This is a question that I recently answered on air during Radio 4's Moneybox programme, but I thought it was worth giving a fuller and more detailed explanation here.
Question:
Rates on ‘normal’ cash ISAs are ‘not very exciting’, 2 or 3 % maybe. I’ve looked on comparison websites and there are some growth deposit plans which appear to be cash ISAs which pay interest based on the FTSE over 5 years. How do they work and are they likely to pay a reasonable return?
Answer:
Well first of all these types of investment are what are known as Structured Deposits. These are deposit accounts (which can be held in a cash ISA) which provide interest often based on the level of an index, such as the FTSE 100. This interest could be paid as income or rolled up to the end of a set term.
To give a typical example:
- full repayment of capital in 5 years time
- plus 130% gross of any growth in the FTSE 100 Index after 5 years with no upper limit.
- If the Final Index Level is equal to or lower than the Initial Index Level you simply receive your money back with no interest.
Is your money safe?
- As stated these are savings accounts where the level of interest paid is usally linked to the performance of an Index, such as the FTSE 100. As long as the product provider's deposits are covered by the Financial Services Compensation Scheme (FSCS) then your original deposit is protected, up to £85,000.
- But your money is usually locked in for a set period of time and should you pull your money out early then you could get back less than you paid in.
- Make sure you do not confuse Structured Deposits with Structured Investment. The latter offer far less protection and greater chance of capital loss.
Will they provide a reasonable return?
Essentially you are taking a bet with your interest as to whether the FTSE 100 will be higher than it is now. So whether it will pay a reasonable return is akin to looking into a crystal ball. But the real question is whether they provide value for money.
Do Structured Deposits offer value for money?
Not really because:
- the costs of these products are wrapped up in the eventual return so this lack of transparency always grates somewhat.
- But more importantly these products might appear simple but there is usually a catch if you look hard enough. For example the Index reference points are often averages (i.e. the average closing price of the FTSE 100 over the last 6 months of the contract).
- Most of the investment returns from investing in the FTSE 100 comes from dividends. Structured Deposits usually reference only the FTSE 100 Index - so you miss out on any returns that dividends would have generated over the product term.
- You might not necessarily get all the uplift in the FTSE 100 Index, often returns are capped.
- But if the Index doesn't perform as stipulated in the product's terms and conditions you will simply get back your original capital deposit with no interest. So the real value of your money will have been reduced by inflation.
However, if you really are convinced on the direction of the FTSE 100, for example, there is nothing to stop you putting most of your money in a cash ISA and a small amount in a total return FTSE 100 tracker within a Stocks and Shares ISA. That is of course assuming you are comfortable with investment risk, and the risk of capital loss within the Stocks and Shares ISA. You will then likely receive more of the uplift in the FTSE 100 while keeping most of your money on deposit.
