Central to RDR has been the aim of raising the professional standards of investment advisers, giving consumers greater confidence in the advice being offered.
Although journalists are keen to focus on fees one aspect they seem to be missing is the importance of financial planning. In the next next two blogs I want to explore this further, and why it matters.
One of the most important aspects of investing is planning. As I have argued before in blogs you don’t approach a DIY job without putting in place a plan and ensuring you have all the tools to deliver on the project.
Whether you go down the DIY route or whether you seek financial advice the crucial aspect is planning.
In this first blog I want to focus on the fixation we continue to have on cash savings. There are two aspects to this, firstly we perceive cash to be safe and secondly in retirement cash has been seen as a source of income.
In 1999 the average cash ISA was paying 6% a year. So the argument around an income seems a strong one. So if I had £100,000 then I would receive around £6,000 in interest payments. However, the average cash ISA is now paying less than 1% a year. If I continue to take £6,000 a year not only am I losing out to inflation but with no growth I am quickly eroding my savings base.
Even if I don’t take any income £100,000 invested in cash in 2012 could see its value fall by 17% over the next 10 years. This is based on an interest rate of 0.8% and inflation of 2.6%.
Another aspect to consider is that if the cash is being used in retirement we are living longer, for many 20 years of retirement is not unheard of. To hold money in cash for 20 years will have a material impact on retirement income.
So how does this apply to financial planning? I recently searched for retirement income; I came up with a number of solutions from direct platforms – structured products, corporate bonds, investment funds etc. Many promising income of 5% p.a. plus. This all seems really appealing but there is a risk with all of these investments and how much do we understand that risk.
Financial planning starts with looking at what your goals are and then working down to the solution. So let’s consider someone with £100,000 and wanting to provide an income.
Financial planning will start with what income the person wants, and what they have to deliver that income. So for example someone might want £1,500 NET a month. They have a state pension paying £800 GROSS per month, perhaps some pension income paying £500 GROSS per month. So the net income is around £1,200 per month. This means they need around £300 a month from the investments.
The next step is then to consider how to provide sustainable long term income; this is about understanding a client’s attitude to risk. Most clients in retirement will say they are cautious or even defensive but if you tell them that their investments will erode whilst in cash they start to worry. Carefully constructed portfolios can deliver returns over the long term in excess of cash and inflation. There will be an element of volatility but it enables clients to receive income and growth.
Once you start to build a plan around the investments then you can consider the most tax efficient wrapper, this could be an ISA which provides a tax free income, or it can be held outside of an ISA where you use your CGT allowance.
So a financial plan is about building a whole picture. We no longer live in a risk free world, and whether you decide to go direct or go to a financial planner you need to consider what your plan is. RDR will make charges more transparent but ultimately if we don’t understand the concept of a financial plan then no amount of changes to our industry will help in our attitude to investing.
Disclaimer: This is just an example, other solutions may be appropriate depending on an individuals circumstances.