Pensions

Managing investment risk

Money that may be needed in a specific short term time frame is usually held as cash deposits. The worry that cash may not keep pace with inflation is of less concern as the money is, in effect, an immediately accessible reserve. However, if your time frame extends beyond the immediate to say three years or more, it can be well worth consulting an Independent Financial Adviser -IFA to see what opportunities may be available to achieve returns that exceed inflation.

For many the idea of risking savings in the stock market can be a cause for concern. It may be tempting simply to leave your money on deposit.  Every investing decision you take – including staying out of the market altogether – carries risk. The key is understanding which risks you can afford to take, and which you should avoid.

Let us look at the main types of risk.

Opportunity cost and inflation risk

If you keep your money in low-risk, low-return assets, there are two big risks. First, you sacrifice the returns you could be making if you had invested elsewhere. Worse still, your wealth could be eaten up by inflation. For example, if you try hard, you might get a return of around 2% on cash savings today. But prices (measured by the retail prices index) are currently rising at around 3% a year. So after a year, your savings will buy you fewer goods and services. They’ve lost value in ‘real’ terms and we have not even factored in the impact of taxation which can reduce the returns further.

The same is true of the tiny returns on so-called ‘risk-free’ investments such as UK government bonds (or ‘gilts’). The government is unlikely to go bust: it will always be able to pay you back, even if it has to print the currency to do so. But with bond yields well below inflation, every day you hold gilts, you risk losing money in ‘real’ terms.

Liquidity risk

Timing matters in investing. If you are close to retirement, for example, you should focus not just on the return on your money, but also the return of your money. In short, you need liquidity – the ability to get out of a position quickly, at minimal risk of loss. Some assets are far more liquid than others. Big blue-chips can be bought and sold on the market easily and at low cost, even in the toughest conditions.  Smaller company stocks and bonds aren’t as easy to offload. And buying and selling property takes weeks or months, not seconds.

So, when you look at your portfolio, ask yourself: “How easily can I get out of this asset at short notice? And how likely am I to need to do so?” If you have sufficient ‘liquidity’ elsewhere you can retain investments rather than being a forced seller in a falling market.

Price risk

Asset prices go down as well as up. This may discourage many investors from the likes of equities. So they buy ‘low-risk’ investments. If your financial goal (usually retirement) is a long way off this can be a mistake.  If you have 20 or 30 years to go, you can afford to take lots of risk early on, aiming to earn a decent return.

Also, you should positively welcome falling share prices: the further they fall, and the cheaper they get, the more you can afford to buy.  Indeed when saving for the long term, say in a pension or an ISA, ‘pound cost averaging’ is vital. The key point about pound cost averaging is that you invest small amounts on a regular basis. This means that when prices are high your monthly contribution may buy fewer shares or fund units, but when prices are low your investment buys more shares or fund units.  Buying cheap assets with the potential to offer big long-term returns is the secret to growing your retirement pot.

You can afford to tolerate a bit of price risk in the meantime. The best way to deal with it is to spread your money across different asset classes. For example, inflation is usually bad for bonds (as most pay a fixed income), but it can often be good for shares, as long as the companies you own can raise prices to compensate.  A good IFA will construct a portfolio based on a core asset allocation which he will use as a point of reference to manage the risk associated with individual investments.

Regret

Regret is an emotion of pain and anger when you think that you have taken a bad decision in the past and could have taken one with better outcome. In financial markets we experience regret when we sell an investment and subsequently see the price rise further or we fail to sell an investment that is showing a good profit only for the price to subsequently fall. We look back at what was rather than what is!

Regret is such a powerful negative emotion that the prospect of its future experience may lead some people to make non-rational decisions relative to their present situation.

As with all investing talk to your IFA and explain clearly what you want to achieve and when! Your IFA will then construct investment portfolios appropriate to the risk that you can tolerate to give you the opportunity to be well rewarded and to meet your expectations.

The next time you’re nervous about the risks you are taking… remind yourself which risks you’ve actually got rid of because of those decisions you have made with the help of your Independent Financial Adviser.

Using EIS investment funds for building your investment assets

For higher rates taxpayers the advantages of investing into a pension are well known. However the amount that you can invest into pensions has been significantly reduced from £255,000 to £50,000 and will further be reduced to £40,000 in the tax year 2014/2015

However  improvements to the Enterprise Investment Scheme EIS means this scheme is now potentially one of the the most generous tax saving investments available to UK taxpayers.

Enterprise investment schemes can be utilised to supplement more traditional pensions and ISAs as a means of saving for the future. Investing in smaller companies must be seen as a high risk strategy however investors in EIS schemes can reduce the risk by picking good fund managers and investing in an EIS fund as opposed to a single company.

The fund can reduce risks by diversifying across a range of companies and different industry sectors so even if some companies perform poorly it is still possible to enjoy good overall investment returns.

The amount of loss relief available means that for the 45% tax payer the maximum exposure to loss is 38.5p in the pound which is a very generous tax allowance and should significantly reduce the overall exposure.

Most importantly lost relief against income tax payment in the year the loss is realised can be claimed against each individual investments and so are not to offset against any gain made from the winning investments within a fund.

As the new rules allow funds to invest into bigger companies with up to 250 staff and gross assets of £15 million and the risks of investing into EIS funds have been reduced further. This does still not make them suitable for risk adverse investors but could be a consideration for some people on some of their overall investment portfolio.

Most importantly investors should seek advice from independent financial advisers who are experienced in this area

Pensions auto enrollment

After ten years since it was first muted, automatic enrolment for employees into an employer sponsored pension scheme finally went live on 1st October 2012. There is perhaps the inclination to think that now the systems and processes are

in place we can relax. Indeed, NEST has been open for business and has had members since July last year –working with over 300 employers, including more than 100 large firms that have chosen to use NEST to meet their automatic enrolment duties. These include household name firms such as the BBC, BT, McDonalds and Travelodge.

But in reality, the hard work is only just beginning. Over the next five years, over 1.2 million employers and up to 11 million workers will be automatically enrolled into saving for a pension, many for the first time and as time goes on, the sheer numbers of employers facilitating arrangements means one on one support from the actual scheme will not necessarily be an option. During summer 2014, 25,000 employers will hit their ‘staging date’ – NEST alone expects to welcome about 5,000 employers during this period and while it is simply not practical to engage with them on an individual basis, NEST will provide support in a number of different ways. It can take up to 18 months to put everything in place to comply with the duties. While there’s no getting round the work employers have to do to get ready, NEST has been built with simplicity and ease of use very much in mind, from the initial set-up, to its award-winning investment strategy to managing the opt-out process.

NEST also offers delegated access, which lets employers appoint an IFA to set up and run aspects of the scheme on their behalf. By contacting us for an initial discussion or to request a meeting at your work place. You can find more about how Mark Hughes & Associates  are working with employers to ensure that they are both compliant and offering a suitable pension solution for their employees.

Automatic enrolment is both a challenge and an opportunity. The scale of the task at hand is great, but represents a once in a generation chance to foster a culture of saving for retirement in the UK, it should also be an opportunity for employers to add value to their employee propositions.

Support to equity and bond markets going into 2013?

EU agreement on the European Central Bank’s role as single banking supervisor i.e. the first step towards banking union. The first priority is to finalise the legal framework and secure the support of the European Parliament. The ECB must then hire staff and decide on implementation. Supervision is unlikely to start earlier than April 2013 and will not be fully operational until March 2014. The ECB will regulate between 150 and 200 banks directly, mostly cross-border lenders and state-aided institutions, with powers to investigate all 6,000 banks if necessary.

This is just the first step to banking union and later on a resolution authority and fund to wind up failed banks would need to be created and deposit guarantee schemes coordinated to avoid bank runs. The exercise will take several years and will have to overcome potential opposition from the Eurosceptics e.g. the British. However, it is significant that Germany has publicly applauded the new proposals.

Around about the same time that the EU announcement came out, the US Federal Reserve announced the expansion of its quantitative easing programme (QE4) and indicated that US interest rates will not rise, at the earliest, until US unemployment falls below 6.5m, provided that it expects inflation to stay below 2.5% for the following 1-2 years.

In addition, the Fed announced an extension of its bond-buying programme. The current $40b per month programme of mortgage-backed securities purchases will continue and an additional $45b per month of US Treasury purchases will begin. This action should help keep a lid on bond yields and assist the markets in the re-pricing of short term rates.

These two important initiatives should provide some festive cheer for equity and bond markets.”

However as with all investments, experienced independent financial adviser should be consulted

The Chancellor’s Autumn Statement

The Chancellor George Osborne has today given his Autumn Statement the government’s commitment to addressing its finances should be welcomed by the financial markets.

Below is a summary of the key announcements made today.

Economy and Government Spending

  • The Office for Budget Responsibility expects GDP to contract by 0.1% in 2012, significantly down from forecasts of 0.8% growth in March. The OBR then expects the UK economy to grow by 1.2% next year.
  • The government’s fiscal consolidation programme is to be extended by another year to 2017/2018.
  • The UK budget deficit is set to fall from 7.9% last year to 6.9% this year.
  • National debt will not begin falling until 2016-17, a year later than previously expected.
  • UK unemployment is expected to peak at 8.3%, lower than initially expected, and employment is expected to rise every year moving forward.

Taxes

  • There is to be no new tax on property (“mansion tax”).
  • 40% tax rate threshold will rise from £41,450 to £41,865 in 2014 and then £42,285 in 2015.
  • Corporation tax will be cut by another 1% in 2014, taking the rate to 21%.
  • Capital gains tax allowances will rise by 1% in 2015 to 11,100
  • Inheritance tax  allowances will rise by 1% in 2015 to £329,000
  • Tax free allowance raise is to rise by £235 to £9,440.
  • Planned 3p rise in fuel duty not just postponed, but cancelled.

Benefits and Pensions

  • Most working-age benefits to rise by 1% per year over next three years.
  • Child benefits are also to rise by 1% per year over two years from 2014.
  • Tax relief on the largest lifetime pensions reduced from £1.5m to £1.25m starting in 2014-15, the annual allowance will now be £40,000 rather than £50,000.

To discuss how this may affect your own circumstances as always please do not hesitate to contact us to schedule a meeting.

Will one of the Eurozone superpowers sink the listing ship?

A recent headline article in “The Economist” highlighted the precarious and deteriorating state of the French economy, thereby debunking the popular myth that France is one of the Eurozone’s safer ports. The following stats give plenty of food for thought:

  • The bloated public sector now accounts for over half of GDP;
  • Public debt is heading towards the whole of GDP;
  • Current account deficit close to 100m euros;
  • Share of exports to other Eurozone states less than Holland which has a quarter of France’s population;
  • Average pay rates higher than Germany’s although productivity rates are much lower;
  • Growth of only 0.2% in last quarter and likely to deteriorate this quarter; and
  • Recently downgraded credit rating.

Staying in the Eurozone will increase the pressure on France’s economy as it cannot benefit from a depreciating currency and lower pay rates. The new French President’s intention to increase tax on higher earners, to help balance the books, is likely to fail as it will dis-incentivise those people and encourage them to look abroad for a fairer working environment, so net income tax receipts are unlikely to increase.

2012 was the year that Portugal, Italy, Greece and Spain were under the Eurozone spotlight. Could 2013 be the year when France becomes the bête noire that finally sinks the listing Eurozone ship?

This is exactly the kind of senitment that moves markets and as such regular reviews of investment and pension portfolios to reduce risk are essential. Good financial advice alongside a regularly reviewed financial plan is always worthwhile.

When should you buy an annuity?

All the major annuity providers recently cut their rates for guaranteed annuities as corporate bonds and gilts fell following the turmoil in the global financial markets, which has been caused by the European debt crises and concerns about the US economy.

The benchmark annuity rate has changed over the last 12 months. (The benchmark rate is male age 65, female 60, £100,000 purchase, joint life 2/3rds, guaranteed 5 years and level payments). Annuity and gilt yields fell at the end of last summer but picked up later in the year, but the ongoing economic turmoil is likely to have a further negative effect.

Enhanced annuity rates have also been cut because they too are priced in relation to the same yields.

In simple terms, this means an individual retiring now with a pension fund of £100,000 will secure a lifetime income of £115 per year less than a few weeks ago.

The main reason for the sudden reduction in yields stems from the European and US debt problems. When investors are worried about global equities there is a strong demand for gilts. As the price of gilts rise, the yields fall – UK gilt yields are at their lowest level for many years.

What can be done about falling rates?

At times of falling annuity rates I am always asked, “Should I hold off buying an annuity until rates increase?” My stock answer is that individuals should take as much time as they need to decide which type of annuity to invest in and once that decision is made they should not necessarily delay because rates could fall even further.

Although it’s impossible to second guess the financial markets and accurately forecast future annuity trends, professional advisers and their clients can maximum the amount of lifetime annuity income by taking a few simple strategic and tactical steps in the right direction.

And remember, it’s important to separate the strategy from the tactics.

Strategy

It’s important to have a plan. And, strategically there are two important questions:

When is the best time to take tax free cash and income?

What type of annuity or drawdown?

The timing is important because two factors come into play; what is the trend for annuity rates and what are the income requirements?

If an annuity is a long term investment then investors should think about their longer term income requirements and, in particular the issue of inflation.

Many advisers and their clients are taking decisions about a long term commitment based on short term considerations e.g. who is paying the highest income? A more sensible approach is to consider investment linked annuities which provide the potential for future income growth and flexibility.

Tactics

In order to execute the plan it’s necessary to make the right tactical decisions. These include shopping around using the open market option to find the best highest paying annuity and, where appropriate, applying for enhanced annuities which take health into consideration.

Other tactical decisions include the timing of annuity purchase to try and strike when rates are at their highest. If there is concern about purchasing annuities when rates / yields are low, another possible consideration is an investment-linked annuity where the initial income is not pegged to gilt yields.

With conventional annuities, income is set for life at the point of annuitising, with no potential for future income growth. An investment-linked annuity has the opportunity to benefit from the highs and lows of the markets over a 20 year period, not just at a single point in time when rates and markets could be low.

My view

I have been following annuity rates for long enough to know that getting the timing right is difficult, if not impossible. My view is that our clients should take as much time as they need in order to decide on the strategy, but once a decision has been made it makes sense to arrange the annuity sooner rather than later because in my experience few people gain from deferring their annuity purchase.

Too many people have too little pension savings.

Over a third of British adults, equating to 13.6m, do not have a pension, research from Baring Asset Management, claimed.

The investment management firm found that of this figure 1.4m people who are 55 and older do not have a pension in place.

While Barings is not surprised that a high proportion of people aged 18 to 24 do not have a pension, it found it worrying that 47 per cent of 25 to 34 year olds have not started saving into a pension.
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State pension age to increase?

Work and pensions secretary Iain Duncan Smith has confirmed the state pension age will increase to 67 earlier than planned.

The retirement age was due to rise to 67 in 2036 and to 68 by 2046 but Duncan Smith said the timescale, set out by the previous government, was ‘too slow’.

‘We’ve always said that the timescale left by the last government was too slow,’ he told the BBC.

‘The [last] government left us with a deadline in the 2030s and we think that’s too late because people’s age levels have increased even since they made that announcement.
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Pensioners face drop in spending power

PENSIONERS retiring this year on a fixed income could lose 60% of their spending power over the next 20 years.

That means an average annual income of £16,600 will be worth a pathetic £6,700 in today’s money – effectively a £10,000 pay cut over the course of a 20-year retirement.

Figures from Prudential show pensioner inflation, or the Silver RPI as Age UK have dubbed it, is higher than the rate for the rest of us because retired people spend a much greater proportion of their income on goods and services that are subject to the highest rates of inflation.

Assuming inflation remains at its current level, retirement incomes will need to more than double in the next 20 years just to allow people to maintain their current standard of living.

This comes on the back of research from Age UK showing that the over 55s have faced an additional £984.28 per year in living costs since 2008.

This has been caused by Silver RPI averaging 4.6%, almost 50% more than the 3.1% average annual inflation recorded by the Retail Prices Index over the same period.

The figures are frightening when you consider how much today’s pensioners are struggling to make ends meet as escalating food and energy prices show no sign of easing – and things are set to get tougher.

That’s why it’s crucial that anyone approaching retirement, especially those who have saved their hard earned cash into a private pension, makes sure they get the best deal when cashing in savings and turning them into an income.

You only get one chance to get this right – get it wrong and you are stuck with your decision for the rest of your life.

Vince Smith Hughes from Prudential says: “Pensioners on a fixed income are particularly vulnerable when it comes to rising living costs, and our figures demonstrate the true extent to which Silver RPI impacts on the spending power of pensioners.”

There are alternatives to choosing a fixed income in retirement, such as options that increase each year in line with inflation to help boost spending power.

And millions of pensioners lose out on vital cash because they simply stick with the lifetime income offered by the pension firm they have saved up with, rather than comparing deals.

And millions more lose out again because they are unaware of what are known as enhanced annuities.

These offer higher rates to those who smoke or have health ­conditions that affect life expectancy.

Joanne Segars, chief executive of the National Association of Pension Funds, says: “This report shows the importance of inflation and the crucial need to shop around for the right annuity.

“While getting an ­inflation-proofed annuity will be more expensive than a ‘no frills’ approach, it is a decision that demands serious consideration.”