News/Events

When you invest, make sure you understand the risks [3rd December 07]

Risk is inherent in life from the moment you are born. Every day we make risk assessments without thinking of them as such reacting accordingly.

In financial markets risk is complex and expert advice is required.   Types of risk include Capital, Shortfall, Interest, Inflation, diversification, liquidity and currency risk. An explanation of each is impossible to convey within the constraints of this article, but I wanted to illustrate that it’s vital that you fully understand the risks you are taking with your financial decisions.

Thinking that their money is completely safe, many invest large lump sums in one Deposit account with their Building Society or Bank. One account, to attract higher interest rates - you could argue; this is perhaps a risky strategy with “all your eggs in one basket” and limited protection when things go wrong.

The core protection when a financial services firm is unable to meet claims against it is provided by the Financial Services Compensation Scheme (FSCS). The FSCS covers business conducted by firms authorised by the Financial Services Authority (FSA) and is funded by levies from these firms. 

Many would be surprised that for Deposit Accounts the FSCS only protects depositors for up to £35,000 (100% of the 1st £35,000 of each depositors claim). Joint holdings will have double the cover e.g. £70,000. 

You may have been lulled into a false sense of security by investing with multiple providers thinking that they are each covered separately – they may be connected! The Bank of Scotland is a provider of AA, Birmingham Midshires, Halifax, Intelligent Finance and Saga, classed as one provider you will only be covered once up to £35K.  Although Tesco and Natwest are working with Royal Bank of Scotland they are classed as separate entities and therefore any deposits held with each of these is covered separately by the FSCS. Confused? We have a leaflet “Who owns Who”

Compare this to the higher protection the FSCS provides for other investment business up to a maximum of £48,000 (100% of the 1^st 30,000 and 90% of the next £20,000) or life Insurance policiescovering long-term policies such as pensions, annuities and investment bonds that incorporate an element of life assurance.  Where liabilities cannot be transferred to another insurer, 100% of the 1^st £2000 followed by 90% of balance (without limit) is covered.

The risk of needing to use the FSCS for compensation relating to a Deposit account is low, but possible, the events at Northern Rock have raised questions about whether Deposit accounts are the safe haven they once appeared. 

However, non-deposit based investments, including life assurance Investment Bonds, carry other risks such as investment risks, charges, costs and exit penalties and should not be considered if you are adverse to any investment risks and should not be used for deposit based savings.

If you’re reliant on an income from your investments, be aware that a cash investment or low risk funds for cautious investors are unlikely to be able to sustain income whilst also keeping pace with inflation so the “real” value of your investment decreases over time, worse still the income could erode your original capital so your future income and capital could be at risk. 

Markets and tax legislation change, so make sure your investment or deposit is right for you. Speak to an IFA.

This article was written by Langtons - Published in the Western Morning News, This is Money, 3rd December 2007