Risk-free equity investment? Is it guaranteed?

Guaranteed equity bonds (GEBs) have one big selling feature - the claim that they are a no-risk venture into the stock market for cautious investors. Yes, you can get your money back after the investment term (usually five years) even if stocks and shares have crashed, but nothing else is guaranteed. You get no dividends and income tax has to be paid on any profits you make.

Even full capital retrieval might be qualified by an 'if' with certain guaranteed equity bonds; it can be dependent on specific conditions being met by the particular stock market index your bond is tied into.

If the market stagnates over the period of investment your money will not have earned much, inflation meanwhile will have nibbled away at its value and you could well have been better off in an ordinary savings deposit account.

Guaranteed equity bonds come in various forms. Capital return in full is not normally guaranteed on those offered by insurance companies or unit trust managers, whereas it does apply to most of the deposit-based GEBs available from banks, building societies, the post office and National Savings & Investment (NS&I). Such GEBs do not have set interest rates. Instead, they track one, or as many as four, stock market indexes. The average growth in the index(es) specified is calculated over the term of the bond and you, the investor, are paid a percentage of this growth.

For example: the recently launched Virgin Money Guaranteed Equity Bond will return 130% of any growth over a five year period, in the FTSE100, while Bristol & West's Global Balanced GEB (also five years) tracks growth in the Nikkei 225, the Swiss market index and the US S&P500 as well as the FTS 100. It also offers an easy access savings account element; a 12 month bond, paying 5.75% on up to 50% of the capital parallels the GEB component.

The guarantee - trap or neat investment trick?

Usually with guaranteed equity bonds there is no upfront administration fee. But you do not get a dividend on your stock market investment (arguably the main reason for any investment in the first place). Your money is locked in for the duration and you will incur penalty charges if you withdraw early.

However, you don't have the worry of seeing your capital investment fall into a black hole. GEB providers use the financial tool of derivatives to underpin this money-back guarantee. It's the provider that's doing the actual stock market investing, so they get the dividends. You get peace of mind in exchange for (if you invest directly and the market doesn't plummet) around 15% to 20% of your original sum in dividends over the five year period.

Is it a good trade off? It depends on your attitude to risk. The government-backed National Savings & Investments, the leading provider, now has more than 100,000 (presumably happy?) customers who collectively have invested £900 million in GEBs.

Financial experts and advisers are divided on the issue, though. Some argue that GEBs are competitively priced and offer good value, particularly given the current situation where financial markets are not fluctuating wildly. Others say the price of capital protection with a GEB is not tax efficient.

Savers may be better off taking out a cash mini ISA along with a diversified spread of investments, including shares, property and fixed-income products. Another alternative would be a monthly (for as little as £25) stock market savings plan.

Also the time to buy a GEB may not be now, when the stock market is doing well; hindsight allows us to point out that two years ago would have been the right time to link an investment to the FTSE100 as performance since then has been positive.

Nonetheless, equity-based investing is necessary if your funds are to have the potential to beat inflation AND achieve significant growth over the longer term. By all means avoid risk by putting your money into a deposit account, but bear in mind low interest rates and the fact that even our current relatively modest inflation rate can take its toll.

15 July 2008 © Moneyextra.com

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