Investment protection is a term that refers to the measures taken by investors to safeguard their assets from various risks. These risks can include market fluctuations, inflation, currency depreciation, fraud, theft, bankruptcy, litigation, political instability, regulatory changes, and more.
Investment protection is important for investors because it can help them preserve their capital, reduce their losses, enhance their returns, and achieve their financial objectives. Especially in times of market volatility and uncertainty, investment protection can provide investors with peace of mind and confidence.
There are many types of investment protection available for investors. Some of the most common ones are:
- Insurance
- Compensation schemes
- Diversification
- Hedging
- Legal remedies
In this article, we will explain what each type of investment protection is and how it works. We will also discuss the benefits and limitations of each type and provide some examples. By the end of this article, you will have a better understanding of what investment protection is and how to use it effectively.
Key Takeaways
| Type | Definition | Example | Benefit | Limitation |
|---|---|---|---|---|
| Insurance | A contract that transfers the risk of loss from an investor to an insurer in exchange for a premium | Life insurance that pays out a lump sum in case of death | Can cover a wide range of risks and losses | Can be costly and may not cover all scenarios |
| Compensation schemes | A fund that compensates investors for losses incurred due to the failure or misconduct of a financial institution or adviser | The FSCS that covers up to £85,000 per person per firm in the UK | Can provide a safety net for investors in case of insolvency or fraud | Can have eligibility criteria and coverage limits |
| Diversification | A strategy that allocates investments across different asset classes, sectors, regions, currencies, etc. | A portfolio that consists of stocks, bonds, commodities, real estate, etc. | Can reduce the overall risk and volatility of a portfolio | Can lower the potential return and require rebalancing |
| Hedging | A strategy that uses derivatives or other instruments to offset the exposure to a specific risk | A put option that gives the right to sell an asset at a predetermined price | Can protect against adverse price movements and lock in profits | Can incur a cost and may not be fully effective |
| Legal remedies | A course of action that can protect investors’ rights and interests in case of a dispute or breach of contract | An arbitration clause that allows investors to resolve disputes with a third-party arbitrator | Can enforce contracts and seek compensation or restitution | Can be difficult to access and may not be fair or efficient |
Insurance
Insurance is a form of investment protection that involves a contract between an investor and an insurer. The investor pays a premium to the insurer, and the insurer agrees to pay a certain amount of money to the investor or a beneficiary in case of a specified event or loss.
Insurance can cover different types of investments and risks. For example, some common types of insurance products are:
- Life insurance: This type of insurance pays out a lump sum or an annuity in case of death or terminal illness of the insured person. Life insurance can protect the financial security of the dependents or beneficiaries of the investor.
- Property insurance: This type of insurance covers the damage or loss of property due to fire, theft, natural disasters, vandalism, etc. Property insurance can protect the value of the physical assets of the investor, such as a home, a car, or a business.
- Liability insurance: This type of insurance covers the legal liability or responsibility of the investor for causing harm or damage to another person or property. Liability insurance can protect the investor from lawsuits and claims that may arise from their actions or negligence.
- Health insurance: This type of insurance covers the medical expenses or costs of the investor or their family members due to illness, injury, disability, etc. Health insurance can protect the health and well-being of the investor and their loved ones.
- Travel insurance: This type of insurance covers the travel-related risks or losses of the investor, such as trip cancellation, flight delay, baggage loss, medical emergency, etc. Travel insurance can protect the travel plans and experiences of the investor.
The benefits of insurance as a form of investment protection are:
- It can cover a wide range of risks and losses that may affect the investor’s assets, income, health, or lifestyle.
- It can provide financial compensation or support to the investor or their beneficiaries in case of an unforeseen event or loss.
- It can reduce the stress and anxiety of the investor by giving them peace of mind and confidence.
The limitations of insurance as a form of investment protection are:
- It can be costly and may not be affordable for some investors. The premium amount depends on various factors, such as the type, amount, and duration of coverage, the risk profile and history of the investor, etc.
- It may not cover all scenarios or events that may cause loss or damage to the investor. The insurer may have exclusions or limitations on what they will pay for or under what circumstances they will pay. The investor should read the policy terms and conditions carefully before buying insurance.
- It may involve a complex and lengthy claims process that may require evidence, documentation, verification, etc. The insurer may deny or delay paying out the claim if they find any discrepancies, errors, fraud, etc. The investor should follow the claims procedure and keep all relevant records.
Compensation schemes
Compensation schemes are another form of investment protection that involve a fund that compensates investors for losses incurred due to the failure or misconduct of a financial institution or adviser. These schemes are usually established by governments or regulators to protect investors from insolvency or fraud.
Compensation schemes can cover different types of investments and financial services. For example, some common types of compensation schemes are:
- The Financial Services Compensation Scheme (FSCS) in the UK: This scheme covers deposits, investments, pensions, insurance policies, mortgages, etc. that are provided by UK-regulated firms. The FSCS can pay up to £85,000 per person per firm for deposits and investments1.
- The Securities Investor Protection Corporation (SIPC) in the US: This scheme covers securities (such as stocks and bonds) and cash held by US-regulated brokers or dealers. The SIPC can pay up to $500,000 per customer per firm for securities and cash2.
- The Canada Deposit Insurance Corporation (CDIC) in Canada: This scheme covers deposits (such as chequing and savings accounts) held by Canadian-regulated banks and other financial institutions. The CDIC can pay up to $100,000 per depositor per institution for deposits.
- The Deposit Protection Scheme (DPS) in Hong Kong: This scheme covers deposits (such as current and savings accounts) held by Hong Kong-regulated banks. The DPS can pay up