Introduction:
Whenever financial markets experience a sustained downturn or a higher level of unpredictability, guaranteed products become more appealing. These products generally promise investors a level of capital growth and/or a set income return without all the associated risks of investing in financial markets.
Understanding Guaranteed Products:
Before deciding whether to invest in these products, take a step back, contemplate your investment objectives, and ensure you understand the benefits and features of the specific guaranteed product. Recognize the trade-off between an investment that provides peace of mind but which may also reduce your gains from market upturns and any higher costs often associated with guaranteed products. Only then can you prioritize the product features that are most suitable for you.
The features, risks, and benefits of a guaranteed product need to fit with your specific objectives and needs. Therefore, it is important that you understand the specific features of a guaranteed product before deciding whether and/or which product best suits you.
Different Objectives for Different Needs:
Some investors may place a high value on the security of their initial investment or on a reliable income return. In this circumstance, the investor may be willing to pay higher costs and fees for some ‘peace of mind’. An investor who has a fear of outliving their funds may be willing to accept potentially lower returns relative to a non-guaranteed investment if they can transfer their longevity risk to a reputable product provider.
Each objective may result in a different guaranteed product with specific features being suitable to the investor. The case study below illustrates these differences.
Example: Three Brothers Nearing Retirement
- Archie: Archie is concerned that the recent strong performance in share markets will reverse rapidly and affect his savings just as he is about to retire. He is not sleeping well at night and worries about day-to-day market movements. Ideally, he would like part of his portfolio to achieve a certain positive return. A product that provides a guarantee of the capital for a period of 5-7 years may be attractive to him for peace of mind. Archie may be more resistant to paying higher fees, which may reduce the net return for his portfolio.
- Lachlan: Lachlan expects to live well beyond his life expectancy and is concerned that his portfolio will not last long enough to provide a reasonable income level in the later stage of life. He may favor a guaranteed product that transfers the risk of outliving his funds to a reputable institution that can provide a minimum level of income in the later years of his life.
- Finn: Finn is conservative and recognizes that investing in growth assets makes sense for the long term but is uncomfortable with the high level of risk associated with growth assets. He may prefer a product that provides a guarantee of the capital over a long-term period but also enables him to participate in any positive market movements. Finn is willing to pay a premium for effective insurance to invest in growth assets.
In each case, these three brothers are likely to choose different guaranteed products to meet their specific needs.
Checklist for Evaluating Guaranteed Products:
| Feature | Considerations |
|---|---|
| Term of the Investment | The term of the investment needs to match your investment time horizon. |
| Return of Capital | The investment may provide a guaranteed return of capital. Often, a guarantee on the initial investment is only offered if there is no/limited access to your capital over the term of the investment. |
| Guaranteed Income | Consider how competitive this income return is relative to other alternative defensive assets such as cash, and consider any higher fees that may reduce the net level of income you receive. Evaluate the potential for indexed income levels to keep up with inflation. |
| Strength of the Guarantee | Recognize how and by whom any guarantee is supported. The financial and business strength of the organization needs to be analyzed to ensure the guarantee will be met when it falls due. |
| Access to Capital/Partial Withdrawal | Ensure you have other assets or a source of income to meet your expenditure and income needs if the guaranteed product does not allow you to access your funds before the end of the term. |
| Underlying Investments | Understand the underlying investments that back the guarantee and affect the outcome of your investment. |
| Choice of Investments | Consider any restrictions on the choice of investment options, as they may reduce your ability to tailor the portfolio to suit your specific objectives and risk profile. |
| Potential for Capital Growth | Understand whether your investment outcome can benefit from gains in financial or real assets that provide the potential for capital growth over the long term and the extent to which you can participate in such gains. |
| Fees | Assess and understand the fees charged within the structure, particularly any fees relating to the provision of the guarantee, to determine whether the costs are reasonable. |
| Opportunity Costs | Consider the opportunity cost of a conservative guaranteed investment compared to potential returns from growth-oriented or non-guaranteed investments, especially during periods of strong market performance. |
Conclusion:
Guaranteed products can offer peace of mind by providing secure capital growth and/or income returns, but they come with higher costs and potential trade-offs. Carefully evaluate the features, benefits, and risks to determine if a guaranteed product aligns with your investment goals.
The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.
