It’s hard to know where to invest your money at the best of times, let alone in times of unrest when the stock markets become very unpredictable. So what’s the answer?
We’re all sick of hearing the B word. We can’t get away from it, or the effect Brexit is having on the stock markets, not only at home but also in the USA and Europe.
Deposit returns from cash are not keeping up with inflation, and equity returns are uncertain. Even property prices seem to be experiencing unusual times.
If we do get a resolution to B****T (note that’s a 6-letter word, not an 8), it’s quite possible the equity markets could respond favourably and we could see decent returns. However, if the current situation drags on, or we go for a hard B then perhaps not!
Sit back, structured investments could do all the work
Structured investments are fixed term investments where a reading of a market index, such as the FTSE100, is taken at the beginning of the investment period. The plan then offers certain returns if the required conditions are met.
There are two plans and it is important to understand the difference between the two:
Structured deposits are savings accounts, offered from time to time by some banks, building societies, and National Savings & Investments. The rate of interest you get depends on how the stock market index or other measure performs. Unlike structured investments, the capital you originally invest has the same protection as any other savings account.
Structured investments are commonly offered by insurance companies and banks. Typically your money buys two underlying investments; one to protect your capital, and another to provide the bonus. Your capital is at risk and the return you get depends on how the stock market index or other measure performs.
A popular structured investment is the ‘Kick Out’ plan. There’s even one called a Step-Down Kick Out plan which sounds more like a line dancing move than an investment! Not that I know anything about line dancing! Ahem.
Moving on.. the terms and rates will differ from provider to provider and between specific tranches.
A structured investment ‘Kick Out’ plan
A typical structured investment Kick Out offering might look something like this…
Let’s say you invest your £20,000 ISA allowance and, at the beginning of the investment term, the FTSE100 stands at 6800.
If, on the second anniversary of your plan, the FTSE100 is at 6800 or above (even if it’s just 1 point above), the plan will mature (kick out) and return your capital with a fixed rate of simple interest of, say, 5% per annum.
The rates differ between offerings and are fixed from the outset.
All well and good. But what if the markets have fallen?
If the markets have fallen below 6800, the plan doesn’t mature at that point, but rolls on to the next anniversary when the same test is done. The plan then either matures and pays 5% x 3 years, or rolls on to the next anniversary (because the FTSE100 is still below its start price). And so on.
Either the FTSE100 will get above its start price on one of the anniversaries during the plan’s term – this is typically 6 to 8 years, in which case your money is returned with 5% simple interest for every year it’s been in force – or the FTSE100 could still be lower than its start value at the end of the term.
What happens if the FTSE100 is still lower than its start value?
If the FTSE100 is still lower than its start value, one of two things could happen:
If the index is above a specified threshold:
If the index is above typically 60% of its initial value (so in this example that would be 4080), then your full investment is returned but with no growth.
The index is below the specified threshold:
If the FTSE100 is actually below 4080 on the maturity date (European Barrier*) then you’ll take a loss in the same way you would have done if you’d invested directly into an index tracking fund.
Such a fall in so many years’ time is pretty unlikely. However, we obviously cannot guarantee this. Your capital is at risk and you may get back less than you invest (more on this in a moment).
*A European Barrier is where the index is tested just once at the end of the period. Less common are plans that use an American Barrier and aim to return the original capital at maturity unless the underlying asset falls below the initial level by more than a specified percentage at any point during the investment term.
So what do structured investments offer overall?
With structured investments, you not only have the chance of a really good fixed rate return, it’s pretty tax efficient too. Your return is only liable for capital gains tax (CGT), not income tax, and remember, you have an annual CGT allowance (currently £11,700 2018/19 tax year) to use before you have to pay any tax.
It could get even more tax efficient
If your structured investment is held within an ISA or a SIPP, it leaves your capital gains tax allowance for other investments – so even better! Couple that with a degree of protection against downward movement in the markets; the market could fall by up to 40% and your capital would still be safe. Something to consider in case it’s right for you!
Great, what are the risks with structured investments?
The main risk is that the markets could fall substantially and remain below the level where your capital is returned. If this happened, you’d take a corresponding hit on your investment and wouldn’t receive any interest/growth.
These structured products are generally quite complex. They contain a variety of features that can make it difficult to compare them with other alternatives. As a result, many product providers will not allow investors to buy direct, without financial advice. You need to ensure you understand the various terms, know who is providing the return, and fully understand that your capital is at risk.
There is also something called ‘counterparty risk’ to consider.
When you take out a structured investment with a bank or insurance company, it’s not actually them promising to return your original investment or to pay a given return on your money. Your money typically buys two underlying investments from the plan’s ‘counterparties’; one to protect your capital and another to provide the bonus. The return you get depends on how the stock market index or other measure performs.
How does counterparty risk work?
Because you don’t have an agreement yourself with the counterparties, if your structured investment fails to give you your money back or provide the promised return, you don’t have a direct claim on them and no compensation scheme applies.
Some plans use a spread of counterparties. This helps mitigate single issuer risk, and aims to reduce the impact felt should a single counterparty fail.
It’s all about understanding risks and finding the right structured product backed by a financially strong, secure counterparty. The skill is in establishing whether structured products are right for you and if so, choosing between the different types of products available. Fear not, that’s where your financial adviser’s expertise comes in!
The choices are endless! Ensure you understand the mechanics of the plan you are taking out, and you have the appetite and capacity to withstand a potential loss of capital.
These plans do not work if they are cashed in before they kick out or mature. It is important to only invest money that you will not need to access during the term of the plan.
The figures and product features in this article are used for illustrative purposes only. The example shows a ‘kick out’ structured investment with a European Barrier. It is important that your financial adviser fully explains the features and terms of any plan before you proceed.
The rates and examples that have been used are also very generic – terms change from product to product and even tranche to tranche with the same provider.
Remember, the “safer” the plan, the lower the potential rewards tend to be, and vice versa. You may get more by investing directly in the stock market if it is a rising market. You wouldn’t get any protection from any falls.
Try not to let the risk factors automatically put you off. These plans have been around for a long time, and have proved very successful investments for many doctors and dentists with ‘an appropriate’ risk appetite. They are only ever used as part of a balanced investment portfolio.
Whilst we are definitely facing uncertain times which are affecting the markets, you still need to take steps to make your money work for you – perhaps more so than ever – so ‘let’s face the Brexit and dance!’
Have you considered investing in a structured investment? Let us know by adding a comment below.