Case Study 2: James wants to achieve a retirement income of £26,000 p.a.

Scenario: James is 55 years old, divorced father of two. He is in good health and is looking to retire in line with his state pension age which would be 66. He is aiming for a retirement income of £26,000 per annum. The current source for his retirement income is his pension fund which has a fund value of £114,500. He will also qualify for the full state pension. He has a disposable income of approximately £750 per month after essential and social expenses.

Thoughts:  James has 11 years to retirement. When he retires he will qualify for the new state pension of £7,865 per annum or £151.25 per week. This will leave his pension fund to make up the shortfall of £18,135 per annum. Based on current best buy annuity rates of 5.8%, James will require a fund value of £312,672 in order to purchase a secure retirement income of £18,135 to supplement his state pension.

If James wants a secure income which can only be achieved by way of purchasing an annuity, then he would have to start making some serious pension contributions. This would need to be in the region of £700 per month, provided the fund achieves a consistent growth rate of 7% per annum. James could also make a one-off contribution of £70,500 now in order to improve his chances in closing the fund gap.

But how realistic would it be to achieve 7% growth per year consistently for the next 11 years. Bear in mind this would also have to be net of fees and if the total cost of your investment is 1.5% per year you will need your fund manager to return at least 8.5% to cover their fees too.

This rate of return means James would need to be invested in a higher risk category to maximise his possibility of reaching his target growth fund of £312,672. But realistically, how many of us out there can really afford to save £700 per month? As for James, despite the fact his disposable income is stated to be £750 per month, slightly above the amount he needs to save, this is very tight. I have yet to see accurate and reliable expenditure details. Life is simply not consistent. Furthermore, he probably only disclosed his standard social expenses forgetting that amount we tend to spend on impulse.

It would be great if we could make more impulse decisions to save rather than spend. Investors and savers need to become more literate on a whole host of things that can affect their lifestyle in retirement. James’s situation could have been far better if he saved even a small amount per month consistently from the age of 20, reinvesting all of his dividend income and benefitting from compound growth.

Putting money aside just feels like another ‘expense’ and also another ‘task’ and in that sense providers can assist with technological and software developments. This can facilitate a more collaborative relationship with the investor by bringing their investments to their fingertips by making use of mobile and portable devices. This way savings and investments needn’t feel like they are in a distant place removed from the investor. By working with the investor to recognise and achieve a particular financial objective it could give UK investors a solid opportunity to build their savings and investments portfolio not simply by way of a regular direct debit but also by way of impulse especially at times when markets are low and when investors have that extra little amount to put away.

Anyway, back to the topic at hand, we have established James needs to start investing in a high risk fund but by no means is this performance target guaranteed and it is this that James must consider carefully. If he has a Financial Advisor, among many other things, he or she would be exploring his tolerance, and capacity to take investment risk whilst also exploring potential catastrophic life events.

Tolerance largely relates to James’s psychological and emotional profile which is usually assessed by way of a psychometric and scenario based questionnaire. Capacity is about the portion of your overall wealth that you are effectively investing and/or the effect a loss in your investment value will have on your lifestyle. Be careful here though as you may be ok with a loss in your investment in the second year of your investment but what if it dropped by 50% just before you intended to withdraw from the market?

Then there’s the case of thinking about how to mitigate catastrophic life events that could lead to a loss of income and/or an increase in expenditure due to paying for healthcare or home support.

All of these things will temper James’ exposure to risk which could mean he has to compromise on meeting his retirement goals. Compromising may mean reducing the level of secure income he takes and keeping the remainder of his monies invested in order to allow for growth or simply taking no secure income thus drawing on his investments directly. Bear in mind during retirement, James is unlikely to be invested in a high risk fund in case he were to suffer a very poor year and would need to divest more of his capital in order to meet his income needs, thus overly risking his entire retirement income. This in turn means, his potential rewards would also be significantly lower.

Consider that average life expectancy is approximately 82 years. This would mean James would need a retirement income for 16 years.

James could transfer his current pension into the high risk fund in accordance to his risk profile without any plans to make any further contributions. If this fund grew at the targeted growth rate of 7% per annum, he could have a pension fund of £246,740 in 11 years’ time.

Provided he didn’t take his 25% tax free lump sum, he could withdraw £1511.25 per month or £18,135 per year assuming a growth rate of 4% net of charges which should see him through his retirement.

James has an opportunity to realise his goals however, it will require a strong need for planning from now and ongoing reviews of his entire estate, income and ambitions to ensure his retirement goals are on target. Who knows, he could have forgotten the fact that he may want to fund his daughter’s wedding sometime in the future.

In any case, the lesson is, invest now. Think about what goals you could potentially have when you get married, when you have children, when you could want to take a gap year and then do what you can even if it be by making bitesize contributions now.

Case Study 1: Using your pension to purchase your bakery

Mr Baker has owned a small bakery for the past 20 years and he is close to retirement. He currently rents his commercial unit. He is interested in purchasing his premises without any recourse to any costly loans. He spoke to a financial adviser who had told him he could potentially use his pension to purchase his commercial premises.

Mr Baker has a private pension plan valued at £750,000. The commercial unit will cost £450,000 to purchase outright. Mr Baker’s current private pension does not allow him to invest in commercial units directly. Mr Baker, will need to transfer his pension to an appropriate Self Invested Personal Pension or SIPP, which allows direct investments into commercial property. This is sometimes referred to as a full SIPP.

Following the 30 day pension transfer cancellation period, the pension funds can be used to purchase the commercial unit. The SIPP can also be used to pay for associated legal, surveyor, and Stamp Duty Land Tax fees.

Pros:

• Mr Baker no longer pays rent to a third party; rather he pays it directly into his pension.
• The rental payments itself are tax deductible, as they are a legitimate business expense.
• The commercial unit is also outside the Mr Baker’s estate for inheritance tax purposes.
• If Mr Baker wanted to sell the commercial unit at a later date, it can be sold free of any capital gains tax.
• Mr Baker could decide to retire as per normal and rent the commercial unit to someone else who would pay rent into his SIPP. Mr Baker could then draw on his pension fund which would then come to him as income, at which point it would be subject to his marginal rate of tax.

Cons:

• Mr Baker is investing 60% of his pension into a single asset. Therefore, should the value of his commercial property plummet, the value of his overall pension would plummet too. This could mean his retirement income needs are not met.
• Mr Baker will not be able to use this commercial unit as a security against any future lending he may require.
• The full implementation cost could be prohibitive and would require an adequate investment horizon before the costs are fully recovered.

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The Future of Wealth Advice in the UK

The financial services industry is in an interesting place in 2015. It has been nearly 3 years since RDR and for the large part the industry has spent their resources focused on transitioning into a new and more rigorous regulatory landscape. The pressures from regulatory change have now subsided and organisations have adapted and the demand for advice in light of pension reforms and the threat of inheritance tax has increased. The demand is also unlikely to recede as people live longer and the need for more complex advice on how to grow and extract wealth becomes relevant to more people.

In today’s marketplace close to 60% of investors look for advice online despite 25% conceding that there is not enough quality information available to base their decisions on. Although what is positive is that once engaged with an adviser almost 90% are extremely or mostly very happy with the quality of the service provided by their adviser. The challenge therefore is clear, in a time poor society, with ever increasing pressures, the traditional mode of face to face contact with wealth advisers is seriously threatened for the mass consumer and more needs to be done to harmonise technology with a client centric experience whilst also improving on business efficiency.

Any thoughts that the future of wealth advice would be the preserve of the wealthier older generation who would prefer direct face to face interaction is likely to be short-sighted as the penetration of social media engagement crosses all age demographics. Consider the fact that Facebook’s membership growth is the fastest among those aged 55+, and if you are wondering how Facebook relates to the dignified professional realm of wealth advice, it’s because of leveraged multiplier marketing; that is creating awareness and recommendations from peers in a digital space. This stems from the synergy created between the digital space and mobile technology, forcing advertising to become more personalised, bringing the producer or service provider closer to the customer in terms of engagement be it via Twitter or Facebook as customers engage with their devices at all times of the day.

What’s more, the figure from Facebook tells us something else, it is that confidence is growing among older clients in using the internet to converse and relate to others. So, just imagine that same demographic, taking a further step into the use of quality internet banking services, and now being exposed to quality investment management and advisory services...all online.

Resting on one’s laurels would be ill advised for the traditional advisory firm regardless of how successful they may be right now or have been in the past especially with the rise of relatively low cost web based advisory solutions offered by the likes of Wealth Horizon and True Potential which offer self-directed investment propositions tailored to one’s risk profile but also allow personalised financial advice over the telephone or face to face. Another popular investment platform with a strong brand that has plastered the London Underground with their advertisements for the last few years has been Nutmeg. Since their inception, they have attracted users due to their very low cost and transparent fee structure coupled with a straightforward and simple user interface but has not offered any advice services for their client base. What’s interesting is that they plan do so now and are currently on a recruitment drive to incorporate financial advisers into their proposition.

Although the latter organisations are new into the marketplace and despite the fact that their customer base and market share is relatively small they all have phenomenal potential as they have been able to build a compliant client centric infrastructure without the burden of dealing with legacy clients and systems which is an unfortunate challenge to the traditional wealth advisory organisations. Provided that these emerging tech savvy solutions can also overcome a potential recruitment obstacle in finding the right talent who also share their passion and can also relate to the new age of web based and cross platform wealth management solutions they pose the strongest medium to long term threat to the traditional model of wealth advice.

Consider the fact that only 10 years ago Facebook raised $12.7 million for capital investment, or the fact that Blockbuster was valued at $8 billion, YouTube was just founded, and as for Uber it was still 3 years away. Today however, Facebook is valued at $230 billion, Blockbuster is defunct, YouTube is valued at $70 billion and Uber is valued at $50 billion. Facebook and YouTube innovated and recognised a market opportunity that has since changed our behaviour and our relationship with our mobile devices and much more, Blockbuster couldn’t innovate fast enough and as for Uber it is the single biggest threat to the black taxi trade as we currently know it. So, what does this mean? Basically, innovate, otherwise risk becoming another Blockbuster.

What does the future hold? There will always be a strong demand for advisers, as an advisers role is not merely to instruct clients where and how to invest but also provide bespoke advice around tax planning, wealth extraction, inheritance tax and even death planning which can never be automated as every client situation is different. However, the delivery of this advice for the large part is likely to be over the phone and internet for most clients.

Although demand will be strong for advisers, ironically, the industry on the whole is not doing enough to attract quality candidates despite the fact that roles exist aplenty for experienced advisers. You only need to ask a Financial Adviser who has their profile on LinkedIn for the number of requests they get to consider new opportunities. Although, something can be said for the likes of Towry, which has been in the industry for over 50 years and have come through a number of downward markets to continue to be in a strong solvent position managing billions of client funds. They’ve invested considerably into their operations to train quality future advisers to service their client base as their existing experienced advisers retire and move on. They have also recognised the mass market opportunity utilising web based and telephony services and have made some interesting developments to adapt their proposition towards the millennial client.

Traditional firms are however, more expensive, and the millennial client is tech savvy and engaged and an opportunity exists to tap into this demographic sooner rather than later. It’s interesting that the banks have managed to do something right – that is maintaining customer loyalty. We are more likely to change our partner than we are to change our banks; in actual fact our relationship with our banks tend to last over 16 years which is longer than the average length of a romantic relationship which is at 14 years.

If only wealth advice firms thought about ways to garner that loyalty early on, possibly at the same time individuals leave school or go to university by offering a web based service such as a budget planner or a platform to view all their bank and credit accounts whilst showing the monthly expenditure patterns. This way wealth management firms will be on a journey with their clients as they move through different income zones whence they will require different types and level of advice.

Certainly, traditional firms will need to adapt or lose their existing clientele to newer more tech savvy propositions with a desktop and mobile interface but this will essentially mean finding lower cost propositions for their clients as they compete over cost whilst also finding the resources and capital to invest into the new service offering, all the while being compounded by the fact that firms may have debt accrued due to RDR. As the impetus for web based solutions get more traction we may see more acquisitions take place by the larger traditional firms of their smaller but growing competition.

On the whole, it’s an exciting time for the industry and for consumers alike and I'm looking forward to participating in it.

The GREAT Tax Credit Divide 2015

The proposed reduction in tax credits which are to reportedly negatively affect close to 3 million families has set off an incredible commotion as the House of Lords rejected the controversial cuts planned by the current Conservative government earlier this evening. The tax credit reform is part of a wider reform of the UK’s welfare system coinciding with the introduction of Universal Credit which seeks to simplify the welfare system by consolidating a number of benefits.

However, reforming the actual administration can only go so far in making efficiency savings until serious cuts need to be made to welfare payments directly. In fact, public spending is being cut everywhere, defence, healthcare, education, the police and pensions. The reason for these cuts is principally because of the current government’s approach to the economy, which is effectively balancing the books, that is to only spend what you earn. Bear in mind the UK debt currently stands at over £1.5 trillion and it is growing, we haven’t even been able to chip away at that amount yet and it’s unlikely that we will be able to chip into it until we run a budget surplus; that is earn more in revenues than what we spend.

The debate between the Osbonites and the Corbynites revolves around how to essentially get the UK economy back into the budgetary surplus in order to begin to reduce the debt. Now, as the UK debt is close to 90% of current GDP, we could be debt free in a little less than a year if we literally stopped funding absolutely everything; that’s no police, no welfare, no healthcare, no pension payments etc., whilst we continued to pay our taxes and maintain our current spending patterns. Obviously that’s not going to happen and even if it did the anarchical effects which would probably resemble a cross between The Purge and The Great Depression of essentially no government would outweigh the price of the current debt probably many times over.

So more reasonable economic solutions actually stem from two salient economic theories that have survived the last couple hundred years or so, that is free market capitalism as advocated for by the likes of Adam Smith and Milton Friedman and a planned economic system as advocated by the likes of Karl Marx and Maynard Keynes. Though these days we actually live in a mixed economic system it is important to be aware of some key principles that could be seen as the driving force behind taxation and welfare policies.

A free market approach tends to want less regulation over everything including working conditions, the minimum working age and the minimum wage as it is more concerned about the supply side of labour, that is reducing the friction that employers have to face when deciding who to employ. Now contrast this, with the current government policies towards the unions, tube drivers, the NHS and more recently medical doctors who are facing pay cuts or a challenge to their influence over employee labour conditions. You can also argue that increases in the national minimum wage whilst appearing to be against free market principles can actually complement it when you remove the apparent cushion of tax credits, thus encouraging more parents to commit to longer hours of work whilst employers actually get a concession in their corporation tax to assist in paying for the increased wages.

But would a planned economic approach be any better? In the aforementioned situation you are essentially tightening the country’s belt, something which has come to be known as ‘austerity’, but you are dealing with the problem of government debt head on. Or are you? Especially considering the cost of white collar crime at £60 billion a year with a detection rate of only 5% coupled with billions in lost tax revenues by corporate powerhouses such as Google, Amazon and others for not paying their portion of UK tax. It can appear the poorest and the least powerful are to pick up the burden of UK debt. Sadly, we live within an economic system that relies on foreign investment that creates jobs and in turn income tax that the government would not have had otherwise and thus the reason why the government has always turned a blind eye towards tax avoidance until it became a public moral issue following investigative journalism.

So, yes, back to whether a planned economy could be any better. According to Keynesian economists, the government actually needs to spend more to create more jobs and encourage greater private sector investment and increasing exports which would yield greater returns over the medium to long term. This is actually referred to as Aggregate Demand, that is the demand for the gross domestic product of a country and there’s actually a really fancy formula which goes something like AD = C + I + G + (X-M)…forgive me if I don’t explain it in this piece but note it’s not scientific no matter how much it may look like it is.

Look at it as if you were to take out a business loan in order to kick start a business and when the business is in profit it would start to repay the loan. This is effectively what the Corbynites advocate, potentially sweeter times now funded by debt with the hope that any national investments work itself out.

So what is the right way forward? At the time of writing this piece, I truly don’t know, my mind often sways between two extremes and I simply don’t have enough policy information to make a judgement. What I do know is that we must put a truer value on the economic cost of our policies, for instance, if we were to take away tax credits and force parents to work more hours, or where they literally cannot work more hours have only to cut back on heating and food for themselves and their children what would be the human cost be it psychologically and socially that would affect our communities in years to come as our societies which are already challenged with serious mental health crises navigate themselves into adulthood and then parenthood.

Shaping finance through shariah: a layman’s observation

Faith and finance could not be any more dichotomous today, yet the UK is the leading western country and Europe’s premier centre for Islamic finance with US$19 BLN of reported assets.

London lawyers have evolved skills and experience to become well versed in shariah compliant contract law as well as financial instruments in order to service the growing appetite for shariah compliant investments from Middle Eastern investors who believe the UK to be a judicious and profitable place for investment; our accountancy and banking sectors have similarly adapted to this growing and profitable emerging market. Couple this with the need for foreign investment into the UK’s major national infrastructure projects for the next 20 years we can be certain that because of our national economic interests, the UK offers a profitable and most importantly a potentially halal enterprise for our market evolving a service provision for the religiously conscious wealthy foreign investor.

However, ironically, Islamic finance has yet to take off amongst the UK’s 2.7 million Muslims and this is largely due to the fact that UK consumers approach Islamic finance as a debtor whereas foreign consumers tend to be creditors or investors. This has a significant impact on how you relate to the current modus operandi and structure of Islamic finance. For instance as a creditor, be you a stock and shares investor or a current account holder, you can be confident that your money is invested in a shariah complaint manner which is similar to conventional ethical funds that screen investments to ensure your monies are not invested in what are known as vice investments e.g. funds that invest alcohol, tobacco, munitions, gambling etc related stock. Furthermore, for investors in shariah compliant funds, there are added considerations to ensure where interest cannot be ignored that interest is siphoned off and donated to charitable causes. Another interesting criterion for shariah compliant funds is that they will not include companies which generally carry more than 30% debt.

So to summarise the three key principles for shariah compliance are 1. There should be no interest or riba which means an increase on the capital 2. Not investing in vice funds and 3. Not investing in companies that are in significant debt. However, all these principles are secondary to the fundamentals of ideal human conduct which should be based on equity and mercy.  

Our global political system has become incredibly connected through the membership of a whole host of international organisations be it the World Trade Organisation or the becoming of federal alliances like the EU and also cooperative alliances between a select group of countries such as the G7. Naturally, the world utilises the banking systems of nation states which when enters into the arena of international trade they are also governed by what is known as the Basel Accords which proffer guidance to regulate the global banking industry.

The implication of a well-connected economic system tends to create fluidity in markets meaning fewer barriers in the movement of people, products and services in order to encourage economic prosperity meaning more jobs, innovation and entrepreneurship. However, for the sake of ‘economic prosperity’ we seek to encourage the deregulation of markets, create and loan money that literally does not exist and then are legally allowed pursue the debtor. As we have deregulated markets we have unwittingly ‘deregulated ethics’ allowing companies to freely promote a culture not based on moral values but one based on maximising our consumption, at the lowest possible cost, at the highest margins with total disregard for the net societal interest.

As we have mastered the exploitation of our own markets our businesses encroach on politically weak and less technologically sophisticated cultures and communities, where the goal is rarely philanthropic but rather to open markets for the purpose of profit regardless of the consequence on the host society.

Therefore, in an age of profit and a failure of theology of sorts, Islam has begun to offer a strong alternative to the conventional approach to profit and investment. Having proven its resilience before and after the global crisis in 2008, as evidenced by the IMF, the future for shariah inspired principles for the growing socially conscious investor and the risk mitigating fund manager who opt to invest in shariah compliant funds will offer a powerful economic challenge to riskier vice enterprises that although may be profitable on the balance sheet remain incredibly costly to our societies. 

How is your money invested? An insight into Discretionary Investment Management and Model Portfolios

Investors can get confused with the nature of investments that they have been recommended by their financial adviser. No doubt they would have been told about the pertinent points of their investments such as charges, taxation and exposure to risk but it is important to also understand the comparative cost of what is being offered and what you can probably get elsewhere. What’s more in an ever evolving technological landscape you should also be thinking about how your provider has made use of those web based interfaces to make your investment experience that much more wholesome and inviting.

It’s easy to be intimidated by jargon and an articulate professional, but in truth there is really no substitute for logic and common sense. Investors should be confident that they understand the services being offered and in that regard ask the questions that appear to sound stupid and not be afraid to seek justification for claims being made. Simply asking, ‘How? What? Why?’ can go a long way in testing the competency of any professional consultant.

One such area where confusion can exist is the different approaches to fund management and the costs associated with the respective approaches. There are however two areas that would be useful to understand and they are referred to as Discretionary Investment Management (DIM) or as its old moniker Discretionary Fund Management (DFM) and since 2012 the rise of Model Portfolios; but in order to understand them both we need some historical context.

Since 2012, the financial services industry has changed radically following the implementation of what was known as the Retail Distribution Review or RDR, and it is generally agreed for the better, especially in relation to improving the competency of financial advisers, the transparency in costs and the investment management service itself.

In the past advisers retained the responsibility for fund selection and asset allocation and would require consent to make changes to the overall portfolio. This was known as an ‘advisory portfolio’; this ‘advisory portfolio’ included a form of fund management services, although, within the ‘advisory portfolio’ it was limited to the particular fund that particular fund manager was in charge of. So there would essentially be multiple fund managers, all working independently of each other, contributing to the performance of the wider portfolio which had the oversight of the financial adviser.

Also during this period a premium service existed that could manage a client’s entire investment portfolio day to day  and that particular service offering was provided by a DFM who would construct a portfolio based on the client’s attitude to risk and investment strategy i.e. particular ethical considerations or interest in niche investment areas which would all be explored by the adviser. 

However, the DFM would not need to seek consent from the client to make decisions to alter the holdings in order to respond to market changes, which was crucial in reducing risk and maximising market opportunities. Now the privilege of having a DFM to manage your investments would often require several hundred thousands of pounds to invest due to the associated costs of research and day to day investment management, thus this being of benefit to the few with the rest having to rely on the more accessible and cheaper ‘advisory portfolios’.

Now fast forward to today and the investment universe has evolved, with contributory influences coming from I.T and now DIM service providers. The I.T industry has recognised that they can provide an interface between fund management and the client and the DIMs have thought about ways to implement solutions for both advisers having to deal with the change in the regulatory landscape mandating better investment management for their clients but also recognising a market opportunity to service clients with less than the several hundred thousand to invest.

This has led to the development of model portfolios which comprise of a bespoke mix of investments for a number of different risk profiles. The adviser concludes which model would be suitable for you and invests your monies into that portfolio. On the face of it, it appears similar to what DFMs end up doing i.e. managing your monies in line with the parameters given by your adviser but crucially I.T plays a significant part in ensuring a model portfolio retains its integrity throughout the year via periodic rebalancing. This means that based on market movements, a particular asset class may become disproportionately represented due to its increase or decrease in value thereby affecting the risk vs reward balance. In order to mitigate an adverse exposure to risk, units or shares are automatically sold to return the portfolio to its initial position.

Whereas with a discretionary investment management service you have a specific investment team looking after your portfolio day to day, with a model portfolio, you still have access to those specialist fund managers focusing on their respective areas independently but I.T plays a crucial role in ensuring your portfolio is not exposed to too much risk or maintaining levels to encourage efficient rewards.

It is for this reason, model portfolios tend to be considerably cheaper than DIM services and for the majority of investors where a bespoke investment strategy guided by the client is not required, it offers a sensible solution to meet their needs.