THE SOVEREIGN NEWSLETTER

The news is full of the various Government moves to cut back expenditure. Such moves are likely to affect us all in one way or another. So it is a good idea to keep close watch on your finances. For example, mortgage rates have become very competitive again. So, unless you are already on an excellent deal, it is worth finding out what is available for you. We can make those enquiries quickly for you.

With the growing likelihood of an increasing number of redundancies as a result of these Government cutbacks, an up-to-date knowledge of pension and investment options becomes important.

Risk is a key factor in determining what pension or investment choice is appropriate. By risk is meant the possibility of your investment going down in value as well as up. In a broader sense it also needs to take into account the effects of inflation, as putting your money under the proverbial mattress means it is losing purchasing value at the rate currently of more than 3% per year.

ANNUITIES – A LOWER RISK CHOICE

An annuity is basically the swapping of a sum of money in exchange for a guaranteed income for life or for a specified term of years. The Government backs these guarantees in most cases. So if you have £50,000, for example, and do not need the capital but do need to increase your income, you can go out to the market and trade the capital for an income. Once the deal is done you are guaranteed to get your income, so there is no investment risk – in most cases. Annuities are normally only worth considering by those aged 55 and older.

HOW MUCH WILL I GET?

The first point to highlight with annuities – whether or not they are pension related, is that there is an Open Market so you are not restricted to arranging an annuity with just one company. Annuity rates go up and down and each company decides on its own rates. So what you can get for your money will vary from company to company. We can help you find the best deal.

With annuities generally, the older you are, the more you will get for your money. There are also now impaired life annuities so if you have, or have had, significant medical issues, or have been a long-term smoker, you may get an even higher annuity income for your money. The company providing the annuity has access to the tables showing how long an average man or woman of a given age will live. They can then work out the averages and see what they can offer. They will want to cover their costs as well as securing a profit for the company. The bad news regarding annuity rates currently is that they are historically very low. We are living longer so they have to pay out the guaranteed income longer; and long term investments like Government Bonds, which annuity companies rely, on are giving a lower rate of investment return.

WHAT ANNUITY CHOICES ARE THERE?

Annuities can be arranged for life or for a specific period of time, e.g. 5 years. Such short-term annuities allow those who are not happy with the current level of annuity rates to obtain a guaranteed income now with the chance that annuity rates will improve in the future. Annuities can be arranged which do not increase in payment as the years go by, or they can be arranged so that the income increases annually by a fixed amount or in line with an index, such as the Retail Price Index (RPI). Where there are a husband and wife, the annuity can be arranged to go on until both have died. Annuities can also be arranged where the income return is based on the underlying investment performance.

INVESTMENT RISK

In an ideal world any annuity taken would keep place with inflation and provide adequate income for the investor. Current annuity rates make that difficult for most people. In the ideal world an investor could also avoid any risk to his capital and simply enjoy payment of interest on his cash holdings at a level in excess of inflation and adequate to his needs. That is not the world today. Interest on cash investments is very low and guaranteed annuity rates that keep pace with inflation are very low as well. For those who are not lucky enough to have a guaranteed pension adequate to their needs and adequate investment returns on their cash investments, the next step almost inevitably involves taking a risk.

MAKING INVESTMENT DECISIONS

You can invest your money in many ways. The different general groupings of investment choices are called asset classes.  An asset class is a type of investment, which shares its characteristics with others in the class – both as regards risk and the way they behave in the investment market.

The three main classes of assets are as follows:

• Equities – by which we mean investment in companies either directly, e.g. buying shares in British Telecom, or through an investment fund, which invests in a number of companies, e.g. a pension managed fund.
• Fixed Income – referring to bonds (essentially loans to a company or the Government – when they are called “gilts”). The company or Government pay an agreed rate of interest on the loan and promise to return the capital at the end of the agreed term.
• Cash – usually money in a high interest savings account or ISA, but could also be actual cash you have in a safe or under your mattress.

In terms of risk, Cash is considered the lowest risk, followed by Fixed Income and then Equities.

Equities can be broken down by:

• Size – large companies or small companies
• Industry – health care, energy, technology, building, etc
• Country – any specific country or geographical area, including global funds

Bonds can be broken down by:

• Safety – a bond issued by the Government is considered safer than one issued by British Telecom, which in turn is considered safer than one issued by a relative small or new company, since they are more likely to run into trouble and have difficulty repaying their debt.
• Term – a short-term bond (i.e. one that will come due in less than 1 year) is not as risky as a longer-term bond (i.e. one due in 20 years time).

Other asset classes would include Property, Foreign Currencies, natural resources, precious metals like gold, collectibles such as art, coins, stamps – or even fine wine.

SO HOW DO YOU CHOOSE WHERE TO INVEST YOUR MONEY?

There are many schools of thought on this but it is generally agreed that an investment portfolio (by which is meant any group of investments) should be diversified.  In other words they should be spread out amongst the asset classes.

Why?  Different asset classes react differently to changing market conditions. If you have your investments spread out amongst different asset classes, it is likely that at any given time, some may be rising while others may be falling. This helps to reduce the investment risk, but it can also act to hold back the overall return. As to how much to diversify and what asset classes to use, this is comes back working out what level of risk the client wishes to take. Different portfolios can be worked out to cater for different tolerances of risk.

All of us are invested in one asset class or many. We may have money on deposit in our savings. That is one asset class. If interest rates go up, it benefits.  If they go down, it suffers. We may own residential property. The value of properties can go up or down. Many of us have some sort of pension investments. Often these are with some type of Managed Fund which has an investment manager in charge of working out which asset classes to put your money into, and who is actively trying to increase the value of your investment.

WHERE DO WE GO FROM HERE?

To Sovereign Finance, of course. Whether you are approaching retirement and need to look at annuity options, dealing with redundancy and needing to make decisions on investment or pension arrangements, or just looking to invest wisely, we can assist. We are independent so we can look at all the options for you.

NEW OPTIONS

With pension legislation changing and the public demanding more choices, we are seeing more and more new approaches being taken.  As an example, there are two that have been successful in the US for many years and have recently hit the UK.

THE INCOME FOR LIFE BOND

This investment guarantees that the income you receive from your investment will always be paid at least at the level set at the beginning. But it can go up if the underlying investments in which your money is invested go up in value. The death benefit can be guaranteed and it can be used for effective income tax and inheritance tax planning. Investments can be for as little as £10,000 and extra amounts can be added. Income can start from age 55 or can be deferred for a higher income later. There is access to your capital if you need it. Contact us for further details or a quote.

THE TEMPORARY ANNUITY

Rather than taking out a guaranteed for life annuity now while annuity rates are low, you can choose to take a guaranteed income for a fixed period of time, e.g. 5 years. You then have a guaranteed amount returned to you so you can either repeat the process or buy a lifetime annuity at that point. For some unwilling to take an investment risk, this can be a useful way to guarantee a level of return on your pension fund without investment risk. Here too we would be pleased to provide further information and quotes.

HIGHER RATE TAXPAYERS

Next year’s tax changes will bring an estimated further 700,000 more individuals into the higher rate tax bracket. There are also changes expected in the pension allowance for higher rate taxpayers. There are actions that can be taken to counter these changes. Contact us for a discussion and recommendations.

Best wishes

Tom Shuster and Trevor Tupholme