Beware of banks that target the novice investor

Published by Sally Hamilton on 16 August 2011.
Last updated on 17 August 2011

Piggybank target

Novice investors are the plankton at the bottom of the food chain, ensuring the big fish of the investment world - the banks, investment houses and insurers - are well-fed.

Sales staff and adverts lure large numbers into buying their mass-market ISAs, funds, structured products and investment bonds with soothing words like 'secure', and 'protected'.

But once you swim within range and your commission is digested, the jaws snap shut.

Patrick Connolly, spokesperson at IFAs AWD Chase de Vere, warns: "The products come with misleading comfort words such as 'cautious' or 'balanced,' which can confuse people as to where they are invested and lead them into taking more risks than they realise."

Dennis Hall, managing director of independent financial adviser Yellowtail Financial, says this is a particular peril for first-time investors visiting their banks. "They package up products in such a way as to be all things to all people, and try to squeeze all their customers into one product," he explains.

This may come at a high cost. As Jason Witcombe, director of Evolve Financial Planning, says: "Novice investors never really look at the charges on their funds. When we show them how much they're paying in charges, they're shocked."

So, if you're new to investing, what are the baits you should beware of?

Read: A beginner's guide to investing in the stockmarket


Designed to give customers higher returns than on standard deposit accounts, these plans are usually linked to the performance of a stockmarket index and offer capital guarantees. The drawback is that your money is tied up for five or six years, with the maximum returns you can earn usually capped.

There's also a risk that you can lose everything if the company underwriting the plan (the counterparty) goes bust. 

These investments have earned a poor reputation, partly because the now-defunct Lehman Brothers was the bank behind plans which left thousands of investors high and dry, and partly due to a variety of structured products dubbed 'precipice bonds', sold in large volumes in the early 2000s. These did not offer adequate downside guarantees; investors lost serious money and the banks were landed with bumper mis-selling fines.

Justin Mowbray, founder of financial website Candidmoney, says: "I get worried when I see banks and building societies selling these products, as I doubt many staff or customers actually understand how these plans work.

"To make matters worse, the banks and building societies seem to be pocketing top-whack commissions: Nationwide receives 7% for selling a Legal & General plan; Santander, around 6.8% for selling its own plans; and Yorkshire Building Society, 4% for selling a Credit Suisse product. The typical commission paid to financial advisers is 3%."

However, you should be able to find one of the decent plans around - so long as you make sure you take independent financial advice first. There are also plenty of alternatives.

Swap for...

• High-interest deposit accounts (currently up to 4%). Hall says: "Look at fixed-term savings bonds or those with temporary bonuses. Keep on your toes and shift your money to another deal when the term or bonus is up."

• Corporate bond funds also offer higher income than savings accounts, and although your capital is at risk, they are more flexible and easier to trade than structured plans. 

National Savings & Investments index-linked bonds are risk-free and tax-free. The current issue pays interest (an average of 0.5% a year), plus inflation-linking over five years, and you can access your money early if necessary, although you'll lose some of the interest.


Some of the biggest actively managed funds plugged by sales staff are the most lacklustre performers, whether they stand alone or are packaged as tax-efficient ISAs.

"Novice investors are often pushed into an actively managed fund that's no more than a pseudo-tracker, with higher charges," says Hall.

"These funds are often sold in an ISA wrapper on the back of the tax advantages. But for basic-rate taxpayers, there may be little value to investing through an ISA, as share dividends are taxed at source anyway [only higher-rate taxpayers will see a tax saving on dividends], and everyone has an annual £10,600 capital gains tax allowance to offset against gains."

So-called 'cautious' and 'balanced' managed funds are also a popular choice for the inexperienced investor. But Connolly says: "They imply security, and there are some good funds in this group. But for some investors, a fund with 60% invested in shares does not have a 'cautious' approach; similarly, 'balanced' managed funds can have up to 80% in shares - which isn't particularly balanced."

Swap for... 

• A genuine tracker fund is a computer-driven passive fund that mirrors an index. Annual charges are as little as 0.25%, compared with 1.5% plus for active funds. But novices need to remember that these funds will mirror a crashing as well as a booming index.

• Consider a corporate bond fund ISA where the income generated, in contrast to share dividends, is paid entirely tax-free.


Funds that consist of a basket of other funds sound like the perfect solution for the beginner who wants to spread risk. These funds are either 'fettered', investing in the manager's own in-house funds, or 'unfettered', holding funds from different managers. However, their high charges dent returns. 

David Norman, founder of TCF Investment, which specialises in low-cost passive funds, says: "Spreading risk across equities, bonds, property, and even different managers makes sense, but charges levied by the multi-manager and the underlying managers can total about 2.4% a year. Take into account trading costs, and you can add in a further 2% a year. That's expensive."

Swap for...

• Your own multi-manager fund. Norman suggests checking the asset allocation of a leading cautious managed multi-manager fund, for example, and mimicking the contents using low-cost trackers bought through discount brokers or fund supermarkets.


These insurance-based investments, which earn sales commission of typically 5% to 8%, are plugged as a simple and potentially tax-efficient way to hold diversified investments in one place. But while they may suit some investors, critics dislike their opaque charging structure. 

Hall also warns that the bonds are of little benefit to basic-rate taxpayers and of no benefit to non-taxpayers, as income and CGT in the fund are paid by the insurer and so reduce returns.

"Only higher-rate taxpayers who expect to be on the basic rate when they cash in the bond may benefit. The rules let you take out 5% a year while you hold it, without being taxed."

But if you're over 65 by the time you cash in the bond, your age-related personal tax allowance for that year may be reduced.

Swap for...

• Your own diversified fund or mix of unit trusts or open-ended investment companies instead, inside or outside an ISA.

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