# Pensioner investing a lump sum



## searcher (5 Jul 2008)

I am in my mid 60s and wish to invest a reasonable size lump sum to supplement my pension. I have been advised by a financial advisor to invest in a Caladonian with profits fund. However from what I understand I would be locked in for a considerable lenght of time - 10 years. This does not seem very attractive and also the present time of stock market volatility does not seem the best time to be opening a new investment policy. In the short term for the next year or so I was thinking of investing in the high-interest  schemes of companies such as Rabo or Irish Nationwide etc.
I would welcome comments of the above.


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## jpd (5 Jul 2008)

What kind of financial advisor was this ? A tied agent? a broker?

Did he explain why this was the most suitable investment ?

It would not be remiss to complain if this was not done.

Without a review of your financial and tax status it is difficult to suggest a suitable product but some possible choices would be an annuity, gov't bonds, high dividend yield shares (Irish banks are yielding 10% now - sorry only joking), ...

Try so get advice from an independent, fee-paying advisor


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## GeneralZod (5 Jul 2008)

Locking in for 10 years in your mid 60s doesn't sound like a good idea to say the least. Is the advisor commission based? If you don't want to have a high probability of losing a lot of money I'd go with the plan of seeking out the high interest accounts. If you have sufficient income to get tax benefits perhaps you could put it into a cash fund without any term restrictions. Avoid equities.


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## eileen alana (5 Jul 2008)

Have a look through the financial best buy forum, Rabo and nationwide along with a few others are offering good interest rates on term deposit accounts although bear in mind interest rates for savers may go up again in light of the latest ECB hike.


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## Marc (6 Jul 2008)

In my opinion, there are two very important issues being raised in this post:
1) What advice to provide to an investor in their mid 60s to supplement their retirement income 
2) Should you invest in a With Profits bond with Caledonian?

Since the first question has so many variables which are specific to the individual such as how much income they need, how much income they would like, how much capital they have to invest, their attitude to risk and investment timescales etc my recommendation is that advice of this nature should always be obtained from an experienced, qualified adviser for a fee rather than commission. 

Also, I understand that there is an obvious temptation for people to be attracted to a packaged solution (such as a tracker bond or other such product) and it is clear that many people trust their Bank for advice. Yet, the recent RTE Primetime investigation into investment advice for the elderly exposed the flaws in this approach with numerous examples of questionable recommendations for various packaged products such as tracker bonds.

That said, I don't believe that investing all (or even most) of one's capital in bank deposits is a clever strategy either for an investor in their mid 60s. The risk of loss of purchasing power due to inflation is an absolute certaintly over the long term (remember that an average 65 year old could expect to be invested for at least 10 years and probably much longer than this).

The devestation caused to one's savings from even modest inflation should never be understated. For example if you have €100 today and you take all of the interest from your savings account and spend it, in 10 years time you will still have €100 in your account. If inflation has averaged 3% over this period, then your €100 will be worth only about €74 in real terms. 

Remember also that the personal rate of inflation for an individual can be very different to the average figure provided in the official statistics. If I have a mortgage and interest rates decline, my cost of living improves (as I pay less in mortgage interest) yet a retired person with money on deposit sees their income reduce and is worse off.

It is generally accepted that the rate of inflation for retired people can be considerably higher than the official figures (think of the additional heating costs in winter as one example) so perhaps at present it would be prudent to factor in a personal rate of inflation of say 5 to 7%pa. 

Even gross savings rates of 5% do not offer any real prospects of maintaining the real value of savings.

The complexity of the approach necessary to balance the various considerations of taxation, asset allocation, volatility and investment risk, inflation risk,mortality risk etc cannot be understated. Prospective investors should only consider taking advice from an experienced, qualified adviser who can model, using monte carlo simulations, the safe level of spending in retirement from a given capital sum.

I also think the time has come to establish higher professional standards in Ireland for those offering  advice to the elderly an vulnerable in society.

Which leads onto the second question. In my experience (over the last 15 years) many elderly clients have been sold with profits bonds as a low risk investment offering guarantees. In many instances, these were compared to bank accounts with the bonus rate being compared to interest from a savings account. However, with initial commission rates of up to 7% at one time on offer compared to 3% from a unit trust and nothing at all for a bank account, it isn't hard to see why these products were so popular...........with advisers!

In my experience, With Profits bonds are complex and opaque investments where the investor is at the mercy of the Insurance Company Actuary for their future investment returns. There are considerable downside risks especially in the early years due to early surrender penalies and the risk of a market value reduction being applied. A guarantee to get your original capital back (less any withdrawals) at the end of 10 years is almost worthless. Once inflation is taken into account you will almost certainly get back less than you started with in real terms.

from the product literature* - "*Bonuses depend on profits yet to be earned and decisions by the Society's Board as to their distribution. The amount, if any, of any bonus addition to the Bond cannot be predicted in advance. Interim bonus rate can change at any time." 

Royal Liver Assurance Ltd. has one fund - the With-Profits Fund. The With-Profits Fund holds assets in respect of both with-profit and non-profit business. The split of investments detailed is for the whole fund.

Source Royal Liver as at 31st March 2008
Equity
UK Equities 10.2%
Euro Equities 13.2%
USA Equities 2.7%
Far East / Asia Equities 8.0%
UK Property 8.4%
Euro Property 9.6%
Alternative Assets 6.1%
Total Equity 'Type' 58.2%


Fixed Interest
Sterling Bonds 20.7%

Euro Bonds 18.6%
Cash 2.2%
Total Fixed Interest 41.5%

The issues around with profits investments are complex and include an analysis of the asset allocation (as above) free asset ratios etc

In order to appreciate the complexity of with-profits policies and the challenges they present it is helpful to know a little about their history so I will write a key post on with profits investments.


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## Duke of Marmalade (6 Jul 2008)

Jayz _Marc_, lot's in there, maybe GFD material. I make a few rhetorical points.

You are over obsessed with inflation. The fact that a deposit will almost certainly undershoot inflation does not condemn it outright. We see that the alternatives which *might* beat inflation bring a considerable risk of losing capital. We're into utility considerations here. For many the loss of hard earned capital through stockmarket volatility is much more painful than the erosion of inflation.

There are lots of things which inform a person's utility. Take Tracker Bonds. _(BTW these were not the products highlighted on Prime Time.)_

Tracker Bonds play to a very common utility mindset especially amongst those who are retired.

1. A dread of losing any capital - they know about inflation but psychologically that is not nearly so painful.

2. A fear of seeing the next guy clean up if we get one of those 90s style bull markets, at least with TBs you get a bit of the action.

3. Probably an extension of point 1 but people don't seem to mind "gambling" with their interest as opposed to their capital.

4.  The "bet" is well defined and independent of the provider, this is perhaps the great attraction for both parties.

Getting back to inflation. For a retired person inflation should not be measured simply in terms of the level of prices. What matters is the level of expenditure i.e. volume x prices. I have in mind here that an 80 year old will likely have a much less volume of expenditure than a 60 year old (M.E. notwithstanding). For a retired person the problem of how to spend their accumulated savings is perhaps greater than the problem of how to invest it.

Finally, I do think we are overplaying the "elderly and vulnerable" thing here. Did you know that the Financial Regulator wants to define EAVs as over 60s? Goddammit the next president of the USA could be 72.


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## searcher (7 Jul 2008)

Thanks to everybody for your replies but in particular to Marc and Harchibald for your long notes.
My advisor whom I engaged about two weeks ago is an independent financial advisor ( IFA). I have been looking for someone for ages, but found that those recommended to me just wanted to sell me new investment policies (on which they get commission) and close down the current small ones I have, (both managed funds with New Ireland and Irish Life). I'm now rather dsperate and prepared to pay someone who will give me independent advice. Currently I am paying 300 Euro an hour to the IFA - a lot of money. The main advice I got was to invest in Caledonian with profit bonds which I was told were safe. However from what Marc said I should be wary. The fact of the large commission mentioned by Marc would make me even more wary. There have been no discussions so far about commission. Who gets the commission when one goes through an IFA ?

Harchibald's response to Marc about inflation is interesting. My past investments ( including the ones mentioned above) have just been so so and I could never seem to find out what they were costing me. The brokers who sold them to me were long gone. I am nervous about locking myself into something very long term ( 10 years) for me now in my mid 60s for which I will  not have access to. In the short term, the reasonably high deposit accounts of Rabo etc ( with lots of others) look to be attractive but this is only in the short term as the rates will likely drop when the credit crunch problem is eased in a year or so. Thanks again for the discussion and for Askaboutmoney which is a great learning experience for me


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## Brendan Burgess (7 Jul 2008)

Hi Searcher

I think that Marc correctly highlights the risk which you face by putting your money on deposit. Most people feel that deposits are risk-free. They most certainly are not. 

There is no safe place to put your money. 

So which is the least risky - equities or cash? 

We have gone through a very bad patch over the last ten years in equities. Long term, they have always beaten cash. 

I would feel that, at current prices, the stockmarket has fully allowed for all the downsides and that the stockmarket is very low risk at the moment. 

If you do decide to invest in the stockmarket, you should buy a diverse portfolio of around 5 to 10 shares directly. This approach has tax advantages over unit-linked funds.

You are taking risk, but I estimate that the risk in placing your money on deposit is greater.

Brendan


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## yob (7 Jul 2008)

Brendan said:


> Hi Searcher
> 
> 
> There is no safe place to put your money.
> ...


 
i have to agree with brendan here,there is no safe place for your money.
i dont know about the stock market being low risk,thats as maybe with regard to there current prices,but i cant see any or much growth in the foreseeable future,(12 - 18 months),so maybe a high deposit with a review in 6 months,but more than likely 12 months,before i'd move.
yob


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## GeneralZod (7 Jul 2008)

yob said:


> but i cant see any or much growth in the foreseeable future,(12 - 18 months),so maybe a high deposit with a review in 6 months,but more than likely 12 months,before i'd move.
> yob



Have to agree with this. Why go into equities now when we've got more bad news to play out yet. Certainly review it every few months and start rotating back into equities when there's some sign things are improving. With luck the markets have shed most of their excesses. Don't just drop the lot into the market now in the hope that in the long run any short term losses will be made up. If a share falls by 50% it takes 100% growth to get back up to the previous price. People that stuck with the ISEQ through it's recent falls will effectively never recover their losses. 

 Deposits have held their value much better than shares over the last year. My savings will buy me a lot more house now. You won't get rich long term with savings but at least you can avoid throwing away money when the world is in an obvious bear that is probably part of a larger structural bear that started with the dotcom bust. Historically many shares prices are still high and we've got huge problems such as a growing dependancy ratio and non environmentally damaging energy sources aren't coming on-line fast enough to cope with the increased demand. 

The best savings rates are currently keeping pace with inflation and will probably continue to as the ECB are determined to counter inflation with higher interest rates. So surely under the current conditions a savings based approach to minimise losses is the safest strategy.


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## Marc (7 Jul 2008)

I think Brendan has raised some more important questions here:

1) Which is more important taxation or diversification?
2) Is the choice simply between Equities or Cash?
3) Can an equity investment ever be low risk?

1) There is an old investment adage: "Never let the tax tail wag the investment dog". I could invest my capital in a pension for a significant tax break and then watch this all evaporate because of poor investment choices. Tax is a consideration, but the most important factor is always the investment consideration ie the choice of investments I make. One should never invest in direct equity investment just because it is more tax efficient than a collective investment. 

In empirical studies, Taxation probably accounts for only around 2% of the total expected long term return from a portfolio. Asset allocation is generally accepted to be the most important factor. Most studies support this.

The potential downside risks of investing in a single company will always considerably outweigh any tax differential. Still don't believe me? Ask anyone invested in a "portfolio" of Enron, Energis, Marconi, British Telecom, Nothern Rock, Bradford & Bingley, Baltimore Technologies etc etc etc.

2) On the same theme and remembering the lessons of the shares above, I just don't see how 5 or 10 shares can ever be considered sufficient diversification - in any market in the world. In Ireland, where the market is effectively 50% in 4 companies and three are banks, this makes absolutely no sense at all - especially during a credit crunch.

To protect against these risks, a balanced portfolio should include as wide a range as possible of different assets and a wide selection of sub investments within each asset class. The key being to look for a lack of correlation between these different asset classes. Ie investments that do well when other investments do badly.


3) Simply no, not at all!

For all investors, the risk of a large fall during their lifetime cannot be ruled out just because, on average, it is statistically unlikely. In fact, the risk of severe market falls appears to be significantly higher than is predicted in orthodox financial theory.

I believe that an investor should expect, and prepare for, significant falls during a normal investing lifetime and to allocate their capital in a much more diversified manner than a traditional Managed fund in Ireland would do. It is my belief that, on balance, wealth preservation is more important for many investors. The reduction in wealth that would arise from a collapse of a market is therefore more significant, than the possible gains that might be available from investing heavily in equity markets just because they have gone down.

To put this into perspective, let's look at an analysis of the ISEQ covering daily returns for the for the period 4 January 1988 to 28 November 2003. 

Min Max Mean Variance Skewness Kurtosis
Returns −7.5691 5.8423 0.0389 0.9808 −0.3225 5.1683

The daily variance rate is 0.9808 for the daily returns. Assuming that
there are 252 trading days per year, this yields an approximate annualized
volatility estimate of 15.72%

As is evident from this and from the values of the kurtosis and skewness coefficients we have here yet another instance of the well-established empirical fact that daily returns data exhibit non-normality and, in particular, heavy tails.

That is to say, although on average we would expect an annualised volatility of just under 16%pa. On occassion, the market could be expected to move by more than this in a single year. Which is exactly what has happened this year. What is to stop an equally large fall next year? Nothing at all. The market is not less risky just because it has already had a bad year in just the same way a bank share that has already lost 50% of it's value can still half in price.


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