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 FINANCIAL
PLANNING FIB #2
Whoever came up with the phrase
'capital protected' should be given a marketing achievement
award by the finance industry. It works like a magic bullet
in sales presentations.
For many commission-based planners, selling financial products
is a process of building up the list of advantages until the
client is ready to sign on the dotted line. For relatively
simple products, like cash management trusts, pointing out
the high interest rate and well-known corporate brand will
probably do the trick.
But for complex products, clients generally need more convincing
and that's where 'capital protected' comes to the rescue.
When a planner is explaining how limited recourse loan facilities
and knockout events work, most clients' eyes are probably
glazing over but the mood nearly always lightens when they
hear that their capital is protected.
Fund managers have also realised that 'capital protected'
is a sales clincher and the range of products with some form
of capital protection has exploded during the last decade.
But there are two things to be wary of when you hear this
phrase.
The first is that no company is going
to take on someone else's financial risk without being handsomely
compensated for doing so. If there is a genuine risk of financial
loss, you can be sure that the capital protection feature
is not going to come cheaply and that the terms will not be
in your favour. In many cases, the company offering the capital
protection is just taking the opportunity to sell you two
financial products instead of one. Namely, an equity portfolio
plus a put option or an equity portfolio plus a loan.
The second is that nowadays capital protection is being used
to promote products where there is little or no risk of a
capital loss anyway. For example, there are a number of equity
products which claim to be capital protected at maturity,
which is typically in six to eight years' time. But such guarantees
are really just an advertising gimmick. That's because the
risk of a share portfolio being below its original cost after
six years is just 0.2% (i.e. a one in five hundred chance)
and after eight years the risk is zero.
So when you hear capital protection offered as a good reason
to invest, be alert. Often it has more to do with boosting
the fund manager's income rather than protecting your capital.
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