Ask the Experts

Every employer will be required to offer the NEST scheme to their employees and the scheme will be rolled out between 2012 and 2017.  The details are still sketchy but the scheme is designed to make both employees and employers contribute towards retirement provision.  You will have to pay in 4% of your earnings, the employer 3% and the government 1% via tax relief making a total of 8%.   Employees will automatically be enrolled into the scheme but will have the choice to opt out.

Without doubt we all need to start putting more aside for our retirement years.  We are all living longer and wanting to do more and spend more in our retirement and at the moment we are way behind in our planning.  Because employers have to contribute to the scheme you will be getting additional funds added to your retirement pot.  

The downside may be that whilst the costs of the scheme will be low, the investment options may be limited within your fund. i.e. for other types of pensions you normally have a wide choice of funds to invest into. The better funds are unlikely to be available within NEST however. Also if your employer doesn’t start the scheme till later, valuable saving years will be lost.

The money lost by leaving your retirement planning for five years is typically half the final fund at the end so rather than leaving your retirement planning you should get on with that immediately via tax efficient investments such as ISAs, Personal Pensions, Stakeholder pensions or the new NEST scheme.

I would recommend talking to your employer and seeing what plans they have for this new scheme.  Then armed with this information speak to an Independent Financial Adviser to consider your options.

Q. I want to receive income from my investments and went to see two advisers.  The bank told me that taking out 5% across their product would be appropriate.  The adviser who arranged our mortgage mentioned that taking dividends would put the capital under less pressure.  Which approach is right?

A: The truth is that both approaches have their advantages and disadvantages but the best solution depends on how you think, your attitude to risk and when you might like access to your money. ensure you seek Independent investment advice before acting.

The first method involves investing the capital and drawing the income via taking out a percentage of the capital on a year-by-year basis. 

The second involves buying income producing assets such as Gilts, corporate bonds, commercial property, cash and high yielding equities with good dividends.

The first method is the most common method of taking an income. The advantage of this method is that the capital can be freely invested without any investment restriction.

The investor simply buys the best investments they can and takes out a return at the end of the year. Being free to invest, unlike the second option, can be much more advantageous. The second option  is really like the tail wagging the dog. In certain market conditions these assets can do well, in others, they may not. For example in a rising interest rate market, fixed interests (corporate bonds etc) are likely to have quite a bit of pressure on their capital value.

Q. I saw an advert on TV from a very well known high street bank which suggested that a saver would probably be interested in an investment bond product. Why is this?

A: Onshore bonds are products that are offered by the insurance industry and many of the banks and their merits are highly dubious.  It is rare that a fee based investment adviser would consider them.

There are a few obvious issues with them. They are tax inefficient for most people if not everyone. They have extremely high 'hidden charges' (most that I see have 7% commission and a 4% set up charge hidden around a marketing gimmick called an extra allocation) and often the investments you are exposed to are not the real fund.

Inside a bond you will have a choice of investment funds to consider. They are often a mirror of the real fund.  The mirror fund is a specifically 'genetically' engineered version of the true collective which is often to charge higher fees and subsequently pay increased commissions back to the unscrupulous institutions who sell them.

The consequence for the investor is that due to the higher fees, the performance of the portfolio will suffer substantially over time compared the same portfolio of the true collectives. In one comparison I saw recently the customer buying the fidelity special situations fund direct would be 12% per year better off than buying it in an investment bond. 

Q. My adviser talked about WRAP investment and said that it would be a good way to manage the growth and the income from my investments.  How does this work?

A: The Uk has been dominated by retails banks and insurance companies selling investments through the high street at extortionate costs. Whilst the U.S, South Africa, New Zealand and Australia have moved a to a more cost effective solution called an investment wrap, the Uk has been slow to react. A wrap is simply the most cost effective way you can buy and hold your investments.

There are many benefits of WRAP.  The unit trusts that make up a portfolio are not mirrored versions, they are the true funds – and they are bought in the cheapest possible manner available to the consumer. Often the cost of an investment is zero unlike a bond which is c11% with high commissions and a unit trust/ISA which is typically 5.25%.

Combined with this, part of the annual management charge is rebated back from the providers and if you have a good adviser they will pass this benefit directly onto you. 

Every year when you make changes to your portfolio there is no charge to do so as there is no initial costs with the investment. Moreover, every day when you want you can dial in and see what every fund is worth in your portfolio. You can also make changes to it at the flick of a switch and your adviser can do a review with you without actually meeting you as you can both dial in without having to meet.

Q. My Mum & Dad gave me a plot they had on their land.  I want to build my own house but don’t know how to get a loan to do so?  Will banks lend you money on a plot?

A: Despite what the papers are saying many banks and building societies will be happy to lend you money as long as your proposal is correct. 

The kind of loan you require is something which is known as a self build mortgage . This is where a lender grants you a mortgage on a site and allows you to release money, bit by bit throughout the build.

The lender will value the plot and consider what it is worth now, and what it will be worth when you finish your proposed build.  They will then allow you to draw funds down from your agreed mortgage, based on its value throughout the build process.

The fact you own the land is good as you will be able to draw some money down straight away to allow you to start the build.

Each lender has very specific criteria when assessing a new self build mortgage application.  It is therefore essential you seek mortgage advice from a fully qualified independent mortgage broker prior to putting forward an application. 

Q. Do you think interest rates will rise as I am considering fixing my mortgage rate and I don’t want to be in a position where I cant afford my payments. A Jump from today's rate to the normal rate would probably treble my payments?

A: Let's remember we are very much in a honeymoon period with interest rates. If we look at the bank of England base rate since 1972 there are only two very short periods that interest rates have dropped briefly below 5%.  It was only back in 1990 that borrowers were paying 15% for their mortgage yet today they enjoy the fantasised luxury of 0.5% base rate. In mortgage terms, that’s the difference between an average mortgage owner of £112,000 paying £1400 per month at the peak of the market as opposed to £46.60 per month now.

You should seek the advice of a fee based Independent Financial Adviser on this before acting on this as they will be able to explain all the parameters to you.

Clearly it is a supportive measure but it is not sustainable by any means. The biggest threat of inflation is already upon us.

January noted a huge rise in inflation which surprised on the upside. It was the biggest monthly rise in inflation since records began.

Naturally as a mortgage owner, you would panic at that thought. High inflation is generally curbed by high interest rates. However I don’t believe this is as big a threat as many would believe.

Looking at inflation firstly, we had VAT revert from 15% to 17.5%, then we have the colossal tax which is being levied against fuel. I filled up last week at 116p per litre. Two years ago we had hurricanes, global demand from China and all sorts of other twaddle being blamed for oil prices driving fuel to these sorts of levels.

What is  the excuse today? None. Its just tax. The great thing is that the government are controlling this as opposed to market forces. No seriously, that is good. If they are controlling inflationary pressures by creating them, they can easily ‘uncreate’ them.

Also most believe that companies will not be passing wage increases to employees and that the current shocking state of public finances will put huge downward pressure on wages and employment.

So whilst that will ease any short term inflationary fears, the reality is that 2010-2012 will be a period of global deleveraging – we will continue to try and lower our debt, both the general public and government.

Unemployment will rise due to cutbacks, and wages will fall. So don’t expect rates to go up too soon;  they will rise eventually, but as inflation is not as big a threat as it is being laid out the rise will be benign.

Q. My bank has offered me a capital protected or 'structured product' and they want me to invest into it. It says that the investment wont fall unless the FTSE falls by more than 50%. Seems too good to be true.

A: In short it's misleading and the actual risk to these plans is a lot more than most people know. Be sure to sit down with a fee based investment adviser who will be able to discuss all the risks with this.

They are currently being reinvestigated by the FSA at the moment. Apparently nearly $40bn is being invested into these at the moment.

Most of these types of 'guaranteed' or 'protected' investments will be sold via the high street in banks.  They are typically marketed to those who have an aversion to risk, or as I prefer to say it, where the financial adviser neither explains risk, or cannot explain risk.

So why might many investors be close to losing all their money when they believe they are protected?

These plans works as follows: A plan provider (a bank for instance) creates a product by placing some of your money with another financial institution. That financial institution offers a fixed return to the bank over a set period of time. So for example (in really simple terms) the bank is offered 5% per year over the next five years with UBS as an example. The bank knows that if UBS pay that 5% per year they will have 25% (simple terms) in five years time.

And so they can place 80% of your money with UBS and in five years time the 80% will grow to 100% - hence your capital protection. The remaining 20% will be used to buy a range of complex financial instruments which participate in the upside of the stock market. So you might then see them marketed as ' 100% capital protection* (note the very expensive asterix) plus 60% of the upside of the stock market growth' (typically the FTSE100).

Seems good? Prepare:

There are three key points: Firstly the 'capital protection' only works at maturity (end of five years typically) and you have to ask yourself over how many five year periods in history has the FTSE 100 not returned at least your capital back? Rarely. So what value does the capital protection really have? None really.

Secondly, these 'protected' plans will not benefit from the yield in the FTSE100 (i.e. its dividends). This is currently running at c3.2%. So if you were invested into a product such as that above you would be 17% worse off at the end of the term.

The most worrying issue however, is in relation to the 'capital protection'. Remember these are aimed at investors who are risk adverse.

There is a potential with these plans that an investor could lose all their money, unlike the stock market where your capital simply fluctuates up or down. If the institution from which you are buying the capital protection goes bust, there is no protection under the financial services compensation scheme, due to the 'large company' rule. Therefore your money could be completely 'out the window'.

And here is where companies put investors at risk. The lower the credit rating of the institution, the bigger the return they offer, so banks can simply move downwards with their choice of provider to then offer higher returns, catapulting your risk skywards.

A credit default swap (basically the cost of insuring a company's debt) is a good analysis of a company's strength. Today the cost of insuring £100 of Lloyds TSB's debt (127.35) is 119% more expensive than the cost of insuring HSBC's debt. (2)

This cute move of moving down the credit curve is putting millions of cautious investor's capital at risk and they are oblivious to it.

Peter McGahan, independent financial adviser