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A bond farewell

Hargreaves Lansdown is no stranger to expressing views which some others see as controversial, most recently in our comments on structured products which are mostly hopeless, yet sold to thousands.

In that sense, they are not dissimilar to insurance bonds which have been oversold in the extreme. I naively assumed that the Financial Services Act would do them down but it was not to be. However, with capital gains tax reduced to a flat rate of 18 per cent, are insurance bonds now finally dead?

Since the CGT changes were introduced in April, insurance bonds are now a clear second best to unit trusts for most private investors, in my opinion. Even the Association of British Insurers says if you are investing in stockmarket funds for growth, collective investments like unit trusts are more tax-efficient.

In my view, insurance bonds have been a poor second to unit trusts for some time for all but a few specialised cases.

In general, insurance bonds pay tax within the fund up to 20 per cent, with higher-rate taxpayers subject to a further 20 per cent on the profits. On the other hand, unit trusts pay no CGT until you sell or transfer and then the first £9,600 is tax-free. The remainder is only ever taxed at 18 per cent, even if you are a higher-rate taxpayer. You can also offset losses against gains.

Why are insurance bonds still being sold en masse? Well, I see two reasons.

Most are structured to make it look as if you are getting something for nothing. Often, they invest 100 per cent of your money, seemingly without charge, and they pay hefty up-front commission to the adviser. What many investors do not realise is that they pay for the cost of investing and commission through the bond charges, even if it does not look like they do.

The second reason is the increase in guaranteed options. There is no doubt that we look at guarantees in a different way than a year ago. In these turbulent times, it is understandable that investors are attracted by certainty and safety and a plan offering stockmarket returns with an underlying guarantee of capital or income looks attractive.

However, you pay through the nose for that guarantee, either by sacrificing the dividends from the underlying shares – not insignificant – or with higher charges or both.

What you end up with is a product where there is limited upside. One of the worst I have seen provided a guaranteed 5 per cent income but the product needed to achieve an average return of 8.5 per cent after charges. This meant that to get 5 per cent, the fund needed to achieve 10 per cent or more.

A cynic might say the only real guarantee that you get with these types of product is that you will be disappointed with the long-term performance. In my view, perhaps the worst time to buy these products is when the market is at a low point. You are much less likely to benefit from all the upside when it happens.

If you do want a guaranteed investment, probably the best time to buy is when the market is at a peak but actually I would prefer to go to cash at that point rather than be tied into an expensive product with complex charges and taxation.

Investing in the right funds and markets is very important and getting the right choice of product can be even more important. If it seems too good to be true, it probably is.

Mark Dampier is head of research at Hargreaves Lansdown

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