Tuesday, June 12, 2007

Capital protected products

Dear Mr Tan,

I like the financial products that guarantee no loss of capital and the chance to earn a good rate of return, better than deposit rate.

How do I calculate the chance of getting a better return, and the amount of that return?

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REPLY:

If you wish to have a safe investment, you should buy government bonds and earn 3% per annum, or 15% in 5 years.

If you buy a specially structure product, you are taking a gamble. If the gamble is 5% up or down, you stand the chance of earning between 10% to 20% for 5 years - before deducting expenses.

The charges for designing and marketing this product can take away 10% for the 5 years. So you may get an average return of 5% for 5 years. The actual return could be between 0% to 10%.

To make it more attrative, the financial engineers, working for the issuer of the product, can give you a 75% chance of earning close to 0% and a 25% of earning a better return, that can go up to (say) 20% for 5 years (or just 4% per year). They advertise the potential return of 20%, but does no tell you that the chance of achieving it is quite small.

Many investors in these financial products have earned a poor return, close to 0% for the past years.

Lesson: If you want a safe return, buy government bonds and earn 15% for 5 years. Do not spend money to buy other product that eats into the return.

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