FOOL'S EYE VIEW
Avoid These Awful Investments

By Cliff D'Arcy
September 2, 2003

Here at the Fool, we're big fans of simple, flexible, tax-efficient savings products that 'do what they say on the tin'. Likewise, we loathe complicated, inflexible, opaque products that include nasty stings in their tails. Here are two examples of the second group.

Baby Bonds®

These are regular savings insurance plans sold by The Children's Mutual (TCM), a trading name for the Tunbridge Wells Equitable Friendly Society. Here are the basics of these policies:

• You save from £10 to £25 a month (or between £120 and £270 annually)
• You must save for a minimum of ten years
• Your money is invested in a with-profits fund, which invests in a spread of shares, bonds and other assets.
• Your return comes from the annual bonuses and discretionary final bonus added to your pot, which grows tax-free.

They sound pretty good, don't they? However, you should reject them every time, because:

• They are very inflexible, as they're just another type of endowment (and you know how we Fools hate those!), so you can't increase, decrease or temporarily halt your payments.
• If you don't pay all your premiums on time or stop your plan early, you'll usually get back less than you paid in, especially in the early years
• They include incredibly high charges (because they pay such generous commissions to financial advisers, as TCM's sales director pointed out in a recent article in Moneyfacts).

You won't find any explanation on TCM's website about its charges, probably because it doesn't want to advertise just how shockingly high they are! Here's what you might get back if you save £25 a month in a Baby Bond® for 18 years (a total of £5,400), versus a product with no charges:

Annual return       5%       7%       9%
Zero-charge plan  £8,667  £10,582  £12,986
Baby Bond®        £7,290   £8,640  £10,200
Difference        £1,377   £1,942   £2,786 (what you lose in charges)
Percentage          26%      36%      52% (of the £5,400 you've paid in)

TCM promises that the final value of the above plan will be at least £4,875, which isn't much of a guarantee, because it's £525 less than the £5,400 you've paid in over 18 years!

Just because an investment is tax-free, doesn't mean that it's any good. I can't find a single reason to recommend these plans, so Baby Bonds® get the Foolish thumbs-down. Instead, read this article on saving for children.

Guaranteed Equity Bonds (GEBs)

These lump-sum investments were created to tempt consumers away from the safety of deposit accounts, without exposing them to full stock-market risk. Generally, you are guaranteed to get your money back if the market falls or is flat over, say, five years. Conversely, if the market rises, you get a pre-set fixed or variable return.

However, GEBs have numerous catches, such as:

• They are overly complicated, difficult to understand and tough to analyse (could this be deliberate in order to pull the wool over our eyes, I wonder?)
• They often include surprisingly high commissions and hidden charges
• They are promoted as being halfway between a deposit account and a stock-market investment, but often combine the worst elements of both.

Nevertheless, despite these drawbacks, GEBs are incredibly popular, with 221 products issued in the first five months of 2003 alone. Here's one recent issue:

National Counties BS recently launched a Guaranteed Growth Bond that tracks the performance of the shares of twenty leading international companies. The list includes UK heavyweights Vodafone (LSE: VOD)(NYSE: VOD), GlaxoSmithKline (LSE: GSK)(NYSE: GSK) and HSBC (LSE: HSBA)(NYSE: HBC).

Your money is tied up for 5½ years, after which you are guaranteed to get back your initial investment plus 10%. However, if this basket of shares has risen in value, you could get a greater return, according to this formula:

• Each share's growth is capped at 25%, so all shares that have grown by more than 25% over the 5½ years will be cut back to a 25% return
• An average of the results of all twenty companies is calculated
• Finally, your return is three times this average, which gives maximum growth of 75%.

It's an utter nonsense to create a bond based on just twenty companies (however 'carefully selected' they are), especially using the complicated formula described above. What's more, 'share baskets' of this type are difficult to track, which means that it's hard to figure out how much you're making, and difficult to look back at the Bond's historical performance before investing.

The minimum return (10% over 5½ years) equates to annual growth of 1.75% compounded, which is hardly generous, as it's about half the current yield on the blue-chip FTSE 100 index (which also offers a far greater spread of risk).

The maximum return (75% over 5½ years, which you only get if all twenty stocks are up by 25% or more) equates to annual growth of 10.7% compounded, which is less than the UK stock market has produced over the long-term.

I think some wily investment bankers have talked the usually conservative NCBS into launching this Bond. However, in my opinion, whoever designed this complete dog's breakfast should be spanked severely!

Give these half-baked products a miss in favour of cheaper, simpler investments, such as a combination of a cash mini-ISA and an index tracker, if you want to combine security with stock-market growth.

More: Visit our Savings and ISA centres.