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Beware Of Jargon

By Cliff D'Arcy
January 21, 2003

I was highly amused by an advertisement I came across recently in a copy of the Financial Times.

It was a tasteful front-page ad from a luxury Swiss watch manufacturer. A picture showed a very elegant ladies' watch, which the accompanying blurb described as a "small automatic chronograph"!

Obviously, in order to justify the cost to its elite clientele, the maker couldn't market this precious item merely as a ladies' watch. By giving it a fancy name, the marketing team believed they could justify its exorbitant price tag. Of course, it goes without saying that naff things such as prices are never shown for fashionable items, including these delightful watches.

This left me contemplating how financial companies use similar jargon to hide reality.

Don't get me wrong: having worked in financial marketing for over ten years, I respect those who can write good copy. However, when asked what I did for a living, I usually replied: "I work in marketing, so I'm a professional liar."

As I see it, the problem is, particularly where money is concerned, marketing often goes beyond using apt adjectives and adverbs and enters the realm of deliberate confusion.

Let me give you an example.

"Guaranteed" And "Protected" Products

There are a lot of people out there who are nervous about investing in the stock market, whether through shares, index trackers or managed funds.

Fair enough: some people's personal attitude to risk can't encompass losing 25% of one's stake in one year or 42% over three years (the most recent figures for the UK stock market).

However, many of these individuals are also unhappy with the low returns from absolutely safe investments, such as deposit accounts or National Savings. At present, with the bank base rate at 4%, it's very hard to earn more than 4.5%. This means that, after tax (at up to 40%) and inflation at 2.5%, the real rate of growth for savings is near zero.

To entice cautious savers to plunge into the world of investing, many financial firms offer a "halfway house": the Guaranteed Equity Bond (GEB). I have a problem with the first of these three words.

In theory, these products are designed to offer investors some exposure to stock markets, but without some of the risk. Usually, your money is locked in over a period, typically five years, and your returns are linked to the performance of one or more stock markets.

The attraction is that the downside is limited to a certain degree. For example, you are "guaranteed" to receive back all, or a stipulated percentage of your stake, if the market tumbles over the life of your bond.

Let's look at one example:

"My D'Arcy Golden Bond pays back a minimum of 100% of your money after five years, plus a return linked to the FTSE 100 index's performance. You get each annual rise or fall in the index, capped at 20% either way. So, if the FTSE 100 rises 25%, I give you 20%. If the FTSE 100 falls 30%, you lose 20%.

After five years, the ups and downs are added up and I give you the total of these five figures. If this figure is negative, I give you back your original stake. If it's positive, you've made a return on your money. The maximum return is 100% of your money and the minimum is your initial stake. You can't lose - I'm an honest geezer (ignore the professional liar remark above)."

Does this sound appealing? Then let's look at the many shortfalls:

* I give sellers of the D'Arcy Golden Bond 3% of your money as commission. This charge forms part of the hidden costs that provide me with my overall return that you pay. Think of it as me investing only 97% of your money - you're trailing from day one.

* Your return is linked only to the growth of the FTSE 100 index itself, which doesn't include the annual return received from reinvesting dividends paid on the 100 underlying shares. I keep those dividends, which means that I'm pocketing about 3.5% a year, on current yields, reducing your five-year return by almost 19%, all other things being equal.

* If the FTSE 100 falls more than 20% in any year, I limit your loss for that year to 20%. Fine and dandy but, checking data for the whole stock market since 1869, I know this has only happened four times in 133 years, or about one year in 33 (3% of the time). It's hardly worth paying my protection money!

* If the FTSE 100 has fallen over five years, I give you your stake back. Using the same market data, I know that this has happened only six times in the 129 five-year periods since 1869. This is about once every 21.5 years, or 4.7%. Again, this is a small risk, but it did happen between 1997 and 2002, which is why I know people are worried about further falls at the moment. The previous periods (in reverse order) were 1969-74 (oil crisis), 1936-41 and 1937-42 (include WW2 years), 1926-1931 (the Great Depression) and 1898-1903. So you can see it doesn't happen very often and I know that but I'll still take your money!

* If the FTSE 100 grew by exactly 20% for each of these five years, your profit would be 100%. However, if you invest directly into the FTSE 100, say via an index tracker, annual growth of 20% over five years would return almost 149%, thanks to the power of compounding. The return from the D'Arcy Golden Bond would therefore under-perform the FTSE 100 growth by one-third. I know this but you probably don't!

* If the FTSE 100 rises by more than 20% in a year, I pocket any extra. This "excess return" can be a big contributor to my overall profit. I know it's happened 31 times in the 133 years between 1869 and 2002, around one year in four (23.3%).

* If the FTSE 100 falls over five years, I'll give you back your stake. But, thanks to inflation at, say, 2.5% a year, your money would be worth about 12% less. If you're going to beat inflation long-term, invest in shares, as I do.

The problem is that the returns you'd normally expect to receive from the stock market are often greater than those I'm offering. If you expect the FTSE 100 to do reasonably well over the next five years, you'd be better off investing in it directly, not buying my D'Arcy Golden Bond.

In any event, I'll invest some of your money in the stock market, as I fully expect to make a greater return than I'll be paying you. I've done my sums very carefully so that the odds are stacked in my favour, so it's you that ends up paying for your guarantee.

GEBs may have some appeal to risk-averse savers, perhaps as a one-off plan to meet some future need (such as a round-the-world trip). Nevertheless, smarter long-term savers will recognise that guarantees come at a price and you'll get better returns by investing in a simple index tracker.

Remember, if it's worth my while offering you this deal, it's probably not worth your while taking my bet!

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