Improve Your 'Interest' In Cash
In an article last year, Manage Your Cash – Spread Your Risk, we touched on the idea of spreading risk by diversifying your cash holdings. When considering investment risk, one should look at both investor protection and also actual return.
In regards to the former, legislative changes that came into effect 1st October 2008 now mean that via the Financial Services Compensation Scheme an account holder enjoys 100% protection of the first £50,000 of a holding (£100,000 where an account is held in joint names). For claims between 1st October 2007 and 6th October 2008, the maximum level of compensation was £35,000 (100% of the first £35,000). For claims prior to 1st October 2007, the maximum level of compensation is £31,700 (100% of the first £2,000 and 90% of the next £33,000). This increased level of protection undoubtedly improves consumer confidence for many cash deposit holders although clients should be aware that the protection applies to each institution rather than necessarily each bank. In this current environment where banks and building societies have been acquired or have merged, this increased level of protection may well have actually diminished without clients being aware of it.
The second risk is that regarding return. At the time of writing the aforementioned article, base interest rates had already started to reduce, although since then the rate has dropped from 5.0% to 0.5% per annum. This has resulted in underlying interest rates on accounts declining significantly. Banks and building societies are still endeavouring to attract deposits, although this is often by way of a short-term bonus to improve the headline rate or through longer term fixed rate bond offerings. As part of a cash based portfolio, these may well appeal. However, what alternatives are available?
Our previous article touched on cash based unit trusts and indeed the advantages of this approach still remain.
An alternative that is proving popular amongst clients is that of structured deposits. These come in many guises and apply varying degrees of capital protection or guarantee. However, one should not get carried away by the often potentially better returns that are offered by certain products as these will undoubtedly come at the expense of capital security. However, for low risk investors, those plans that provide 100% capital guarantee may prove to be appealing.
These structure deposits differ from normal bank or building society deposit accounts in that the interest applied to the account will be linked to the performance of an index, such as the FTSE 100 for example. This has proved to be particular appealing to clients given the current stockmarket levels and provides an opportunity to enjoy a potentially higher return over the term than would otherwise be attainable under a traditional cash account at present.
Of course, before investing into these plans, a client should give thought to the institution offering the product and also the provider of the underlying capital guarantee. However, consideration of these types of investment gives clients the opportunity to diversify their cash holdings. Indeed it may reduce exposure over and above the protection offered by the Financial Services Compensation Scheme for those with larger levels of fund on deposit. Furthermore, it may actually reduce investment risk, as interest returns will be linked to stockmarket performance.
The worst case scenario associated with these plans is that at the end of the term, typically 3 to 6 years, if the stockmarket participation yields a nil or indeed negative return, clients will receive a return of their initial investment. In the current interest rate environment, clients are unlikely to benefit much more by retaining their current traditional deposit accounts.
Should you be interested in this type of arrangement, please feel free to contact Steve Prosser, Jeff Crewdson or Chris Raggett to discuss your requirements more fully.
Date of Article: 9th June 2009
