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Don’t Get Caught Out By The Taxation Of Investment Bonds

21 Jul

Earlier this week I met a new client, who is in an awful tax scenario because of how he drew money from two investment bonds – realistically tax should not have been an issue. The problem was caused by their previous financial adviser not understanding the tax rules and making a dire mistake.

I thought I would write an article on this as it is so common for people to suffer a tax bill when no tax could have been payable – the failing being how the bond is taxed and not drawing the proceeds in the most tax efficient manner.

Remember with an investment bond, the policy is made up of mini-policies so you potentially have more flexibility of how you encash.

There are two sets of rules for tax depending on how you withdraw money –  

1. Top Slicing – this is where you draw a proportion of the whole bond equally across all of the mini-policies. The advantage of this is if you draw up to 5% of the original investment, then this is treated as a repayment of capital until such time as you have withdrawn all of your original capital and thereafter assessed to income tax at your marginal rate of tax.

What this means is if you stay within the 5% Rule – you could defer any payment of income tax until another day many years away.

The problem comes if you draw more than this 5%, then the addition is added onto your income to assess the tax liability.  So typically, not the best way to withdraw large amounts of capital from then investment bond.

 

2. Encash whole mini-policies – tax is assessed and payable based on the profit made on each mini-policy.

 

Scenario 1

Client invests £50,000 in an onshore bond and £50,000 in an offshore bond, both invested just under 5 years ago and he has seen a slight drop in value through the investment to £49,000 for each bond.

Client now draws £90,000 – £45,000 from each bond by an equal apportionment across the policies (Top Slicing)

Problem being anything over the 5% Rule, when encashed in this way will be assessed and taxed as income.

Okay, lets say he has an average income of £25,000 per annum

5% Rule for each complete year – 20% of the original – £10,000 on each bond

Onshore and Offshore bonds – to be assessed against income leading to a further expected tax liability of £19,126

 

Scenario 2

Exactly the same as scenario 1 except – now draws £90,000 – £45,000 from each bond by an cashing individual mini-policies

The good news – each investment bond has seen a slight decline in value. Tax is only payable on profits.

Onshore and Offshore bonds – to be assessed against income leading to a further expected tax liability of £Nil 

 

Summary

The point being – if you are withdrawing a fixed regular amount of say up to 5% per annum of the original investment – then Top Slicing can be an effective tool.

If, however you are withdrawing a capital amount there are typically better approaches.

Please be aware that this only touches on the taxation of investment bonds – this is actually a very complicated area but the basics are clear and sound.

CARE NEEDS TO BE TAKEN AND KNOWLEDGE APPLYED

Investment Tax Wrapper – Investment Bonds v Collective Investments

20 Jul

I always find the argument around the suitability of the investment wrapper paramount. Too often I see new clients – who maybe non-tax payers with an investment bond wrapper rather than collective. If this is personally owned I struggle with why someone has chosen to pay Basic Rate Tax when they most likely could have paid no personal tax – admittedly the tax is paid within the fund but all costs will affect investment performance.

OK lets start by getting a bit of jargon out of the way…when I use the global term Collectives, I am referring to anything along the lines of OEICs, Unit Trusts, Investment Trusts, SIVACs, UCITS I, II, III, etc. I am just trying to use an all-inclusive term.

Choosing the most appropriate investment for an individual will depend upon many factors including :-

  • personal circumstances
  • investment objectives
  • current and future levels of income

What factors to consider?

The summary below compares bonds and collectives from the perspective of taking an income, capital growth and various tax and estate planning options.  Whilst the choice of investment should not be made for taxation reasons alone it will be a critical factor.  Other key factors will include product pricing, charges, investment structure, administration and service, fund choice, asset classes, death benefits and trust options.

Investment Bonds

Collectives

Taking an income Taking an income
5% withdrawals can be taken per annum without incurring an immediate tax charge (deferred but not free of tax) and any unused allowance can be carried forward to future years. • Bonds are a useful way of providing an ‘income’ without any impact on an investor’s personal allowance and/or age allowance, (within the 5% allowance).• If withdrawals exceed the 5% allowance (or higher cumulated amount), tax may be payable depending on the tax position of the investor and whether the bond is either onshore or offshore • Because investment bonds are non-income producing assets there is no need for annual tax returns, unless there has been a chargeable event (such as exceeding the 5% annual allowance) resulting in a chargeable gain (realised profit).                             • The income from a collective will be taxable whether taken or reinvested. Non-Equity funds (which hold greater than 60% in cash or fixed interest) have income paid as an interest distribution net of 20% tax (and non-taxpayers can reclaim). Equity funds (which hold less than 60% in cash or fixed interest) have income paid as dividend income with a 10% non-reclaimable tax credit. • Income paid (or reinvested) from a collective will be included in the assessment of an investor’s personal taxation and/or age allowance – although if the collective is held under an ISA wrapper this problem is solved.• Disposal of shares/units to supplement income is a disposal for capital gains tax, although this may be covered by your annual capital Gains Tax Allowance (currently £10,600 in Tax Year 2012/2013). The rate of CGT payable will depend on the allowances and reliefs available to the investor and on their income tax position.• Because collectives produce income they will normally need to be reported each year to HMRC, even if accumulation units or shares are chosen. Capital gains may also need to be reported when a disposal takes place but only if tax is expected to be payable.
Capital growth Capital growth
• When the bond is surrendered (this is a chargeable event) tax is assessed and may be payable depending on the personal income tax position of the bond owner. This is true whether the bond is either onshore or offshore.• Switching funds in an investment bond can take place with no tax implications for the investor. (This is not a disposal for tax purposes while the funds remain under the bond wrapper.)                                              • When shares/units are cashed in, this is a disposal for capital gains tax although this may be covered by your personal Capital Gains Tax (CGT) Allowance. • Losses on disposals can be offset against other capital gains – so can create effective tax planning scenarios.• Taper Relief and Indexation Allowance are no longer available on personal scenarios.• Switching funds within a collective is a disposal for CGT with possible tax and reporting requirements.
   
Tax & Estate Planning Tax & Estate Planning
• Individuals may be able to alter their level of income to reduce or avoid tax on surrender of the bond.Examples – those who have pension income in drawdown can reduce their income received to minimise tax payable; or could use part of the proceeds to help fund a pension, EIS, VCT, etc. so that the tax credit created offsets the tax bill associated with the investment bond encashment. • Gifting the bond (by assigning it nit not for “monies worth”) to a lower or non tax-payer. So an assignment to a spouse or child in further education may not create any liability (depending their personal tax rate) to CGT or income tax. It could reduce or avoid the tax that would otherwise have to be payable by the investor. • Individuals may be able to make a pension contribution to reduce or avoid any further liability to income tax on the surrender of their investment bond.• Gifting the bond to another (i.e. assigning into trust or to an individual) will be a transfer of value for Inheritance Tax and depending the terms of the trust may be covered by an exemption – more commonly though will be treated as a chargeable lifetime transfer.

• Having multiple lives assured can avoid any chargeable event upon death of the bond owner. This is assuming the contract is for encashment on the death of the last life assured. 

• If a chargeable gain arises in a tax year in which the investor is non-UK resident then there will be no further liability to UK income tax.  There may be a tax liability in their country of residence.

• A special relief applies to offshore bonds that reduces the tax liability on chargeable gains for individuals who have been non-UK resident for any period of their investment – Time Apportionment Relief.

• Investment Bonds, depending on the interpretation by local authority, may not be included within the means test for local authority residential care funding – care is needed as this varies from authority to authority, year-to-year, the circumstances surrounding and prior to the investment and many other factors.

• Individuals may be able to alter their level of income to reduce the tax rate payable on a capital gain e.g. those who have pension income in drawdown may be able to reduce it, by careful selection of funds within the collective to select the desires level of taxable income.• Transferring the collective to another individual or into trust will be a disposal for CGT purposes although this may be covered by your Personal Annual Allowance to CGT, or an exempt transfer between spouses. If into trust, gift holdover relief may also be available depending on the type of trust.• Individuals may be able to make a pension contribution which in turn could reduce the rate at which they pay CGT.• Transferring the collective to another individual or into trust will be a transfer of value for Inheritance Tax purposes, although this may be covered by an exemption.• No CGT is payable on death.

• Investors who are both non UK resident and ordinarily resident will not be liable to UK CGT on disposal of their collective.  However, anti-avoidance legislation means they will need to remain non UK resident and ordinarily resident for five complete tax years for the gain to remain exempt from CGT.

•  Collectives are included within individual’s assessment for local authority residential care funding.

Taxation of Fund  Taxation of Fund
Onshore Bond funds’ internal taxation is extremely complex. In general terms it can be summarised as follows:• Interest and rental income are subject to corporation tax at 20%. Dividends are received with a 10% tax credit which satisfies the fund manager’s liability.• Corporation tax is payable on capital gains at 20%. Indexation allowance is available to reduce the gain.• Investors are given a non-reclaimable 20% tax credit to reflect the fund’s taxation.Offshore Bond funds are typically located in jurisdictions which impose no tax upon investment funds, such as Dublin, the Channel Islands and the Isle of Man. And so:

• Interest, dividends and rental income are tax-free while under the bond wrapper. Some non-reclaimable withholding tax may apply to certain overseas income.

• No corporation tax is payable on capital gains.

• Personal tax position, rates and residence status must be considered carefully as taxation is typically payable at your highest marginal rate when the bond is finally encashed.

Collectives are only subject to tax within the fund on income received, and so:• Interest and rental income are subject to corporation tax at 20%. Dividends are received with a 10% tax credit which satisfies the fund manager’s liability.• No corporation tax is payable on capital gains within the fund.

 

Summary

There is no black and white answer on this – it is all circumstance specific but an understanding of the differences is essential. My belief is only pay tax when required and lawful – so products with an inbuilt taxation are to be used only when necessary, the lesser tax rate or for a specific reason/purpose.

Investors make money through investments with three key principles – fair costs, minimise taxation and investment performance.

Mark Lyttleton Is Taking A Leave of Absence From BlackRoch & Fund Management

1 Jun

Mark Lyttleton is taking a leave of absence for the summer (18 June and end on 17 September 2012). So what does this mean for the funds he manages at BlackRock?

Mark Lyttleton to run absolute return fund for St James's Place

In most cases where personal family issues are given as the reason for the break, one can’t speculate on the issues why. Although, it is more common that if they return to work the vast majority of fund managers that take time out do not return to the role they previously held.

For investors the crucial aspect of this latest twist in the Mark Lyttleton tale is – what to do if their money is in one of his funds?

Since the start of this year, Mark Lyttleton has been removed from managing the BlackRock UK Fund. The reason given at the time so that he could focus on the higher alpha strategies he runs – the BlackRock UK Absolute Alpha and BlackRock UK Dynamic funds.

This makes the timing of his three-month break even more extraordinary.

 

My contact details are :- tel 029 2020 1241, email welshmoneywiz@virginmedia.com, twitter welshmoneywiz, linkedin Darren Nathan

What’s The Scenario if Greece Exits The Euro & Eurozone?

26 May

Greek Flag

If Greece left the Eurozone, I expect this would be bad for Greece with a hike in inflation, unemployment, panic and social unrest likely.

There are some powerful factions within the Greek political system who are clearly anti the austerity measures imposed. I, as we all, can sympathise to some extent with the plight but there is a limitation as the problem is partly home-grown – where other countries made cut backs and tough decisions in the last decade these where not in Greece.

If Greece can’t satisfy the demands of the European Union and the IMF, then they will cut off Greece’s last remaining lines of credit. Without this, Greece will not be able to pay its bills and could drop out of the euro altogether.

Who should pay for these mistakes? Is there an answer? We can’t change the past and can only deal with the current and plan for the future.

 

So what is opinion on this :-

 

Carsten Brzeski, senior economist, ING Belgium

  • Chaos.
  • Greek banks vulnerable from collapse (lack of support if problems arise)
  • Greek companies vulnerable from collapse (lack of support if problems arise)
  • Unemployment would spike
  • Expect the new drachma would drop drastically in value
  • Food and energy prices would leap (poor exchange rates worsen the situation)
  • The turmoil would undermine any opportunity for growth
  • The outlook for the Eurozone would worsen.

 

Michael Arghyrou, senior economics lecturer, Cardiff Business School

  • The drachma would be devalued (at least 50%), causing inflation
  • Interest rates will double and all mortgages, business loans and other borrowing will become much more expensive.
  • There will be no credit for Greek banks or the Greek state.
  • Expected shortage of basic commodities, like oil or medicine or even foodstuffs.
  • A lot of Greek firms rely on foreign suppliers, who may cut off Greek customers.
  • Greek companies could be driven out of business.
  • Greece will lose its only reference point of stability, which was its euro status.
  • The country would end up in a volatile period.
  • There would be institutional weakness.
  • The worst case scenario would be a social and economic breakdown, perhaps even leading to a totalitarian regime.

 

Sony Kapoor, managing director of the Re-Define think tank

  • Greeks or European policy makers talking about an exit in a casual blase way are being highly, highly irresponsible.
  • Total cost versus the total benefit remains overwhelmingly negative, both for the Eurozone and Greece.
  • A Greek exit could undo a large part of good work in Ireland and Portugal.
  • If you are a Portuguese saver with money in the bank, even if there is a small likelihood of losing that money, it would make perfect sense to move euro deposits while you can to a safer haven, like the Netherlands and Germany.
  • There would be a significant deposit flight in peripheral countries.
  • It would immediately weigh on investment in the real economy, because corporations would be very reluctant to invest anything at all.

 

Megan Greene, director of European economics at Roubini Global Economics

  • Cascading bank defaults in Greece would be expected
  • Everybody would take money out of Portuguese and Spanish banks.
  • A big part could be plugged by the European Central Bank (ECB) through a liquidity operation that would backstop the banks. The ECB has already done that several times and it would step up to the plate again.
  • Political contagion or unrest.
  • Greece is a small country and the rest of the Eurozone has been making provision for this for a long time now.
  • The Eurozone could survive a Greek exit.
  • The exit could be better for everyone involved if managed in a co-ordinated orderly way. 
  • If a unilateral default, an exit would be a worse option for Greece.

 

Jan Randolph, head of sovereign risk, IHS Global Insight

  • If credit is withdrawn by the EU and IMF, then Greece becomes a cash economy. It means the government can only pay what it collects.
  • The government starts shutting down, 10-15% of state employees don’t get paid and unemployment surges from 20% to 30%.
  • But Greece can still use the euro.
  • It would be difficult for the ECB to keep banks afloat.
  • The Greek banking sector would collapse.
  • More unemployment, as credit for companies would dry up.
  • What happens next is a political question.
  • European nations would probably not accept another Western European country descending into chaos and collapse.
  • The EU and IMF would probably negotiate some kind of aid.
  • Greece could continue with the euro.

 

 My contact details are :- tel 029 2020 1241, email welshmoneywiz@virginmedia.com, twitter welshmoneywiz, linkedin Darren Nathan

 

Greece and a Change to the Eurozone?

24 May
So with the Greek election (take 2) looming only weeks away, the questions is – will Greece remain in the Eurozone? Personally, I believe if they left it would be both political and financial suicide but that is just an opinion. For the Eurozone such an option is unthinkable and hugely damaging – let alone the fear of the domino effect (so who would be next) and I guess that would/could lead to the end of the Eurozone.
 
Drachma may become legal tender in Greece again
 
It seems clear that there is growing support for the opinion that the current strategies for resolving the Eurozone Debt Crisis are doomed to failure. The most likely scenarios are :-
  • a Greek exit, or 
  • a rapid shift to a fiscal union.
If Greece is anything to go by, the current approach of forcing austerity on crisis economies and preserving their membership of the euro leads to dissent by the voting population. If we look at the voters behavioural changes, this seems to have led sentiment towards more extreme parties, both on the left and on the right.
 
In recent opinion polls, the majority of Greek voters (in excess of 75%) want to remain in the Eurozone (but also reject the austerity programme). The issue being, if there is a change/relaxation of the agreed commitments would send a destructive message to all other member states who are part of austerity programmes. This could lead to financial markets losing confidence, outflows of funds from Greece and other associated economies would accelerate, yields on financial instruments would sore. If this was the case it would be realistic to see the Euro could unravel and collapse.
 
A Greek Exit
A Greek default and exit from the Euro could have dire knock-on effects possibly leading to similar financial disasters in Spain and Italy. To prevent this contagion would require the ECB to lend several trillion euros to banks, and the available funds in this scenario are unlikely to be sufficient to cope with the fallout.
 
A Rapid Shift to Fiscal Union
This is expected to avoid the risk of contagion and financial collapse in at least some of the peripheral nations. This would require a substantial move towards a more centralised or federal style control of Eurozone government revenues and expenditures. This includes the concept currently being negotiated of Eurozone government issued bonds on behalf of all member states collectively.
 
If Brussels were to take over the debts of Greece and other struggling peripherals the immediate credit crisis would recede and the Eurozone credit would establish itself alongside US Treasury debt as one of the foremost debt markets in the world.
 
The outcome is stability but the unknown – is at what cost, both short and long-term?
 
This is in direct comparison of the current situation, where the current approach has led to  the Eurozone capitulation to the need to bail out Greece, Ireland and Portugal has undermined the monetary union, and the risk of contagion to Spain and Italy now threatens its very existence.
 
My contact details are :- rel 029 2020 1241, email welshmoneywiz@virginmedia.com, twitter welshmoneywiz, linkedin Darren Nathan

VIX – What The Fear Index Is Telling Me

29 Mar

In the last month or two, I have been concerned that index values seemed over stretched across most equity markets in the UK and Internationally. This was coupled with the VIX being at the lowest level we had seen in general terms since June 2007. 

What was interesting was not only were investors being complacent over risk but the media had also followed a similar track. Was risk a past fear? Were we in a low risk low volatility phase where the markets would only enjoy a bullish (optimistic) ever-increasing cycle? Or was risk about to become a concern and the recent equity gains were at risk of being wiped away? – I clearly sit in the second group as I do not believe the economic data, the global and severe woes, financial problems and robustness of investor sentiment could or would sustain.

I believe such a low VIX reading is likely to be troublesome and expect that the next bout of fiscal problems and re-emergence of existing problems will lead the VIX Index and fear to spike, resulting in a drop in equity markets globally. I think a more prudent question is how far will the markets drop?

While not an absolute short-term indicator, lack of publicity of balancing information i.e. both the good and the bad news, I expect will increase the severity when bad news arrives.

I don’t believe the stock rally is over but rather believe volatility will be part of the equation will large market movements both up and down. I think we are currently poised for a drop but how short- or long-term this may be is dependent on sentiment, fundamentals and further economic data.

There are no absolutes in investing, but a low VIX reading has historically been a good equity sell sign. If we consider, April 2011’s VIX lows led to a swift drop of almost 20% across most equity markets (some slightly better and some significantly worse).

The graphs below show two indices – the S&P 500 & the VIX. I think it is clear to see that there is a strong negative relationship. In addition to the VIX’s negative correlation to stocks, the VIX gives a strong indicator to buy/sell signals.

                  

My opinion is we could be at the bottom of the short-term cycle and the market has pulled-back a little recently. I believe there is further to go before markets normalise as the data and fears in the Eurozone, Asia, China, and possibly returns leading to more fear entering the market.

Investing is not a perfect science and so opinions are exactly that so diving from one strategy to another is not wise, sensible or typically profitable. Rather, the strategy should look at type of asset exposure and the expected risk/reward ratio and a suitable portfolio needs to be structured. Yes, over time the portfolio will be biased towards a higher exposure to equities, Gilts & bonds, Property, Commodities and Cash. This will be dependant on market forces, risk profile and investor perspective.

If you want an answer as to when the perfect time to invest this week, ask me next month; and if you want an answer when was the best month to invest this year, ask me next year.

No one has the answer, no one can effectively time the market. The key with investment planning, when one market is over-priced and ripe for a sell-off; another is under-priced and ripe to rocket up. The art is combining assets to minimise the potential to loss making markets with exposure to those with the potential to outperform.

Good Luck with your investment decisions – any questions or further information, email me at welshmoneywiz@virginmedia.com

Seeking Advice

18 Mar

I have been asked by many, the best way to contact me if you are seeking advice?

The easiest is by the blog email :- welshmoneywiz@virginmedia.com, or my business email :- dnathan.jpl@ntlworld.com or darren@jpltd.co.uk

Or call my office :- 029 2020 1241

Or my mobile :- 07931 388651

Or to follow me  –

On twitter :- Welshmoneywiz

On Linkedin :- Darren Nathan

All the best

Darren

So What’s Asset Allocation & What’s The Point?

11 Mar

I have mentioned throughout many articles, as financial adviser, professional investor and wealth manager, the importance of asset allocation.

I think it is worth explaining more, as to what this means to me.

Many financial experts believe asset allocation is an important factor in determining returns for an investment portfolio. Asset allocation is based on the principle that different assets perform differently in different market and economic conditions. So, diversification reduces the overall risk in terms of the variability of returns. Academic research has painstakingly explained the importance of asset allocation and the problems of active management.

Asset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset class in an investment portfolio according to the investor’s risk tolerance, market expectations, client’s goals and investment time frame.

Each asset class will move to some extent either correlated or negatively correlated with equities. So what this means is some assets will rise and fall with equities; and some assets will generally fall when the stock market rises and vice versa. By combining these assets in a portfolio, we can diversify what we hold and the volatility of the portfolio. The dream is to achieve a straight line of growth no matter market conditions. Admittedly, I believe that this is impossible but it’s what we strive to achieve.

The more equity exposure we take, where the risk profile is increased the wider the range of the possible outcomes both positive and negative. My underlying strategy is to take a diversified broad-based approach but when markets correct aggressively, then the risk-return ratio can achieve significant returns, at least in the short-term i.e. buy cheap and sell at a higher price. Over time the market typically returns to an average return, so care needs to be taken when considering if we are above or below the average. The question being; Are pressures in the market up or down? What time scale are we considering? Following the banking/debt/global economic crisis, what is our time horizon? And, what should it be?

I believe a key constituent to developing a strategy is market expectations. Personally, I am not willing to place a client in an asset allocation, where I expect we will make a loss. I see a person’s risk tolerance as their maximum or normal exposure in a rather abnormal world.

Any decision around this area is discussed first with my client. (My crystal ball works no better than anyone else.) If we are expecting a market pull-back (decline) then a more defensive strategy than normal may be more suitable. By asset allocating, then if we expect equities to drop in value, other markets are growing and so combining or excluding some assets can obtain positive returns in declining equity markets.

Asset classes and strategies

There are many types of assets that may or may not be included in an asset allocation strategy:

  • cash and cash equivalents (e.g., certificate of deposits, money market funds)
  • fixed interest securities such as Bonds: investment-grade or junk (high-yield); government or corporate; short-term, intermediate, long-term; domestic, foreign, emerging markets; or Convertible Securities
  • stocks: value, dividend, growth, sector specific or preferred (or a “blend” of any two or more of the preceding); large-cap versus mid-cap, small-cap or micro-cap; public equities vs. private equities, domestic, foreign (developed), emerging or frontier markets
  • commercial property or residential real estate; and REITs
  • natural resources: agriculture, forestry and livestock; energy or oil and gas distribution; carbon or water
  • precious metals
  • industrial metals and infrastructure
  • collectibles such as art, coins, or stamps
  • private equity and Venture Capital
  • and others

There are several types of asset allocation strategies based on investment goals, risk tolerance, time frames and diversification: strategic, tactical, and core-satellite.

Strategic Asset Allocation — the primary goal is to create an asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon.

Tactical Asset Allocation — a more active approach that tries to position a portfolio into those assets, sectors, or individual stocks that show the most potential for gains.

Core-Satellite Asset Allocation — a hybrid of both the strategic and tactical allocations mentioned above.

Systematic Asset Allocation – depends on three assumptions:-

  • Markets provide explicit information about the available returns.
  • Relative expected returns reflect consensus.
  • Expected returns provide clues to actual returns.

 

Return versus risk trade-off

In asset allocation planning, the decision on the amount of stocks versus bonds in one’s portfolio is a very important decision. Simply buying stocks without regard of a possible bear market can result in panic selling later. One’s true risk tolerance can be hard to gauge until having experienced a real bear market with money invested in the market. Finding the proper balance is key.

Asset allocation is important. It determines an investor’s future return, as well as the bear market burden that he or she will have to carry successfully to realize the returns. We are looking to an investor’s sensitivity to loss in the hope of long-term profits.

It is interesting to see that those with a more cautious prudent approach over the medium to longer term have performed better than more speculative strategies. The depth and severity of the recent recessions (or bear markets) have been the primary contributing factor.

My experience is that my clients risk profile is affected by the level of fear of losses. Generally speaking, I believe we should take a more prudent approach unless the market creates an opportunity to make enhanced profits.

 

Problems with asset allocation

There are various reasons why asset allocation fails to work.

  • Investors’ risk tolerance is not knowable ahead of time.
  • Security selection within asset classes will not necessarily produce a risk profile equal to the asset class.
  • The long-run behaviour of asset classes does not guarantee their shorter-term behaviour.
  • Most all asset allocation decisions fail to consider the effects of personal circumstances and any life changing events

 

Any questions email me – welshmoneywiz@virginmedia.com

Being Defensive Makes Sense in a World Where So Many Things Can Go Wrong?

10 Mar

We are all more fearful of the pain of losses than the pleasure of gains, that is “behavioral finance”.

One of the reasons so many worry is 2011 was such a volatile year – actually one of the most volatile on record. Within the first quarter saw the FTSE 100 drop almost 10%, followed by the markets rallying back and then again in the third quarter another drop of over 18%, followed by a rally of over 12%, leaving the FTSE100 down on the year by about 5.5% but what a roller-coaster.

There were and are concerns that Greece would default on its debt, efforts by China to slow the growth of bank loans, and persistently high U.S. unemployment.The stock market is up 62% since the March 2009 low, and there clearly is still a mood of pessimism and we’re still in redemption territory for equity funds, with a high amount of cash not invested even with cash returns (net of tax) typically between 0% – 2% and inflation in the UK at 3.6%.

So what happens if inflation is higher than the rate of interest accrued, in this scenario, you make a loss in real terms.

Some believe that stocks’ relatively low valuations reflects a rational assessment of their prospects. Profit margins for companies have risen since the March 2009 lows. Profit margins could have peaked and will begin contracting in coming years. So, why pay a premium for earnings which are clearly uncertain?

Others see low valuations as normal market overreaction, so stocks are now cheap. The point is we have over-worried. China was going to have a hard landing but didn’t happen. US, UK and the developed economies was going to have a double dip recession but that again hasn’t happened. Europe was going to disintegrate under internal debt crises but, and again, that just didn’t happen. So, have the worst risks passed?Even if this is true, are investors just suffering from fatigue from the investment roller-coaster ride?

While the latest rally has helped recoup a large proportion of the losses in the latter stages of 2011, it was a particularly punishing setback. I believe it is the severity and the quickness of the fall and how long it then takes to recover, which adds the levels of fear and anxiety investors have suffered.

Over time, if things continue to progress on a step-by-step basis, people will come back to stocks. When investors do, their buying power I believe will lead the market to new highs. In the mean time, I have a foot in both camps which has led to profits in both halves of the cycle. We are poised for the next market correction (this will add additional profits). Also, this stance and asset allocation in my experience leads to profits in most market conditions, so we are well placed to take advantage of market over-reaction (to the good and to the bad).  

The bottom line is – it is very unclear what 2012 will hold but it is expected to be a roller-coast ride.

I am always shocked when I meet new clients who live in fear of the roller-coaster ride (especially the down side – losses) but either stay fully invested whatever, in the hope one day it will get better; or spend too much time trying to time the market, which is impossible.

Any questions – welshmoneywix@virginmedia.com

European Fund Picks for a Difficult 2012

9 Mar

Europe was clearly the worst performing developed region in 2011. This was caused primarily by fear over the sovereign debt crisis and a potential break-up of the Eurozone. There is a belief that these problems may well now been contained and worries over contagions into other weaker European countries could have past.

This could be good news for investors, as history shows that the worst performing regions often bounce back strongly. Although, there are many outstanding isues still to be resolved but if this is the case, there could be a strong argement to invest in Europe.

Some of the most consistent funds, in my opinion, in the sector :-

  • GAM Star Continental European Equity
  • Blackrock European Dynamic
  • Threadneedle European Select
  • Neptune European Income
  • Jupiter European
  • FF & P European All Cap Equity
  • Jupiter European Opportunities (Investment Trust)

My email is :- welshmoneywiz@virginmedia.com