30 July 2012

More About Risk

I spend a lot of time considering and explaining risk in connection with my investment advice. Most of the time we are using "risk" as a shorthand to mean "volatility" - for example, higher "risk" investments are expected to go up and down in value more, but over the long term they are also expected to rise further than lower risk investments.

However, there is more to risk than that. Here's my summary - each of these may need to be considered before investing:
  • Volatility (capital) - how much will the investor see their invested value go up and down? Or, to put it another way, what is the likelihood that it will be down when they want to surrender their money?
  • Volatility (income) - if a regular income is being taken, how well can the investor cope with a variable income?
  • Capital loss - how likely is it that some or all of the value will be permanently lost? You could invest in a small company (low volatility = low "risk" in theory) but your investment could be lost entirely if the company fails
  • Inflation risk - how much of a problem could this be for the investor?
  • Liquidity risk - is it possible that you will not be able to surrender when you want to?

16 July 2012

The Value of Advice

I'm always keen to make sure that my clients get good value when paying for financial advice.

That ideally means that they can see how much better off they are having paid for advice than if they hadn't. Often that is easy to see looking back but is not so easy to be sure about beforehand! Offering "guarantees" is a bit of a "no-no" in the financial world and you can't always be sure what the outcome will be in any case. But on the other hand it can be quite easy to demonstrate in retrospect.

As well as being financially better off, financial advice clients often receive other benefits, including being better protected by insurance, being more confident that they are doing the best for themselves, or reducing the likelihood of a large Inheritance Tax bill on their death, ... to give a few examples.

Here's a list of some achievements (2011) which I included in a recent newsletter. Clients are real but I've changed their names:

Tim and Sarah got 30% more pension income by taking advice, rather than just taking the annuity offered by their pension provider.
Payment from a Critical Illness policy was beneficial to John. After a heart attack he was able to pay off his mortgage.

Paul retired earlier than he had expected. We were able to show him that taking his final salary pension early was worthwhile in the long term, even though the monthly income was lower.

The value of Mike’s investment immediately increased by 25% when he made a lump sum pension contribution, thanks to tax relief.

Clive and Hannah ensured that they would pay less tax in future by moving some existing investment funds across into their ISAs.

Tom and Penny are retired - they increased their income by moving a matured National Savings investment into funds paying an income.

Damian and Carol are still working, and don’t expect to call on their investments just yet. They put aside a lump sum for up to six years in a “kick-out” structured product. They expect a good return in due course (11% per annum).

Philip and Edith are uncomfortable with their investments going up and down too much. A product with a guarantee ensures that their investment will never be worth less than 90% of the amount invested.

Gareth and Sally are not far off retirement but had accumulated various savings and investments which were under-performing. They consolidated onto a platform in ISAs and a new pension plan.

11 July 2012

Auto-enrolment Pensions - Snippet #6

What Pension Scheme Should We Use?
In the early days of auto-enrolment some people thought that all employers had to provide a government-backed pension scheme called (at the time) "Personal Accounts". That isn't the case, and that scheme - now called NEST - is just one of the options to satisfy the auto-enrolment requirements.
In fact, it is perfectly possible to provide a number of different schemes for different types of employee, and that's the route that many are likely to take. So here's a quick summary of the main possibilities:
  • An existing company pension scheme - provided it meets the qualifying criteria
  • A new company pension scheme - some providers are likely to offer additional admin support to employers in meeting their obligations around enrolling staff
  • NEST - a basic scheme for the masses with low costs (although some would argue that point)
  • The Peoples' Pension - another  basic scheme

9 July 2012

Too Little Carr Tax

Following the theme of my previous blog about culture and morality in the financial world, comedian Jimmy Carr's tax affairs have raised some important questions in that area.

For many, it has simply been too easy to condemn his approach of reducing his tax bill. The problem is that he has done nothing illegal. To condemn his approach means that we end up with three levels of legality - illegal, legal but bad, legal and good. The trouble is that the law only has two levels - legal or illegal.

Any further refinement is always going to be subject to the variable whim of public opinion. What about using your ISA allowance to reduce the tax you pay - is that OK? What about making additional pension contributions to obtain tax relief - is that OK? What about shifting the ownership of assets between spouses to reduce tax - is that OK? ... and so on.

Ultimately it should only be the law which judges what is acceptable. Otherwise we all end up open to prosecution at some point in the future - financial advisers particularly! - when the wind of opinion changes direction.

Public opinion should result in a change to the law, not in judgements handed down by the tabloid court!

7 July 2012

Financial Culture and Morality

Two recent news stories have brought the subject of corporate culture and financial morality to our attention.

Firstly there is the Barclays LIBOR-fixing scandal and the corporate culture that seems to have prevailed there. If individuals are prosecuted (and that is probably the right thing to happen) then it would be interesting to know whether those individuals were aware of the consequences of their actions - sufficient to make their own judgements about whether they were engaged in wrongdoing or not. I suspect that they were, although it's possible, I suppose, that they did not understand the full ramifications of their job.

But the larger responsibility must remain with their employer - Barclays, and perhaps other banks yet to be revealed - who gave them a globally significant job to do without sufficient monitoring and, more to the point of this blog, within a corporate culture which apparently did not include the appropriate level of ethics.

I suspect that there are many similar situations in the financial world, and only when something goes publically wrong or is somehow brought to light will we all be outraged yet again.

What is needed is a responsible and ethical culture. But that needs more than a quick training course, for example. It's a question of changing attitudes and culture. And that takes time. The sooner that individual financial institutions have less of an impact on all of our lives the better. They are currently hardly worthy of our trust.

And the second news story? That'll be my next blog.

5 July 2012

Auto-enrolment Pensions - Snippet #5

Who does it apply to?
The legislation talks about "jobholders". What does that mean? The main category includes employees between the ages of 22 and State Pension Age, who ordinarily work in the UK, and earn over £8,105. These are "eligible jobholders" and employers' obligations fully apply to them, although individuals can choose to opt out.

Secondly we have "non-eligible jobholders". These are people not covered above who are between 16 and 22, or State Pension Age and 75, and who earn at least £5,564. These people are not auto-enrolled but can choose to opt in - which means that the employer must make their pension contributions.


Thirdly we have "entitled workers". These earn less than £5,564 and are aged 16-75. They do not belong to the auto-enrolment regime but there are still some employer obligations re pensions.

Of course, people move between those categories. When someone reaches 22 for example, they have to be auto-enrolled, and there are rigid processes to follow within defined timescales.

2 July 2012

Auto-enrolment Pensions - Snippet #4

How much do we have to contribute?
There are 3 basic contribution models of which the first one is the baseline. Here we are talking about the minimum contribution levels. Many employers already make higher contributions, and bearing in mind that this is benefitting your employees, don't just think how little you can get away with! (even though that may be the initial plan).

Option 1:Total contribution at least 8% of "qualifying earnings"
The employer must contribute at least 3% of this (but could choose more), with the employee having 4% deducted from their pay, with the remaining 1% coming from tax relief.
Qualifying earnings includes earnings in a band between £5,500 and £42,500 (roughly), and must include overtime, bonuses, statutory sick / maternity pay, etc..

Option 2: Total contribution at least 9% of "pensionable salary"
The employer must contribute at least 4% (but could choose more), with the employee having 4% deducted from pay, with 1% from tax relief.
Pensionable salary must be at least basic pay, but doesn't have to include variable pay like overtime and bonuses.

Option 3: Total contribution at 7% of all earnings
The employer must contribute at least 3% (but could choose more), with the employee having 3% deducted from pay, with 1% from tax relief.

And finally, although the minimum contribution levels are as above, they can be phased in. For example, if the 3% employer contribution model applies, until September 2017 an employer must contribute at least 1%, then until September 2018 it's 2%, up to the final 3% after that.

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