Saturday, October 17, 2009

Guaranteed products

Some people like to have guaranteed products. They may not realise that these products are "guaranteed to lose".

Suppose you buy a product that is guaranteed to give you a yield of 5% over 20 years. Is this a good product?

If there is high inflation in the future, the value of your investment will drop. You are locked into a product with a low yield, compared to the market rates. The issuer of the product makes a big profit.

If interest rate drops to near zero, like in Japan for many years, will you benefit by getting the guaranteed 5%? Maybe not. If the issuer is not able to meet its obligation, they will declare bankrupcy. You lose again.

Do not buy a guaranteed product unless it is backed by a financially strong institution. Do not buy a "guaranteed product" which may be "guaranteed to lose".

This is why I prefer to buy an exchange traded fund of equities and keep it for the long term. It has liquidity, transparency and diversification. It does not provide any guarantee, but is likely to give a better yield than any guaranteed product.

Note on Exchange Traded Fund (ETF)
There are several ETF available in the Singapore Exchange. The most well known is the STI ETF which is intended to track the performance of the Straits Times Index. It offers diversification into several large stocks and has low annual fee of 0.3%. You have to ask your stockbroker about the ETF or attend a briefing organised by SGX.