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Retirement plans are too important for rules of thumb

Posted on April 8, 2013 by Alan Dick CFP

Financial Planning is a very personal experience and everyone’s needs are unique. This is especially true when it comes to retirement. Yes, there are some general principles that most people would do well to follow but we must check and adapted these to our own personal circumstances.

‘I’ before ‘E’ except when there’s a feisty heist on weird beige foreign neighbours reinventing protein at their leisure.

The above tweet (a Twitter message) flew across my computer screen recently and caught my attention. Although it doesn’t mention financial planning, it struck a chord with me and made me think.

can I afford to retire early?

Don’t rely on rules of thumb to make important financial decisions

I cast my mind back to the initial reasons for each of our clients’ contacting Forty Two. A high proportion originally came to us at the point of making a major financial decision. They had reached a point in the Long and Winding Road of their financial life where they had to make a choice. We sometimes call this fork in the road a “sudden wealth moment”. For many this was the point of retirement, redundancy or selling a business. In such situations the comfort of receiving a regular secure income is replaced with a lump sum of capital that may need to support us for the foreseeable future or even the rest of our life. The most often asked questions included things like:

  • Can I afford to retire?
  • How much longer will I need to work?
  • Can I afford to retire early?
  • Can I afford to accept an early retirement package?
  • Should I apply for voluntary redundancy?
  • Can I afford to take voluntary redundancy?
  • I have been offered a substantial sum of money to sell my business, should I accept?
  • How much do I need to enjoy a comfortable and secure retirement?

Other clients first approached us after a disappointing investment experience with a previous adviser. They often asked questions like:

  • My investment returns have been really poor, is this down to bad management or just bad luck?
  • Could I get a higher return from my investment portfolio without taking more risk?
  • What level of investment return do I need to achieve?

Unfortunately, many people don’t have a proper framework for assessing the situation and reaching an informed decision. In fact, the majority of people (including many advisers) rely on rules of thumb to make decisions about important, potentially life changing, financial decisions.

When faced with any important financial decision it is vital to carry out an informed analysis and not rely on potentially dangerous rules of thumb. That is why it is so important to have a personal financial plan which includes a detailed lifetime cashflow forecast. A picture paints a thousand words. When we can see the implications of various potential strategies on-screen it often becomes blindingly obvious what the right course of action is. For some of our clients the right course of action was take the early retirement or redundancy package and enjoy life, for some it was to accept the offer to sell their business but for others it was work (and save) a few years longer to ensure a secure retirement.

While ‘I’ might come before ‘E’ in most cases, as the original sentence shows, it is certainly not true all the time. With important financial decisions a proper financial spellchecker is much more robust than a simple rule of thumb.

Posted in Retirement Planning, Uncategorized | 2 Comments

Women control 80% of family financial decisions

Posted on March 27, 2013 by Alan Dick CFP

Women get a raw deal financially

Women generally live longer than men. Women are often a few years younger than their spouses. Therefore, it is highly likely that most women will become widows at some point in their life. One recent article suggested that “85% of women will be left alone to fend for themselves by age 65”. This would be bad enough if it wasn’t for the fact that women still earn less than their male equivalents. They are more likely to take a career break to raise the family or look after elderly relatives. Taking a career break can have wider consequences than just having no income for a few years; it can significantly reduce career progression on return to work. Not only does this reduce career earning capacity, it also significantly reduces the ability to save for retirement.

Two thirds of women want to change financial adviser

The inspiration for this blog came from a recent article which stated that only one in four women have a financial adviser. Even more worryingly, of those that did, two out of three didn’t trust their adviser or were unhappy with the relationship and seeking to change advisers. This came as no surprise to me. I had a recent meeting with a couple who have used the same adviser for over 10 years. During our initial chat Fiona told me, “I think I am an intelligent person. I ask relevant questions but I don’t understand a word they are talking about.” We had a discussion about Forty Two’s investment strategy and she thanked me by saying “in all the years I have been coming to these investment meetings, this is the first time I have actually understood what an adviser was talking about.” While this was great feedback to hear it is also a pretty damning indictment of financial advice in general.

It is not surprising then that four out of five widows change financial adviser within the first year of losing their spouse because of the way they were treated when their husband was alive.

Women are better at investing

Women control 80% of all family financial decisions

Who wears the trousers?

Women own 30% of all global wealth but although they may have less money than men, they typically control 80% of all household financial decisions!

This is something that has happened for generations and shows no sign of changing. My grandfather would bring his pay-packet home on Friday and give it to my gran who managed the household budget and still managed to save for a rainy day. Today my son spends his pocket money before he has it (in fact he has spent it several times over by the time he receives it) while his little sister can account for every penny and is capable of making informed financial decisions including which chocolate represents the best value for money in ASDA.

Women are better at investing than men

Research also suggests that women make better investors than men. A study of 38,000 investment accounts by the University of California found that women investors out performed men by 9% per year. David Bach summed it up in his book Smart Women Finish Rich, “As a rule, women make better investors than men. When women become investors, they generally devise a plan, and then stick to it.” Men on the other hand often suffer from a fear of commitment. Rather than stick with an agreed investment strategy they often get bored and led astray by the latest “hot thing”.

It is clear that many women will find themselves widowed at some point. Therefore, it is essential that they are fully aware of their overall financial position at all times to avoid even greater stress when the time comes to look after it alone. Financial planning and investment decisions should actively involve all parties affected by them and not be delegated to one spouse or the other. For those women who have been recently widowed, it is vitally important to find a trusted adviser that can help create a proper financial plan to ensure their continued security rather than some investment adviser who wants to talk jargon and discuss exciting investment opportunities.

Posted in Investing Your Money, Retirement Planning, Truth About Money, Uncategorized | Leave a comment

Who do you love?

Posted on March 14, 2013 by Alan Dick CFP
Avoiding Inheritance tax (IHT)

Avoiding inheritance Tax (IHT) needn’t be difficult

 

I never ceases to amaze me how many people appear to love the taxman more than their family.

When we first meet new clients, we regularly find that their life assurance and pension benefits are arranged in such a way that the taxman stands to be the single biggest beneficiary on their death. This would be unfortunate if it was difficult, time consuming or expensive to avoid. It is almost criminal given that the solution is simple, efficient and relatively inexpensive. When these people become clients of Forty Two they find their affairs better organised.

Take Joe an example. Joe has sufficient assets to exceed his Nil Rate Band allowance for Inheritance Tax purposes (currently £325,000). On death the first £325,000 of his estate will be tax free but the balance will suffer inheritance tax at 40%. Joe has a life assurance policy that pays out £1,000,000 on his death. However, as things stand the proceeds of the policy will form part of his estate and suffer inheritance tax of 40% (£400,000) leaving only £600,000 to be split between his three children. Each of the kids would receive £200,000 and the taxman would receive double this amount. In this situation it would be easy to conclude that Joe loved the taxman more than his own family.

If Joe were to simply place the policy in trust the full £1,000,000 would bypass his estate and no Inheritance Tax would be payable saving £400,000. That’s £400,000 pounds of love!

Trusts can range from simple free “off the shelf” documents supplied by life insurance companies through to some very complex bespoke structures. We recommend that virtually all life assurance and pension death benefits should be placed in trust. Along with writing a will, this should be one of the first quick and easy steps in creating a proper estate plan. As trusts form part of a more comprehensive estate planning strategy we would recommend using a suitably qualified solicitor to ensure the trust meets each individual’s personal needs.

As trusts are legal documents you would expect every solicitor would have his or her own life assurance and pension death benefits written under trust to protect their families from the nasty tax man. However, we often find that this is not the case. It is one of those “cobbler’s bairns” situations where professionals are so busy looking after their clients’ affairs that they just never get round to sorting out their own. One of the key benefits of working with a professional financial planner is having someone to audit current arrangements, recommend a suitable strategy but most importantly ensure the agreed strategy is implemented and reviewed. Left to our own devices, there is always something more important than arranging that trust.

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The single biggest investment mistake – and almost everyone makes it

Posted on February 27, 2013 by Alan Dick CFP

What is the single biggest investment mistake almost everybody makes? If you could pick just one thing what would it be?

•    lack of diversification
•    holding too much (or not enough) in shares
•    over (or under) exposure to emerging markets
•    perhaps holding government bonds when “everyone can see it’s a bubble waiting to burst”
•    maybe you think it’s selling shares after markets have fallen or buying after markets have experienced substantial gains

These are all valid suggestions but they aren’t “the big one”

The biggest investment mistake almost everyone makes is incorrectly identifying and measuring their assets; specifically failing to acknowledge certain assets at all. As asset allocation is one of the most important investment decisions we can make, we better make sure we get it right!

So, how do so many of us get it so badly wrong?

When analysing our total wealth and asset allocation most people include:

•    Cash
•    Fixed interest securities
•    Property
•    Company shares

Of course, the list could be expanded to include sub assets such as shares in smaller companies but there is one glaring omission from this list – YOU

Almost no one properly accounts for their human capital as an asset in their investment plan, but for many people THEY are THEIR biggest single asset.

Take a successful professional such as a partner in a law or accountancy firm, their biggest asset may be their future earning potential, but this is rarely quantified  and doesn’t appear anywhere in the asset allocation or risk budget. The value of human capital changes over time, reducing as we near retirement or increasing with promotion or a successful new business venture. The risk of this asset also varies depending on the nature of income; the future earnings of an entrepreneur will be less secure than an NHS consultant with a contract and generous final salary pension benefits. This needs to be accounted for, monitored and rebalanced in the same way as any other asset within the investment portfolio and financial plan.

Human capital is more than just earnings. Services provided to the household also provide real value that will impact the asset allocation decision. One spouse may decide not to work in order to run the home and be there to look after the kids. This non-working spouse may have no earnings but if they weren’t there there would be a real financial cost.
Many people find it challenging to conceptualise the value of human capital, let alone measure it; they just ignore it and hope the problem goes away. However, a proper financial plan with a clear lifetime cashflow analysis will provide valuable guidance. The plan can be interrogated and stress tested with multiple “what if?” scenarios to quantify the risk in relation to achieving your personal lifestyle goals.

Some scenarios are easy to imagine. If Kylie dies her income will stop and Jason will need to find some way to replace this or accept a massive change in lifestyle. Simple life assurance for an appropriate sum written in trust would provide one solution (often for minimal outlay). Most people understand this but don’t go any further.

Why am I referring to the biggest mistake being an investment allocation issue though?

You are no doubt familiar with the concept of a diversified investment portfolio. By spreading investments across non-correlated assets where some go up in value while others fall, we can reduce the overall risk of our portfolio without sacrificing too much potential return. However, we seldom include human capital in this equation.
How would your earnings be affected  by a stock market crash, or property transactions slowing down further? This will depend on your career and skills. A solicitor specialising in property will be affected differently to an insolvency practitioner. How would your financial plan be affected if your earning capacity suffered at the same time as your investment portfolio tanked? It is essential to consider the full range of assets including human capital; the value of YOU.

Fortunately, the tools exist to allow for human capital in your financial planning. You should ensure you have a detailed lifetime cashflow projection and keep it up to date. At the very least this should be updated annually, or more frequently if there has been a significant change in circumstances or objectives. If it doesn’t include a cashflow analysis it isn’t a financial plan.

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The value of proper independent financial advice could be 10% each year!

Posted on February 19, 2013 by Alan Dick CFP

There appears to be a perception that independent financial advice is expensive and unnecessary.  In a recent article in our Long And Winding Road series, B&Q and Financial Planning, I discussed the implications for independent financial advice given the rise of the DIY investor.

In a recent report KPMG  highlighted a significant rise in the number of execution-only stockbroker accounts among the larger portfolio sizes targeted by Private Banks and Wealth Managers. At the end of 2010 there were over 18,000 DIY portfolios valued between £250,000 and £1m; an increase of 122% since 2008. Over the same period, the number of portfolios valued between £1m and £10m increased by 73%. A study by the online investment broker Hargreaves Lansdown  suggested 84% of investors plan to go it alone and fore go advice. However, there is a significant body of independent academic research which suggests this may be exactly the wrong thing to do.

A recent paper from the Goethe University Frankfurt examined the actual trading accounts of 8,621 investor portfolios from an online execution only broker and found that 89% exhibited “negative skill” before charges (91% after charges). And where investors did outperform there was no evidence this was anything more than luck? The fact that so many DIY investors performed poorly was no surprise; the vast body of research tells us to expect this. What was surprising about this study was the magnitude of under-performance. The authors found that on average investors underperformed the returns they could have expected by luck alone by -7.5%pa before charges (-8.5%pa after charges).

There have been many similar studies in other markets including the UK and US which show that investors consistently under-perform the market and the more they trade; the worse they perform.

We are all familiar with the notion that investors should buy when prices are low and sell when they are high. However, history tells us that, left to our own devices; we will do exactly the opposite. A rough and ready reference for this might be to compare the inflows and outflows of Equity and Bond investment funds against the movement of the stock market.  The level of net sales/redemptions from UK domiciled Unit Trust and OEIC funds can be found on the Investment Management Association website. I have plotted the proportion being invested in equities and bonds since 2003 against the movement of the FTSE All Share index below.

Net retail investment fund sales relative to FTSE performance

The general trend is certainly clear. In 2006 and 2007, when the UK Stock Market was at its peak after 5 years of strong returns, almost no money was invested into bond funds. However, in 2008 after the stock market collapsed investors withdrew nearly £1.2bn from equity funds and invested nearly £3bn in bond funds.

Carl Richard, author of Behavior Gap sums it up perfectly with his sketch “Repeat Until Broke!”:

The value of independent financial advice

The true value of independent financial advice is in helping investors overcome their natural human instincts.

Another recent study by Morningstar  attempted to quantify the true value of comprehensive financial advice for retirees rather than simply measuring investment returns (a similar study could be designed for pre-retirees). Morningstar identified 5 distinct ways in which good advice adds value;

1.    Total wealth asset allocation – taking account of “human capital” rather than just financial assets. This requires consideration of risk capacity as well as risk preference; something which is fundamental to proper financial planning.

2.    A dynamic withdrawal strategy – regularly reviewing the sustainability of withdrawals and making changes as required.

3.    Annuity allocation – giving due consideration to the pros and cons of securing a guaranteed income for life through annuity purchase. Morningstar quote an Allianz study which found the greatest fear among retirees is not death (39%) but rather outliving one’s resources (61%).

4.    Tax efficient investment allocation decisions – if it is possible to hold assets in different ways, some more tax efficient than others, it makes sense to maximise tax efficiency.

5.    Portfolio optimisation that includes liabilities – asset allocation methodologies commonly ignore the funding risks with an investor’s own goals. True financial planning will attempt to quantify the impact of such risks and address these accordingly. A personal lifetime cashflow forecast is a good starting point.

The authors developed a formula to quantify the impact of the 5 factors and estimated the “added value” through proper advice to be 1.8% annually.

It is often said that there is now so much free information available online that investors can do their own research quickly and easily without the need for advice. Unfortunately, life is too short. The real problem may be “information overload”. There is no longer much value in selecting the best funds or executing trades but there is value in investment coaching and filtering out the distracting noise.

Taking all of the above into account it seems that the value of good financial planning and investment advice combined could be as much as 10.3%pa (8.5% + 1.8%). Then again, perhaps Master Card would sum it up as; Investing money 1.5%, tax planning 0.5%, lifetime cashflow forecasting 1%, liability matching 1%, investment coaching 2%, the ability to enjoy your life and sleep at night – priceless.

 

 

(The percentages in the Master Card example are ficticous and purely random numbers plucked from thin air and are not meant to imply specific values in any way shape or form)
Posted in Behavioural Finance, Investing Your Money, Retirement Planning, Truth About Money | 2 Comments

People who can’t write interviewing people who can’t talk

Posted on December 12, 2012 by Alan Dick CFP

Frank Zappa once said that most music journalism is people who can’t write, interviewing people who can’t talk, for people who can’t read. That sounds a lot like much of the financial press to me! Obviously, as with most things in life, there are exceptions and there are some very fine financial journalists doing a great job (you know who you are, keep fighting the good fight) but much of the output of the financial press is investment pornography, scaremongering and advertising dressed up as analysis.

As we near the start of a new year we typically enter the silly season for financial journalism. Over the next few weeks you will no doubt see countless pages devoted to “expert” predictions about the level of the FTSE 100 Index in a year’s time (i.e. at the end of 2013). By all means read the articles and have a good laugh (they will probably be more entertaining than some of the Xmas telly) but bear in mind most of them will be wrong; often badly wrong.

You will also see countless articles about “ten funds you must buy for 2013” or “the top investment themes every investor needs to grasp next year”. Again, most of them will be wrong.

Some of them will be right and the pundits, journalist or fund managers who made them will be proclaimed geniuses; perhaps a new investment messiah. But remember, these people make predictions all the time so by the law of averages they will get some right just by luck. As an old saying goes, “even a stopped clock tells the right time twice a day”.

A very quick search on Google reveals how difficult it is to predict stock market performance. The FTSE 100 index finished 2010 at 5,900. An article on the This Is Money website from 30th December 2011 reveals that every expert they questioned at the end of 2010 thought the FTSE would finish 2011 above 6,000 and one even suggested the FTSE would reach 6,700. The market actually closed for the year on 5,572.

In a similar article at the beginning of 2012, two leading stock brokers predicted the market would finish 2012 at 5,850 (Brewin Dolphin) and 6,100 (Killik & Co). Predictions by various IFAs suggested the FTSE could finish 2012 as low as 5,000.

The This Is Money article goes on to quote predictions from Sunday Times as follows:

investment predictions

We are nearing the end of 2012 and with only a few weeks to go we still don’t know where the “market” will finish so any of these predictions could turn out to be right.

Some of the names above have teams of the best economists and researchers in the world at their disposal and they still can’t agree on a figure let alone get the figure right. Which goes to show that investing based on predictions about the future, no matter how plausible they sound (or how credible the source) is a mug’s game. Instead make sure you have a long term investment plan that is aligned to your own financial needs; your personal goals and aspirations as outlined in your own financial plan. Then, simply stick to the discipline of the plan and let others worry about second guessing markets while you enjoy Christmas Dinner and re-runs of the Great Escape and the Two Ronnies on telly. You should only change your investment strategy when your goals change.

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Possession Is Nine Tenths Of The Law

Posted on November 30, 2012 by Alan Dick CFP

One of the benefits of living in a developed, civilised society is the access to things we take for granted; things like medical care, education, roads, etc. Unfortunately, these all have to be paid for somehow and money doesn’t grow on trees you know. Our Governments fund their spending plans out of income and borrowing just like any household. In the case of income, the Government’s main source (it’s salary if you like) is taxation.

In the UK we have been blessed with a fantastically complex tax system. We are taxed as individuals and as businesses. We are taxed on income, earned and from savings and investments. We are taxed again on consumption/spending (VAT, duty on fuel, alcohol, tobacco, etc), ownership (Council Tax), transfer of assets (Stamp Duty) gains on investments (CGT), death (Inheritance Tax). Despite its name, National Insurance is not insurance but another tax. Even the TV licence is a form of taxation. I haven’t checked ALL the tax rates that could apply but here is a quick sample – 0%, 2%, 5%, 10%, 10.4%, 10.6%, 11.8%, 12%, 13.8%, 18%, 20%, 25%, 28%, 32.5%, 35%, 40%, 42.5%, 50%, 55%. There is even an effective rate of  income tax of 60% in some cases and many of the consumption based duties on tobacco, alcohol and fuel are in excess of 60%.

If we want to enjoy the benefits of our society we need to pay our fair share of tax but obviously none of us want to pay more tax than necessary.

What has all this talk of tax got to do with possession?

Well, possession is 9/10ths of the law as they say. In tax terms, the ownership of many things such as investments, or the source/ownership of income, determines how much tax we need to pay. Good financial planning can often yield a significant reduction in the amount of tax we pay without the need to resort to any Jimmy Carr or Chris Moyles “aggressive tax planning strategies”.

Often carrying out some simple housekeeping on our financial affairs is enough to make a significant difference.

For couples it is worth considering who actually owns any savings. Interest from bank and building society accounts can be taxed at 0%, 10%, 20%, 40% or 50% depending on your other income. Simply moving a savings account from a higher rate tax payer to a lower rate or non-tax paying spouse could result in a tax saving of up to 50%. To put that in perspective, a 50% tax payer with £100,000 in the bank earning interest at 3% would have £3,000 interest before tax but only £1,500 after tax. Simply transferring the savings to a non-tax paying spouse would result in an improvement in spendable income of £1,500 each year. “Simples”, as those annoying little meerkats would say.

Earlier this year a man came into my office and told me he needed investment advice to make his savings  “work harder”. He explained that he had a reasonable level of savings in bank and building society accounts which were all in his name. He also explained that he had already visited two advisers; one Independent Financial Adviser (IFA) and one in-house adviser at his bank. He told them both that he didn’t want to take much risk with his money but needed a little extra return. The bank adviser had him complete a risk profiling questionnaire which placed him as risk group 2 on a scale of 1 – 10; where 1 represents no risk at all and 10 equates to a trip to Las Vegas. Clearly this man did not want to take stock market type risks!

I was shocked to hear that both advisers had recommended a significant portion of his savings (the IFA suggested nearly 100%) should be placed in an Offshore Bond (paying around 7% commission) and should be invested in a range of UK equity funds including some very specialist highly concentrated “recovery funds”.

After discussing his various sources of income, and the fact that his wife had no income in her own name, I told him he didn’t need a Financial Planner. All he needed to do was transfer the savings accounts to his wife. The interest would still fall below her tax free allowance and would therefore provide a 20% increase on the current returns without any additional investment risk.

The same thing applies to gains from investments. Each individual is allowed to make a certain amount of gains each year (for 2012/13 this is £10,600) without paying any tax. Thereafter, gains are subject to Capital Gains Tax (CGT) at either 18% or 28% depending on other income. Simply splitting investments between spouses can double the amount of tax free gains available and can significantly reduce the level of tax paid on any amounts above the threshold.

It is worth noting that the annual Capital Gains Tax allowance is a use it or lose it deal and cannot be carried forward to increase the tax free allowance in future years.

When it comes to earned income, different rates apply to profits from self-employment and salary or dividends from a limited company. Therefore, business owners and entrepreneurs should give careful consideration to how they structure their business interests.

Individuals who are worried about inheritance tax can simply transfer some of their assets to the next generation, either directly or using a trust, and substantially reduce their potential tax liabilities. Obviously this is dependent on their being able to maintain their own desired standard of living.

In addition to the plethora of different tax rates, there are just as many (if not more) tax allowances that can be used to legitimately reduce our tax liabilities.

For many people simple steps such as moving savings and investments to a lower tax-paying spouse will be enough to make a significant difference; they may not even need the help of a financial planner or tax specialist. However, individuals (and businesses) with more complex tax affairs should definitely seek specialist advice from a financial planner, accountant and/or tax adviser.

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Pensions, Investments and Heinz Baked Beans

Posted on November 29, 2012 by Alan Dick CFP

In my last blog Three Steps To Heaven I outlined my three simple steps to successful Financial Planning – Define It, Cost It, Fund It. You may recall that the two most important steps define your desired lifestyle and work out how much this will cost have nothing to do with financial products. It is only at step three – Fund It that we might consider financial products.

I have been in this business for nearly 25 years and it seems to me that, during that time, financial products have become ever more complicated. There is a multi-billion pound advertising and PR machine dedicated to convincing us that the final stage of the process is really complex. In fact “High Net Worth” or “Sophisticated Investors” are even allowed to opt out of the protections available under the Financial Services Act to access often complex unregulated products. Apparently, we all need the latest structured product linked to a combination of Mongolian tin futures, Tibetan yak farming index and Greek ouzo bonds. No we don’t!!!!

I would argue that, for somewhere between 99% – 100% of the population, simple is best.

A good friend of mine, Anita Gatehouse, is a financial planner in Kidderminster. Anita runs a Financial Planning firm called Cre8 Wealth Management and has just finished writing her first book, A Widows Guide To Financial Planning which will be published shortly. Anita asked me to read a draft of the book recently and offer some feedback. She has managed to distil often difficult concepts into a friendly easy to read format and I am sure the book will be a major success. One particular phrase in the book really stood out for me, “sometimes simplicity is the most sophisticated strategy of all.” Go girl! I wish I had written that line.

When it comes to selecting financial products to carry out the Fund It stage of our process (and this also includes protecting your plan using appropriate insurances) simple low-cost, plain vanilla products that are easy to understand and do exactly what they say on the tin are all the vast majority of us need. In fact, financial products such as Pensions, ISAs and Unit Trusts are not added value products as the marketing and advertising machine want us to believe but mere commodities – just like tins of beans. You may like the taste of Heinz or Branston but Asda or Morrison’s own brand probably have almost identical nutritional value. The added cost is in the packaging, advertising and buying prominent shelf space but it is unlikely to provide more energy for your body.

Often financial products advertise unique features, but unless you actually need these features you are simply paying too much for your beans. Financial products may come in “57 Varieties” but the truth is that deciding how much to pay into your pension or ISA, or how much life insurance you need (cost it), will make a far bigger difference than worrying about whether a Standard Life pension is better than Scottish Widows’ or any other company for that matter. And don’t get me started on premier bank accounts! Unless you actually need the “added value” features of a premier bank account such as travel insurance and breakdown cover (which you may already have anyway) you are simply throwing money down the drain. Two or three simple products that actually do what they are supposed to will often represent better value than one complex product; which no one fully understands and is riddled with exclusions.

Simplicity is also generally advisable when creating a Financial Plan. In order for anyone to commit to the action points in their Financial Plan they need to understand the reasons and the expected outcomes; a complex plan seldom gets implemented and followed through. Even if it does, it often leads to problems later when no one can remember why a particular course of action was deemed appropriate way back yonder.

Remember that selecting products is a commodity service with limited added value. Real financial planning focuses on defining your ideal lifestyle and working out the cost of achieving and maintaining it. Make sure that your Financial Adviser has the knowledge and experience to deliver the important parts of your financial plan and not just select tins of beans.

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Three Steps To Heaven

Posted on November 28, 2012 by Alan Dick CFP

At Forty Two we provide a service which is often referred to as Lifestyle Financial Planning. When I say that to most people they get a picture of some Californian hippie, hugging trees and smoking wacky backy while chanting some strange incantation or mantra. It’s not like that, honest!

I do now have a mantra which I have decided to adopt thanks to a presentation Richard Allum of Paraplan Plus and Moneyscope gave at the Institute of Financial Planning Scottish Conference recently, but more of that in a minute.

When I first meet someone new one of the first questions they often ask is “what is it you do then?” I always struggle with this. When I say “I’m a financial planner” the poor person who asked the question usually doesn’t know which way to turn and can’t run away fast enough. They often say something like “oh! I already have a pension” or “I’d don’t trust IFA’s” or some other variation that shows they don’t actually know what a Financial Planner does. Sometimes they just make the sign of a cross with their fingers and wave cloves of garlic in front of me. This isn’t their fault; it is a perception created over decades by the media and an industry of financial advisers who keep changing the name of what they do, without actually changing the service they provide. Do you remember when everyone was an Independent Financial Adviser? Then endowment mortgages got a bad name and the same people became Financial Consultants or Investment Consultants. Some are now Wealth Managers or Financial Planners but they are still providing the same basic service – the distribution of financial products.

So, my dilemma is, how do I tell people what I do in a few seconds (i.e. before they have fallen asleep) without causing them to reach a conclusion based on prejudice and previous experience of the financial services industry?

I have heard numerous marketing gurus say that you should never answer this question truthfully. They tell me that “whatever you do don’t say I’m a Financial Planner” or “I’m an IFA” or anything at all that might imply what it is I actually do.  No, instead I apparently need to make it sound interesting and exciting – make it sexy! I need to say something like “I help successful people, who are in the process of selling their enormously successful business for bucket loads of money, lead the life they have always wanted but never knew they could afford.” Alternatively I could just say “I’m in the peace of mind business” but that conjures up images of fat gangsters with violin cases. The answer is supposed to be vague enough that the person asking the question will have no idea what I actually do and will therefore, need to ask another question like, “how is it you do that then?” at which point I can launch into an explanation of what a real financial planner does without ever uttering the words Financial Planner and becoming a social pariah.

I have two problems with this approach;

  1. I am actually very proud to be a highly qualified professional Financial Planner who makes a real difference to the lives of my clients.
  2. I’m uncomfortable telling lies or even being liberal with the truth. It feels wrong and I just can’t get comfortable with a slick “elevator pitch” or sales sound bite.

I guess I’ll just have to find a better way to explain what a Financial Planner does before people switch off or run away.

The truth is we do help people live the life they want both now and in the future. We help people achieve their desired life if they can’t afford it yet; and we help them protect it if they are already financially independent. Financial Planning is as much about common sense and discipline as it is about clever financial strategies, tax planning or investment portfolios. There are actually only three steps to financial heaven. So my new mantra is;

  • Define It
  • Cost It
  • Fund It

Let me hear you chant it after me, Define it, Cost it, Fund it! Define it, Cost it………

Financial Planning in three easy steps; it’s not rocket science you know.

The problem is that most financial advisers start at step three (which they assume requires financial products) and miss steps one and two completely even though they are far more important.

If you don’t know what you want out of life how will you know if you have achieved it?

If you don’t know what your ideal life looks like, how will you know how much money you will need to live it?

Clearly defining your ideal life must be the first step in the process not an afterthought. You can’t build a castle without firm foundations.

Once you and your adviser know what you are aiming to achieve you need to work out how much this will cost and when it will be needed. Different objectives might need money at different times so the only way to know this is build a personal cashflow projection that takes account of your own personal income, spending, assets and liabilities, now and in the future.

Only after the cost of your desired lifestyle is known should you even begin to think about financial strategies to fund it. These strategies might involve regular saving for the future, investing a lump sum, repaying debt, changing your working life, working longer (or shorter) etc. Any lifestyle funding should also be stress tested to make sure that it is still affordable in the event of any disasters such as death, illness, loss of income (possibly redundancy) or an investment market crash.

Financial Planning is really pretty simple but that doesn’t mean it’s easy.

The first two questions in particular often need a trusted adviser to coach you and challenge your assumptions; to make sure you are being honest with yourself and help you deal with any compromises or trade-offs. The third question often requires someone to hold you accountable to the agreed strategy, to provide discipline and help maintain a long-term perspective among all the short-term “noise” of everyday life.

I can’t think of a better time than Financial Planning Week to take a step back and re-evaluate your ideal life then Define it, Cost it, Fund it. This is the real value of Financial Planning.

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To Fail To Plan Is To Plan To Fail

Posted on November 27, 2012 by Alan Dick CFP

For years now I have been banging on about the need for proper financial planning. It’s often a lonely experience as the weight of the media thrusts its consumerist propaganda of sod the future live life now buy whatever you want because “you’re worth it”. This kind of reckless spending on the debt fuelled merry-go-round is exactly what got us (and our governments) into the current financial crisis.

In their book “The Millionaire Next Door”, Thomas Stanley and William Danko examine the conundrum of why so many people who live in expensive homes and drive luxury cars are not actually wealthy. I was reminded of this last week when a potential new client came in to my office. I have changed some of the details to protect the innocent and ensure they remain anonymous but I feel a need to share the story and highlight the real issues facing lots of people today; not just people who appear to be in financial difficulty either.

A couple came in to see me, let’s call them Vincent and Flavia for the sake of argument (I’ve obviously been watching too much Strictly Come Dancing recently!). Vincent is nearly 60 years old while Flavia is nearer 50. Vincent has worked all his life in well paid professional positions earning a six figure salary. Flavia has never worked, preferring to stay at home and raise the family who are now self-sufficient.

At the start of the meeting Flavia explained that she thinks they need “one of those financial plan things” as she has only recently found out that they have no plans for the future; and I mean literally no plans for the future. Until this point Vincent has handled all of their financial affairs but he says he doesn’t need to save anything as he isn’t going to stop working. He likes working and will work until he “drops”. In fact, he thinks pensions are such a waste of time that he opted out of his employer’s scheme years ago. The truth may actually be that he is too embarrassed to admit to Flavia that he hasn’t been saving for the future and now realises it may be too late; but that’s a whole other discussion for another day.

After an initial chat to find out what they want their future to look like, we started to build a very rough financial model of their affairs together. We do this in our first meeting with clients to let them experience the difference between true financial planning and the product-focused financial advice they may have encountered in the past. We often find that it is almost impossible to explain Financial Planning but as soon as client’s experience it they just get it.

We started the exercise by entering approximate income and expenditure figures into our financial planning software. I explained that if we both agree to work together we will need to dig much deeper and gain a proper understanding of “what’s coming in?” and “what’s going out?” both now and in the future. However, for the purposes of the demonstration a very rough estimate will suffice.

Next we looked at their assets and entered these into the model. They have a very nice house in a good neighbourhood. The house is worth £750,000. Unfortunately, they still have a mortgage of £675,000 outstanding. Not only that, but the mortgage has been arranged on an interest only basis until the latest age the lender would allow (70). They only make minimum interest payments each month as this keeps outgoings to a minimum and allows them to enjoy a very nice lifestyle.  However, the outstanding debt stays at the same level year after year. They haven’t thought about how they will repay the loan when Vincent is 70 and currently have no means of repayment in place at all.

In addition to the house and mortgage, they drive very nice German luxury brand cars with outstanding finance against them. They also sheepishly hinted at “a couple of other loans” but no further details were forthcoming. They dressed very well and obviously spend money on their appearance.

They enjoy nice holidays abroad on a regular basis. When I asked what savings and investments they have at the moment they said, “a few thousand pounds in the bank, that’s it”. Sorry? Effectively, they have no savings, not even a basic emergency fund.

I explained that, although we had only gathered enough information for a very rough overview, their position was clearly not good. They will not be able to afford even a basic standard of living (let alone the standard they have become accustomed to) for more than a few months after Vincent’s income ceases.

I also pointed out that the decision to stop working may not be in Vincent’s hands. How would Flavia cope if Vincent had died yesterday? There is some very modest life insurance in place but it wouldn’t even cover the mortgage let alone future spending. So basically Flavia would be left destitute. I asked if she had ever thought about getting a job but this didn’t seem a realistic option to her.  In which case they need life assurance and critical illness insurance (which is likely to be extremely expensive at age 60). Depending on the contract of employment, Vincent may also need income protection insurance as his salary may stop immediately if he suffers ill health. However, every pound spent on insurance is a pound that is not being invested for the future which they also need to fund (and quickly!).

This is probably the worst case of a lack of Financial Planning I have ever seen but it would surprise you how many people who appear wealthy are actually stumbling through life overspending today and ignoring tomorrow. Our whole society has become possession and lifestyle obsessed. We want the latest fashions, gadgets, cars, holidays and houses and we want them now. As Queen once sang “I want it all, and I want it now”. In a little over a generation we have degenerated into a nation that, just like petulant children, feel it is our right to have what we want when we want it and damn the consequences.

I often say that we are in the people management business, not the investment management industry. Financial Planning is really pretty simple but that doesn’t mean it’s easy or that everybody can do it on their own. Sometimes a good financial planner’s job isn’t to sell a fabulous investment opportunity but just provide a simple reality check. Financial Planning isn’t rocket science. At its simplest level it is just a matter of spending less than you earn and saving the rest. As our lives become more complex with families and commitments we will need to think about strategies to protect our current situation and our loved ones such as life assurance and income protection.

Once the basic discipline is instilled and the level of assets increase, we can move on to diversifying risk and creating a suitable investment portfolio to fund our future goals but at the core the basic principles still apply. We desperately need to change our attitudes to consumerism starting with ourselves then our children. We urgently need good financial education in schools but that doesn’t mean that, as parents, we can simply abdicate responsibility. Financial Education needs to be a partnership of joined up thinking. Changing lives and attitudes towards saving and debt will take years, possibly generations but we need to make a start. That is why initiatives like Financial Planning Week are so important.

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