jones Euro Stoxx 50 and Nikkei 225. Such a mix gives you diversification across countries.  

So while you will earn a return linked to stockmarket performance over the period (and with today’s stockmarket levels this is a particularly attractive time to invest in one of these funds), provided the fund offers a 100 per cent capital protection, your original capital is as safe as it is in a bank account.  Your capital cannot fall below the original value, but you will have the potential for higher returns than a bank account.  

Returns are added to your capital on maturity and how much you earn depends on how your particular fund works.  You would ideally find a fund that will pay a return even if only one index outperforms over the period (though in this case the returns would be lower).  If all stockmarkets underperform you will not receive any returns – but with a 100 per cent guarantee you will receive the full return of your original investment.  Your capital is protected even in falling markets.

The risk on such an investment is the loss of any bank interest you would have made had you left the money on deposit, but with interest rates likely to remain low for some time, this risk is lower than it would normally be.

Choose a fund where each stockmarket index is ‘ring-fenced’.  This means that a negative performance of one of the indices will not affect the returns generated from the others.  

Some guaranteed funds offer a bonus if all four indices outperform over the period, giving you increased potential for capital growth.  

There are various types of structured products on the market, and although at a glance they can appear similar, some are more risky than others and you may be better advised to leave your money in the bank.  It depends on how they work and the guarantees offered.  Ask a reputable financial adviser like Blevins Franks to explain the product to you, including all the risks, and establish whether it will be appropriate for your objectives.

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