"Safe" investments can prove risky

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Savings inflows to building societies have set a new record, the latest figures from the Building Societies Association (BSA) show.

Some 1.26 billion pounds flooded into cash savings accounts in March, up 70 percent on a year ago.

That is the latest in eight months of outstandingly high savings figures for building societies, which has helped them ride out problems in wholesale money markets, from which they receive around 30 percent of their funding.

"Against the current uncertain economic climate, building societies are seen as tried and tested, traditional and trusted," says Adrian Coles, director-general of the BSA.

"Together with the competitive rates of interest they offer, these attributes mean societies continue to attract record levels of savings."

But contrary to popular belief, savings accounts are not always a low risk option - and could even be seen as a risky choice for long-term savers.

That is the view of Jonquil Lowe, author of "Save and Invest", a book from consumer group Which-

In the wake of the Northern Rock crisis, falling property prices and a volatile stock market, consumers are seeking out safe havens for their cash - but, by doing so, they might lose out on thousands of pounds in the longer term, says Lowe.

"There is no such thing as risk-free saving," she says. "Even sticking cash under the mattress is a fairly risky strategy, as your capital will be seriously eroded by inflation over time.

"For short-term savers, a cash ISA (individual savings account) or other high-interest savings account is a good option. But for those savers who are looking at a longer period of time and are willing to be a bit more adventurous, other options could give a greater return."

Although there is little or no risk that people will lose their money in a cash-based savings account - the Financial Services Compensation Scheme covers deposits of up to 35,000 pounds per provider should it go under - beating inflation can prove tricky, particularly for higher-rate taxpayers.

If inflation runs at 4 percent per year and you invested in an account paying gross interest of 6.4 percent, higher-rate taxpayers would get a return of 3.84 percent after tax - lagging inflation by 0.15 percent.

Returns are, also, generally too low to achieve major long-term goals, such as saving for retirement or paying off a mortgage. Those planning to tie up funds for a decade or longer should look to "riskier" options, such as shares, and spread their money across a range of asset classes to mitigate risk, says Lowe.

Data from investment fund analyst Moneyspider.com shows that "low risk" UK money market funds are also delivering poor - and in some cases negative - returns.

The sector, as defined by the Investment Management Association (IMA), includes funds that invest at least 95 percent of their assets in money market instruments - cash and near-cash, such as bank deposits, certificates of deposit, very short-term fixed interest securities and floating rate notes.

Retail investors poured 138.6 million pounds into the sector in February alone, giving a total 5.4 billion pound investment.

That ranks the sector second only to the UK All Companies sector in terms of size, according to the IMA.

However, the largest fund in the money market sector - Threadneedle's UK Money Securities - has produced negative returns over the past three and 12-month periods.

It has fallen more than 3 percent in the year to end-March, and has returned less than 10 percent over five years - failing to keep pace with inflation.

In contrast, risk-adverse investors can obtain returns of more than 6 percent on tax-free cash ISAs offered by high street banks and building societies: National Counties Building Society and Alliance & Leicester both currently have accounts paying 6.26 percent, according to Moneyfacts.co.uk.

"Most people probably do not realise that money market funds can actually fall in value," says Tony Ahearne, a director of Moneyspider.com, which monitors and ranks the 2,000 unit trusts and open-ended investment companies (OEICs) available to British retail investors and rates them against funds in the same sector, all funds, returns on the FTSE 100 and cash yields.

"It's crucial to recognise that these are not simply cash schemes, but funds which are exposed to market volatility - and the market is, as we know, currently very turbulent."

Instead, private investors could help to safeguard their capital and reduce risk by including funds of hedge funds in their ISA and self-invested personal pension (SIPP) portfolios, says independent financial services group Killik & Co.

Contrary to the racy image of hedge funds - likely to continue being a riskier strategy with higher barriers to entry through direct investment - a fund of hedge funds approach dilutes risk and produces absolute returns over time with less volatility than equities.

That holds true to the traditional meaning of hedging as a way to protect against stock market falls, says Mick Gilligan, director of fund research at Killik.

"ISA and SIPP-qualifying 'absolute return' funds using hedging strategies, such as Close AllBlue, made a net asset value gain of 5 percent in the first quarter 2008 despite the FTSE falling 8 percent during the same period," he says.

"The ability to move ISA money into hedge funds as a means of diversifying risk and reducing portfolio volatility should not be overlooked."

Until recently, it was not possible to include hedge funds in ISAs, but the emergence of a hedge fund sector on the London Stock Exchange and wider hedging powers of unit trusts and OEICs now make this an option.