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Q&A - Capital protection

Q. I have recently come across an investment product, which comes with capital protection, which sounds great, but can we really believe that we won’t lose our money? 

A. These sorts of financial instruments are often called structured investments and can be quite complicated to understand for normal people. They can be differently constructed but let me give you an example of one to talk you through the basics. One product I have looked at takes part of the money you invest and puts it into some kind of fixed deposit or bond product that, say, over the five year period will ensure that your invested lump sum can be there at the end of the five-year period. This can be supported by financial derivatives, which acts like insurance, to make sure the money is protected. With the rest of the money lots of creative things can be done to try to bump up the returns. A product I came across lets you borrow to buy shares, so this gives you a gearing effect, which can either bring a great return or KO you! That’s the gambling bit with these products. With this product you pay around 11% interest, which is big but it’s offset by the dividends, the franking credits on the shares and the tax deductions that go with the borrowed funds for the shares. You could end up really paying around 3% or so. The next important question is: What can go wrong? With capital protection many people think they are safe but what if you had a capital protected product with Lehman Brothers or Bear Stearns? Ultimately there are blow up clauses meaning if the company disintegrates, your capital protection might not be worth the paper it’s promised on! That’s why capital protected products from big name banks look like a better kind of protection. 

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Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

Published on: Thursday, September 03, 2009

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