RBS is being too clever by half

Steer clear of a new investment product from Royal Bank of Scotland. It sounds good when you first hear about it but the complexity should put most people off.

Royal Bank of Scotland has launched a new investment product that aims to give you the best of both worlds. In other words, it’s designed to be safer than investing in conventional shares whilst offering a higher return that cash. The product is called the RBS UK 10% Autocall. Until 17 March, you can only buy it from Barclays Stockbrokers.

So how does it work?

Well, that’s the first problem with this product. It’s complex and hard to understand. At lovemoney.com, we believe that simple products are normally the best option. If you don’t fully understand what you’re buying, you’re more likely to buy something that isn’t appropriate for you and your needs.

Anyway, let me try to explain how it works. Basically, this is a product with a maximum five-year term which may give you a return of up to 10% a year. 

So let’s imagine you buy the Autocall product on 14 March 2011 when the FTSE 100 stands at, say, 6,000 points. (I’m writing this article prior to 14 March.)

If, on 14 March 2013, the FTSE 100 is at 6,000 or above, the certificate will automatically wind up and you’ll get your money back plus 20%. That sounds pretty good. If the Footsie only rises 2% over the course of the next two years, you’ll get a 20% return!

Now let’s imagine that the Footsie is actually lower than 6,000 on 14 March 2013. In that case, your money remains locked away for at least another year. The product is reviewed again on 14 March 2014, and if the Footsie has now gone over 6,000, you’ll get your money back plus 30%.

If the Footsie has fallen over the three-year period, there’s another review in March 2015. If the Footsie is now above 6,000, you’ll get your money back plus 40%.

But what if the Footsie is still below 6,000 in 2015? Then there’s a final review in March 2016 when there are three possible outcomes:

-          You get your money back plus 50% because the Footsie is now finally at or above 6,000

-          You get your money back as long as the Footsie has always closed at or above 60% of the starting level. (60% of 6,000 is 3,600.)

-          You get less than your original investment back. This happens if the Footsie has at any stage over the five year period fallen below 3,600 points.

So let’s look at the pros and cons of this product:

The pros

If the Footsie rises gently over the next few years - say at 2% a year – the Autocall product will give you a better return than a tracker fund which replicated the performance of the Footsie.

You’ll also get some peace of mind in that the chances of you losing money are reduced. But you still could lose money.

The cons

The scenario where you’d lose money is if there was another stock market crash and the Footsie fell below 3,600 points. (Strictly speaking, it’s not 3,600 points, it’s 60% of the starting index level when you bought your Autocall product.) Autocall protects you against modest falls in the stock market – in which case, you get all your money back. But if there’s a big fall in the stock market, you can potentially lose money.

And don’t assume that stock markets can’t fall that much. The Footsie went below 3,600 points in early 2009.

I suspect most people don’t lose sleep over losing 5% or 10% of their money. But they do worry about big crashes where they might lose 40% or 50% of their money. But the Autocall doesn’t give you full protection from those kinds of crashes - the ones people worry about.

What’s more, your money is locked away and you don’t know how long that lock-in period will last. It could be two years or it could be as long as five.

And then there’s the 10% return. It’s good but perhaps not quite as good as it seems at first glance. The return is 10% after one year, but in future years, compounding means that the annual return falls. So after year 5, the annual return is 8.4%. If you look at stock market performance over the last 50 years, stocks and shares have delivered an average real return of around 5.5% a year (including dividends.) If you add in inflation of 2.5%, that’s an average return of around 8% a year. So Autocall is offering a return that is only slightly higher than the long-term average.

And who knows? The stock market might do really well over the next five years and then you wouldn’t get all the profit.

On top of all that, don’t forget that some similar structured products collapsed completely during the financial crisis. Investors did eventually receive compensation but they had a long wait and plenty of stress before that happened. For that reason alone, I’d steer clear of any structured product.

So for me, there’s no way I’d go near this product. It’s too complicated and it doesn’t even offer me 100% protection from a stock market crash. I prefer to have total control over my money and with luck, I may be able to grow my money by more than 8% a year.

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