Category: ChrisWicksCFP

Beware of the hidden risks of low-risk investing

Most investors recognize and understand the risks involved when investing. However, during times of extreme market decline, even the toughest investors’ risk tolerance is tested. Such dramatic downturns can force many to limit their risk exposure. But, regardless of market highs and lows, investors really need to maintain perspective and proper risk to pursue their long-term financial goals.

“Low risk” investments help protect one from a decline in the overall stock market, but might leave one exposed to other risks not seen on the surface.

Risk #1: Inflation cutting your real return
After subtracting taxes and inflation, the return one receives from a low-risk investment may not be enough to remain ahead of inflation.

Risk #2: Limiting your portfolio’s growth potential
Beware, some portfolios with low-risk investments may be riskier than one realizes due to the limited growth potential of these investments.

Risk #3: Your income can drop when interest rates drop
If interest rates have dropped by the time a low-risk investment becomes due, one might have to reinvest at a lower rate of return, resulting in a lower yield each month.

A properly constructed portfolio with the correct balance between risk and return will mitigate the risks of market volatility. When deciding on how to invest, it is important for investors to take into account their personal attitude to risk and capacity for loss but also to understand the performance characteristics of different blends of equities and bonds and in particular, how their own portfolio might behave. This will ensure that when markets perform in a particular way, investors will appreciate that this is within the range of possible outcomes for their portfolio.

This is where an independent financial adviser can help by guiding investors to the correct choice of portfolio, which has the best chance of helping them achieve their goals. They can also help educate investors so that they better understand what to expect and encourage them to adopt a disciplined approach.

Pension death benefits – you can take it or leave it!

Those looking to pass on their pension fund received a boost today when the Government confirmed they’re following through on their promise to scrap the current 55% tax charge on death. This means the tax system will no longer penalise those who draw sensibly on their pension fund, making pensions a very attractive wealth transfer wrapper.

What’s changing?
Your age at death will still determine how your pension death benefits are treated. The age 75 threshold remains, but with some very welcome amendments.

Death before 75
The pension fund can be taken tax free, at any time, whether in instalments, or as a one-off lump sum. This will apply to both crystallised and uncrystallised funds, which means those in drawdown will see their potential tax charge on death cut from 55% to zero overnight. Using the fund to provide beneficiaries with a sustainable stream of income allows it to potentially grow tax free, while remaining outside their estate for IHT.

Death after 75
DC Pension savers will be able to nominate who ‘inherits’ their remaining pension fund. This fund can then be taken under the new pension flexibility and will be taxed at the beneficiary’s marginal rate as they draw income from it. Alternatively, they’ll be able to take it as a lump sum less a 45% tax charge.

What does this mean for advice?

Funding
Taken with all the other pension changes coming in April 2015, this creates a genuine incentive to save, knowing that family members can benefit from the remaining fund. It means that a pension will become a family savings plan, enabling one generation to support the next.

Drawing an income
The current 55% tax charge on death acts as a penalty for scheme members who take a sustainable income from their pension pot. The only way to delay this charge is for a surviving dependant to continue taking an income from the fund.

The option of taking a lump sum is often overlooked in favour of postponing the tax charge until the dependant’s death.

The new rules will mean that beneficiaries other than dependants may now benefit from the remaining fund, without suffering a 55% penalty.

Death before age 75 offers the option of a tax free lump sum. But it also allows the fund to remain within the pension wrapper which the beneficiaries would have flexible access to. And nominating a loved one to take over the flexible pension pot will also be a popular choice when death occurs after this age.

These changes will standardise the death benefit treatment for the different flexible income options from next April. There won’t, for example, be any difference between taking phased flexi-drawdown or phased withdrawal, as crystallised and uncrystallised funds will be treated the same on death.

Making instructions known

It will become even more important that death benefit instructions mirror the scheme member’s wishes. A nomination or expression of wish will help to guide the scheme trustees in their decision making. You wouldn’t knowingly entrust what happens to your home or other assets on death to a stranger. If there are no instructions in place, you’re relying on the pension scheme trustees to second guess your intentions. And with such wholesale changes to the death benefit rules to come, advisers will need to revisit existing nominations at their next client reviews.

All eyes on 3rd December

It’s worth stressing that more detail is awaited, particularly on the operational elements of how the new rules will work in practice. The next step is to see the full details in the Autumn Statement on 3rd December. We’ll provide updates on the final pieces of the pensions reform jigsaw, as it all starts to slot into place. Watch this space.

The Seven-Day News Diet

The financial media recently has been consumed by the issue of ultra-fast computer-driven trading and what it might mean for ordinary investors. But arguably what does the most harm to people are their own responses to high frequency news.

The growth of 24/7 business news channels and, more recently, financial blogs, Twitter feeds and a myriad of social media outlets has left many people feeling overwhelmed by the volume of information coming at them.

The frequent consequence of the constant chatter across mainstream and social media is that investors feel distracted and unanchored. They drift on tides of opinions and factoids and forecasts that seem to offer no single direction.

The upshot is they end up second guessing themselves and backing away from the resolutions they made in less distracted times under professional guidance.

Remonstrations by advisors can steer them back on track for a little while, but soon enough, like binge eaters raiding the fridge, they’re quietly turning on CNBC and opening up Twitter to sneak a peek at what’s happening on the markets.

Quitting an ingrained habit is never easy, particularly when asked to go cold turkey. But there are ways of gradually weaning oneself off media noise. And one idea is a “seven-day news diet” that eliminates the distractions a little at a time:

Day: 1 Switch off CNBC. Business news is like the weather report. It changes every day and there’s not much you can do about it. If you really want drama, colour and movement, stick to Downton Abbey.
Day: 2 Avoid Groundhog Day and reprogram the clock radio. Waking up every day to market headlines can be more grating than Sonny and Cher.
Day: 3 Read the newspaper backwards. Start with the sports and weather at the back and skip the finance pages. Small talk will be easier, at least.
Day: 4 Set up some email filters. Do you really need “breaking live news updates” constantly spamming your inbox?
Day: 5 Try “anti-social” media. Facebook is great, but it’s like a fire hose. If you want to be social, pick up the phone and ask someone to lunch.
Day: 6 Feeling the pangs of withdrawal? Go to the library and look up some old newspapers. They can give you a sense of perspective.
Day: 7 You’re nearly there. Use this window to decide on a long-term financial media diet. You might decide to check the markets once a week, instead of once a minute. The important point is to have a plan.
Those who swear off the financial media, if only for a little while, often find they feel more focused and less distracted. The ephemeral gives way to the consequential and they come away from the hiatus with a greater sense of control.

Any changes they make to their investments are then based on their own life circumstances and risk appetites, not on the blitzkrieg of noise coming at them minute to minute via media outlets.

Ultimately, going on a news diet can be about challenging our patterns of consumption and thinking more intently and less reactively about our decisions.

We can still take an interest in the world, of course, but at our own pace and according to our own requirements, not based on the speed of the information coming at us from dozens of gadgets.

In the words of the American political scientist and economist Herbert Simon “a wealth of information creates a poverty of attention”. So it follows that if you economise on your information diet, you can maximise your attention.

What price for Brazil to win?

Every four years, in the build-up to the World Cup, lots of people attempt to predict the results of the competition.

Economists at Goldman Sachs, one of the world’s biggest investment banks, suggest that Brazil is the overwhelming favourite with Argentina trailing a distant second. England has a 1.4 per cent chance of winning, according to the bank.

Stephen Hawking has used a scientific method to calculate that England’s best chances lie in a 4-3-3 formation, playing in temperate conditions, with a European referee, kicking off at 3pm. Even so, he also backs Brazil to win.

And who can forget Paul, the captive German octopus, who correctly predicted the results of all of Germany’s matches in the 2010 World Cup?

People go to great lengths to make credible predictions but it is rarely worth the effort because seldom are they accurate. A more meaningful alternative to making individual predictions is to use the aggregate of all the analysis expressed in book-makers odds. Brazil are currently 11/4 favourites.

We use this idea as the root of our investment philosophy. We do not believe it is possible to reliably predict future events and think it is a waste of money to attempt to do so. We assume that all the relevant information has been taken account of by other people and we trust the aggregate of all analysis.

That aggregate is expressed as the price of a security and is the most reliable expression of the company’s prospects and expected returns.

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Read between the (head) lines

Too often, money gets a bad press. Just in the past few weeks headlines have reported that “Yes, the stock market is rigged”[1] and “City watchdog to probe 30m financial products”[2]. At the same time, investigators are still looking into the alleged manipulation of foreign exchange rates and the rate that underpins most savings and mortgages.

It is hardly surprising that people are put off saving and investing when there are so many scandals. But it’s not all bad news: in fact, there are some very good news stories about money that will never make the headlines.
One of them is that many investors have doubled their investments in the past five years. They didn’t go to great lengths to pick the right funds, or devise a complex investment strategy. They could have spent more time digging a new flower border than poring over stock prices. All they did to achieve this great return was to hold a diverse and low-cost portfolio of global shares and stick with it.

These people have benefited from one of the most powerful wealth-generating machines in the world; the stock market. They ignored the Eurozone crisis and they ignored the lumpiness of the global economic recovery. Instead, they just sat back and watched the steady climb of their investments, while taking care not to give up any returns to bad timing or paying too much in fees and costs.

It might not sound exciting, and there are very few reporters in the world that would be interested in writing about it, but right now, all around us, are people easing their way to their financial goals.

1 http://www.msnbc.com/msnbc/yes-the-stock-market-rigged
2 http://www.bbc.co.uk/news/business-26780863

Hidden Fund Costs could damage your investment performance

Most investors are aware that their funds levy annual charges against their funds. These comprise the Annual Management Charge which ranges from 0.1% to around 1.8% or more for UK mutual funds. In addition the funds are required to publish certain additional fund charges such as custody and legal costs. These two items make up the Total Expense Ratio (TER).

Many investors are unaware of the fact that, in addition to the TER, funds incur costs in two other ways. One of these, the Portfolio Turnover Rate (PTR), is caused by the costs which fund managers incur when the buy and sell stocks. The more they do this, the greater the PTR. In the UK the estimated cost of a sale and purchase is around 1.8%, when Stamp Duty is taken into account. The average UK fund turns over its portfolio by around 100% a year, thus adding around 1.8% onto investors’ costs. Many funds have PTRs of twice or more this level.

A further area in which investors can incur costs is the price at which funds are able to deal in their shares. Generally shares are offered for sale or purchase by market makers in batches of say, £250,000 or £1Million. On dealers’ screens the best priced batches are generally shown at the top of the list with prices getting worse further down the list. A fund needing to offload £10Million of a particular stock could therefore find its self selling via a number of market makers and not all at the best price available on the market. This can be a substantial hidden drag on fund performance, especially for very large funds or those which trade actively.

So what can be done about this? Bearing in mind that the method of access to the market (fund selction) is very much a secondary decision, well behind Asset Allocation, the optimum way to keep fund costs down is to invest in passive or tracker funds. These can be expected to provide returns in line with the performance of the market at low cost. In addition certain passive funds engage in dealing strategies designed to optimise the price at which deals are carried out.

Changes to Early Retirement Rules

On 6th April 2010 the minimum age at which you can access your pension benefits will increase from 50 to 55.

Both your employer’s pension schemes (past or present) and any individual pension plan’s you hold will be subject to the new rules. From 6th April 2010 therefore, you will not be able to access pension benefits unless you are at least age 55.

There are some very limited circumstances where retirement prior to age 55 will still be allowed after this date which are detailed below:

1. Some sportspeople/those in hazardous occupations or those who had a ‘contractual right’ to an early retirement age as at December 2003.

2. Those individuals who are in ill health can still apply to take benefits early and the scheme trustees will determine, following a medical report, whether it will be granted.

In the majority of cases, it is more worthwhile to leave your pension benefits to grow for as long as possible. However, if you need to access some or all of your pension benefits early, between the ages of 50 and 55 you should contact your financial adviser as soon as possible for further guidance.

For the avoidance of doubt, this could affect you if your date of birth is between 7th April 1955 and 5th April 1960.

Top firms’ pension funds plummet

The BBC today reported that the top 100 UK firms have a combined shortfall on their Final Salary pension funds of £96Billion (yes Billion!). This represents a deterioration from a combined deficit of £41Billion at the same time last year. Most of the fall in value has been attributed to falls in share prices but changes in the assumptions, which are used to determine the level of funding needed to meet promised benefits, have also had a significant bearing. In some cases the value of the underfunding actually exceeds the value of the company.

The BBC article goes on to suggest that this will lead to more schemes being closed to new members. Of the top 100 companies, only three still offer Final Salary Pensions to new members. If you are interested, they are Cadbury, Diageo and Tesco.

What the article does not mention is that there are many more Final Salary pensions, mostly held on behalf of small to medium sized employers (and most people in Britain work for one of these rather than a top 100 firm). These will also be suffering from substantial deficits. The difference between a lot of the smaller firms and the top 100 firms is that they are often privately owned and therefore do not have the same access to additional capital as companies that are quoted on the Stock Exchange.

The issue with the smaller companies, who will be feeling the pinch every bit as badly at the moment is that, they are more likely to go bust and therefore be unable to make up the under-funding on their pension funds. Where this occurs the benefits will come under the auspices of the Pension Protection Fund, about which I have blogged before Protection for Final Salary Scheme Benefits could be under threat.

To cut a long story short, the PPF provides limited protection which, over time, can fall substantially short of what was originally promised. Furthermore, due to potential difficulties with funding the protection (based on levies charges to the remaining schemes which are already in financial difficulties) PPF benefits could need to be reduced in future.

So what should you do if you have final salary benefits either with your current or a previous employer? Well, for certain you should obtain details of the Transfer Value and the benefits to which you are entitled. These should be reviewed on your behalf by a pensions specialist (who will also take a whole range of other factors into account such as the state of funding of the scheme and the financial health of the sponsoring employer, amongst others). From this you will be able to form a realistic assessment of the safety of your benefits and whether you ought to move them to an arrangement that provides you with greater personal control.

If you are a financial adviser reading this article and you are not qualified to provide Pension Transfer Advice, consider referring your clients to an adviser who will work with you to ensure that your client’s needs are met in this regard.

Regulators tell Solicitors to only refer to Independent Financial Advisers

New guidance has been issued by the Solicitors’ Regulation Authority (SRA) stating that Solicitors must not refer clients to tied or multi-tied advisers; i.e. advisers who are not truly independent.

The SRA has stated that it is aware that some law firms have been approached by multi-tied and tied advisers seeking to enter into restrictive arrangements to provide financial services to the law firms’ clients. It reiterated that firms must always act in the best interests of their clients. This means that they must refer clients to independent financial advisers for investment advice.’

According to Sifa (the body representing independent financial advisers who specialising in working with law firms), there is confusion among solicitors about the status of financial advisers and this has resulted in widespread breached of the Solicitors’ Code of Conduct. Sifa said it had received numerous calls from IFAs reporting instances of solicitors referring clients to St James’ Place.

This was a subject alluded to in an earlier Blog entitled Confusion on Sources of Financial Advice I have also commented here in more detail about the differences between Independent and Tied Advice.

So, if you are a Solicitor or indeed anyone seeking financial planning advice make sure that you ask the adviser whether they are genuinely independent. Solicitors can be sanctioned for failing to do so and individuals are likely to suffer from a restricted choice and, in all probability, high charges

Top 10 Tips for investing in a recession

The Telegraph on 17th July published a list of tips for investing in a recession, which included a contribution by me!

For top investment tips click here

In summary, my view is to be systematic and disciplined … and keep costs down.