Monthly Archives

June 2022

Drawing of scales with Risk on one end and Reward on the other

Risk and reward, and how to measure volatility

By | Investments

A common theme underpinning all investments, the notion of risk and reward, is a general trade off that affects almost anything from which a return can be generated. Anytime you invest money, there is a risk, whether large or small, that you might not get all of your money back, or in the worst case scenario, that the investment may fail. For bearing that risk, you expect to receive a return that compensates you for potential losses. In theory, the higher the risk the greater return you should receive for holding the investment, whereas if lower levels of risk are taken, lower returns should be expected.

This definition is, of course, simplistic; however, over a period of time, an investor should rightly receive greater compensation for taking greater risk. If this was not the case, why would an investor choose an investment where higher levels of risk were inherent, if they could expect to receive a similar return from an investment that displayed lower levels of risk? This introduces the notion of risk adjusted returns, whereby the return achieved by the investment over time is considered in conjunction with the level of risk experienced.

 

Assessing investment risk

Assessing the risk of any investment relies on subjective assessment of the potential for the investment to fail, amidst a whole host of other factors. For example, placing money in a UK deposit account carries low levels of investment risk. The nominal value of the deposit cannot fall in value, and if the bank or building society were to fail, then assuming the deposit meets the qualifying criteria, the deposit of up to £85,000 would be protected by the Financial Services Compensation Scheme. However, other risks, such as inflation risk, need to be carefully considered to assess the potential “real” return of the funds held in savings, which is expressed as the return less the then prevailing rate of inflation.

Examples of other risks that investors need to consider are liquidity risk, which is the risk that you will not be able to access your money quickly and easily at a time of your choosing, and currency risk, which applies when investments in foreign assets are made, which exposes the investor to the risk of losing money due to movements in the exchange rate.

By undertaking a similar assessment of the risks associated with each asset class, investors can make a judgement as to the level of risk that applies to each investment and by reviewing long term historic returns and projected returns, can begin to assess the balance between risk and reward that applies to any asset class.

 

Time horizon is also key

The length of time an investor is willing to invest for is also a key risk factor. Given that economic growth (and therefore market performance) is generally cyclical in nature, investing for less than the medium to long term (which we would normally express as being a period five years or more) would introduce Time Horizon risk, whereby the point at which an investment is bought and sold may be less likely to produce a positive outcome.

When investors look beyond asset classes to individual investments, volatility measures are used to determine how much the price of an individual investment will move up or down over time. If an asset rises and falls considerably, it is seen as displaying high levels of volatility. On the other hand, if the price of an asset is relatively stable and predictable, then this is seen as being low volatility.

Volatility measures are also useful when considering the risks associated with broad market conditions. The widely reported Chicago Board Options Exchange Volatility Index (or “VIX” for short) measures the expected volatility of the S&P500 index of leading US shares and can be a helpful indicator of how much markets are likely to move, in either direction, over the next trading periods.

 

Deviation from the average

The most common way to measure volatility is through standard deviation. This measures how much the returns of an investment move away (or deviate) from average returns. More volatile investments deviate further and more frequently from their average return, whereas less volatile investments are more likely to track the long term average returns more closely.

The value of investments with very high levels of volatility tends to be dependent on overall market confidence, and sentiment towards riskier assets can be weak during periods of economic uncertainty. In periods when market confidence is lower, investments displaying lower levels of volatility may be less likely to experience poor performance.

When we construct investment portfolios, volatility is a key component we consider when determining which assets are included in the portfolio, and the percentage of the portfolio that is allocated to that position. As each investment has its own volatility measure, when these are combined within a portfolio of different assets, an overall portfolio risk can be determined. The portfolio volatility measure can then be compared to the volatility displayed by similar portfolios, or to recognised benchmarks, to determine whether the strategy is of lower or higher volatility than its peers.

 

Review your risk adjusted return

Risk is always a key component of our research and analysis when we assess investments, and as explored above, risk can come in many guises, all of which need to be considered. We use advanced technical tools to review volatility and standard deviations of investments with the aim of achieving returns that are commensurate with the level of risk being taken. We often come across investment portfolios managed by other fund managers that carry substantial levels of volatility and risk, that the investor is unwittingly exposed to. 

 

If you are concerned about risk levels within your portfolio, then please get in touch with one of our experienced advisers here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Graphic of person on a ladder with a telescope looking over at 2022

2022 – the story so far and outlook ahead

By | Investments

Inflation is the key

Following a very positive year in 2021, investment markets have faced significant challenges over the first six months of this year. Inflationary pressure, that was starting to build following the emergency monetary policies employed by Central Banks at the start of the pandemic, has rapidly increased due to higher energy costs, and increases in the price of food and oil. Much of this is due to the Russian invasion of Ukraine, and the combined impact of sanctions on Russian supplies of energy and lack of exports from Ukraine. Further pressure has been exerted by supply chains, which were damaged by the pandemic, failing to keep up with increased demand, and further lockdowns in China, which have exacerbated the supply side constraints.

To combat higher inflation, central banks in the US and UK have increased interest rates over the course of the year. It is the job of Central Banks to try and navigate a course that reduces inflation (the anticipated consequence of the base rate increases) whilst avoiding recession, which may well arise as consumer confidence falters amidst the higher costs of living. Global economic growth was strong in the second half of last year as economies emerged from the pandemic; however growth is slowing in many Western economies once again, with recession a real possibility in the UK, US and Eurozone.

The latest round of base rate increases saw the Federal Reserve increase rates by 0.75% and the Bank of England by 0.25%. Since December 2021, the Federal Reserve has now increased rates by 1.5% and the Bank of England by 1.15%, and further substantive rate increases are anticipated over coming months.

 

Bear Market in Equities

Global Equities markets have struggled amidst the higher inflation and slower growth. US markets have already moved into correction territory, with falls in the S&P500 and Nasdaq of over 20%. Despite the market reaction, corporate earnings have continued to hold up well in many sectors, and companies with strong balance sheets and cash flow should be able to navigate through these conditions effectively.

Bond markets have not provided a safe haven, with yields increasing over recent months in anticipation of higher interest rates and persistent inflation. Bond markets have now, in our opinion, priced in much of the expected monetary policy decisions, and now offer investors much better value than they did at the start of the year.

 

What should investors expect over coming months

Given the weak performance seen so far this year, investors are questioning what they may expect to see during the second half of the year. It is important to bear in mind that stock markets are a discounting mechanism, and as such, have factored in the expected course of interest rates and slowdown in economic growth. The forward guidance provided by central banks, in particular the Federal Reserve, has outlined the expected path of interest rates that we expect to see as we head through the remainder of the year. Without any further surprises seen from economic data over coming months, it is likely that the rate hike cycle may begin to slow as we move towards the end of the year.

It is evident that higher volatility will persist during the remainder of 2022; however, we contend that price action over the course of recent months has already discounted higher interest rates and slower growth to come, and market participants are looking beyond this period, when inflation begins to gravitate back towards stated targets, and central banks can ease off the brake pedal.

In any given market, opportunities will present themselves. We are watching the so-called “Price Earnings Ratio” of the S&P500 index of US shares, which measures the stock price relative to earnings for each component in the index. The forward Price Earnings Ratio now stands below 16, compared to the 10 year average for the index of 16.9 and 25 year average of 16.3. Assuming earnings hold up reasonably well over coming months, equities markets – by this measure at least – offer value over the medium term.

 

The importance of staying invested

In these difficult conditions, it is important to remember the advantage of staying invested and the risks inherent in trying to time an exit and re-entry to an invested position. Trying to trade these conditions is certainly not advisable for any long term investor. Take the example of an investor in the S&P500 index from March 1990 to April 2022, who would have achieved a return of 10.4% per annum over this period, with all income reinvested. However, by missing the 10 best days over this period, this return would fall to 7.7% per annum, and missing the 30 best days would see the return fall to just 4.5% per annum. It is interesting to note that the 10 best performing days all occurred in 2008-9 and 2020, when markets recovered sharply from heavy falls.

 

A better second half?

The first half of 2022 has seen investment markets struggle, and whilst it is apparent that the volatile and weak conditions may persist over the near term, we are starting to see real value emerge in a number of areas, including Equities and Bonds.

 

If you wish to discuss your investments and how they are positioned in these conditions, then please get in touch with one of our experienced advisers here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Retired couple on a hike looking over at children and grandchildren

Nearing retirement? It pays to get tailored advice

By | Pensions

The Pension Freedom rules introduced in 2015 opened up many new possibilities for individuals to flexibly access their pension savings. The new-found freedoms have generally been popular, although the increased choice has been accompanied by added complexity, given the increased number of options now available. As a result, getting sound advice when nearing retirement has become even more crucial, as these key planning decisions may well have an impact on the income received for the remainder of your life.

To help those reaching this crucial planning phase, the government introduced the Pension Wise service alongside the new pension freedoms. Pension Wise is a government service that offers free, impartial pensions guidance in respect of defined contribution pension options. Users of the service can access a phone or face-to-face appointment at which guidance is provided in relation to the options available, how benefits will be taxed, and how to be aware of pension scams.

Pension trustees and providers have been obliged to make individuals aware of the Pension Wise service since the introduction of the new rules. From June 1st, new legislation has been introduced which places greater emphasis on “nudging” individuals thinking about drawing or transferring flexible benefits, to seek guidance from Pension Wise. The new regulations require providers to offer to book an appointment for the member and the provider can block any action to draw benefits until an appointment has been attended or the individual opts out of the guidance process.

These new regulations do not apply to those individuals who have received regulated financial advice, as Pension Wise is designed primarily to help guide those who approach pension providers directly. Likewise, an individual is able to opt out of the Pension Wise guidance completely, although they will need to make a clear election to this effect.

Pension providers have indicated these additional steps may further slow the time taken to arrange transfers of pension benefits or lead to increased delays where individuals wish to access their pensions flexibly.

 

Guidance, not advice

Users of Pension Wise have generally felt the service is worthwhile, although there have been criticisms levelled at the service, with some users pointing out the sessions are little more than the representative setting out generic information about each of the options that are open at retirement. This is where the limitations of Pension Wise really become apparent, as it is a guidance service only, without the ability to offer advice that is tailored to an individual’s needs and objectives.

Reaching a decision to consider retirement is perhaps the single most important point at which financial advice should be sought. At this point, decisions reached and actions taken could have implications for the next 30 years or more, and it is therefore vitally important that the advice received takes into account all aspects of an individual’s financial circumstances.

 

One size doesn’t fit all

Pension Wise sessions may be helpful in providing a generic background and useful information, but if you consider the range of options provided by different pension schemes, it becomes clear that guidance is no substitute for tailored advice.

When meeting new clients for the first time, we often see the situation where a number of pensions have been accrued during their working life, and making sense of the total level of income that could be generated in retirement can be difficult. The ability to draw pensions flexibly – a key advantage of the new pension rules – is not always available through existing pension arrangements. Within some personal pensions, an internal transfer to a drawdown pension may be possible, where other pensions will require a transfer away to an alternative provider to be able to access the pension in a flexible manner.

We encounter many pensions that have enhanced benefits as a feature of the pension, which cannot be ignored. These include guaranteed annuity rates, which are often attractive, or a minimum fund value at retirement. Careful assessment of these factors is vital to ensure that a valuable benefit is not lost.

 

Seeing the bigger picture

Reaching retirement is a point at which much wider financial planning, in addition to bespoke advice on pension income, is required. Whilst the focus of advice pre-retirement is generally in relation to income production, there are a number of areas that need to be considered at the same time.

Deciding how best to use tax free cash is one such example where advice needs to be tailored to wider financial circumstances. For example, an individual may have outstanding borrowing on their property, which could be paid off by the tax free cash, or the lump sum could be invested to generate additional income in a tax-efficient manner. Alternatively, parents may see this as an opportunity of being able to help the next generation and decisions need to be reached as to how best to gift assets without potential tax consequences.

Inheritance tax planning is also sometimes a consideration, in particular where pensions do not need to be drawn to provide an income. Under the freedom rules, pensions can be very effective planning tools in a wider strategy to mitigate inheritance tax.

 

Tailored to your needs

Providing more information to those reaching retirement can only be a good thing, although Pension Wise appointments can only give guidance which is not tailored to the specific circumstances and requirements of the individual. In our experience, those nearing retirement are at a crucial point where bespoke financial planning can reap significant benefits in determining the way forward, potentially having an impact for 30 years or more. If you are approaching retirement, speak to one of our experienced financial planners to talk about the options open to you.

 

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Person at desk assessing finances while looking at icons of three houses

Thinking of becoming a landlord?

By | Investments

The private rental sector has grown significantly over recent years, with over 4.5m tenants now renting from private landlords in the UK. Propertymark  – the professional body for the lettings industry – reported in April that their agents continue to see strong demand, with 10 new registrants for each available property to rent in their member’s branches. In light of the increased demand, it would, perhaps, be easy to conclude that buying a property to let would be a good decision at the current time; however, tenants’ requirements are also shifting, and with many now working from home on a part or full time basis, having the right property, in the right location, is key.

 

Introducing our Taxation of Property brochure

Whether you are looking to buy, sell, or rent a property a thorough understanding of the tax implications is essential. For up-to-date information and expert advice please access our latest Taxation of Property brochure here.

 

Growth about to stall?

Landlords have enjoyed the benefits of house price growth in addition to rental income over recent years. Despite the effects of the pandemic that were felt across much of the wider economy, house prices have continued to climb (although the Stamp Duty holiday which ran until 30th June 2021 certainly gave prices a helping hand).

Recent surveys and reports have, however, suggested that price growth may finally be slowing. The Office for National Statistics reported annualised house price growth slowed from 11.3% to 9.8% in March, although behind the headline numbers, the rate of growth is variable depending on location. For example, annual price growth in London is only 4.8%, compared to the East Midlands region, where growth has exceeded 12% over the last year.

Given the economic shock of higher inflation and consecutive interest rate increases, it is highly likely that this downward trend will continue, and may well accelerate, as higher costs of living and increased borrowing costs limit affordability for house buyers.

 

Potential changes in legislation

There have been increasing calls for further legislation of the private rental sector, which may well have cost implications for landlords over coming years.

Legislation may be introduced by the end of 2022 to prevent landlords from evicting tenants without giving a specific reason. This could lead to serious implications,  as under the proposed legislation, the likely route to remove tenants would be through the court system or specialist tribunals. One option to protect landlords may be to consider asking for several months’ rent paid upfront or for a guarantor to be provided.

A compulsory energy performance certificate rating of ‘C’ has been proposed, for new tenancies by December 2025, and on all rented properties by December 2028. This could be a major issue for landlords with older properties, as the cost of remedial works may make the financial decision to continue letting an older property unviable. As ever, the proposed legislation is subject to change and carrying out expensive improvement work is not recommended until definite rules are in place.

 

New rules for holiday lets

Holiday lets have become increasingly popular, in particular given the boom in UK holidays seen during the pandemic. However, if you are a second homeowner with a holiday let, you have a year to ensure you won’t be caught by the closure of a tax loophole used by some to avoid council tax bills on their holiday homes.

Currently, those with second homes in England can avoid paying council tax and can access small business rates relief if they state they are planning to use their property as a holiday let.

Until now, homeowners have not had to provide any evidence that this home has in fact been rented out to holidaymakers, allowing some to gain a tax advantage, despite the property being occupied solely or primarily for private use and standing empty for much of the year.

From April 2023 new rules stipulate that holiday rentals must have been let for a minimum of 70 days in the previous year to qualify for the council tax exemption and small business rates. In addition the property must be available to let for 140 days a year. Property owners will have to provide letting receipts and details of where the property is advertised to holidaymakers, e.g. online or via brochures. Those that fail to let out their property for the required period will have to pay council tax the following year.

Business rates are paid to the local authority. Like council tax, the amount paid will depend on the ‘rateable value’ of the business property. However, as many holiday lets are effectively small-scale businesses, many will qualify for small business rate relief, which will effectively mean no charge at all. Government figures show that around 65,000 holiday lets in England are liable for business rates, but around 97% have rateable values of up to £12,000. If the rateable value is less than £12,000 then there will be no business rates to pay. These rates are also reduced, on a sliding scale, if the rateable value is between £12,000 and £15,000.

Landlords running commercial holiday let businesses, which encourage tourism and provide jobs and local revenue across the country, will, however, not be penalised.

 

A more balanced decision?

The property rental market has been buoyant for some time, although we feel the decision to take on a new rental property is more finely balanced than it has been for some time. With a slowing economy, higher interest rates and inflation, and legislative changes proceeding through Parliament, landlords have plenty to consider. It could be the case that other forms of investment, such as a diversified investment portfolio of equities and fixed interest securities could produce an attractive income yield to match rental income, in a more tax efficient manner, and without the potential legislative headaches.

 

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Cupped hands holding a cut out of a family

Providing an income via life assurance

By | Financial Planning

Life assurance is a crucial area of financial planning, particularly where there is a need to provide protection for young and growing families or where others are financially dependent on the life assured. It is, however, all too often ignored by individuals when they assess their financial priorities. According to research undertaken by Canada Life last year, 63% of those questioned have never thought about, or do not have, an active life insurance policy in place.

Lump sum cover

The most common form of life assurance is a term assurance policy, whereby the death of the life assured triggers a lump sum payment to beneficiaries. Often the policy will be established as a decreasing term assurance policy, which is designed to cover a repayment mortgage. These policies are set up so that the amount of cover falls over time broadly in line with the outstanding mortgage balance.

Whilst holding life cover over an outstanding mortgage balance is obviously sound financial planning, a lump sum payment would do little to provide additional funds on an ongoing basis to cover day-to-day living costs and other expenditure for family members left behind. This is where a different type of life insurance – family income benefit – can be very useful.

 

Providing a regular income

The main feature of family income benefit is that the policy is structured to pay a monthly tax-free income to beneficiaries for the remainder of the policy term, rather than paying out a lump sum. It is designed to replace earnings or income that would have been generated, in the event that the policyholder dies, thus allowing surviving family members to maintain their standard of living. The policy is structured at the outset over a specific term, and in the event of a claim being made on the policy, the payments will be made for the remainder of the term. For example, if a policy was established for a 20 year term, and the policyholder died in the 9th year, the monthly benefit payments would continue to be paid for the 11 years remaining on the policy term.

Benefits paid by a family income benefit policy can either be paid on a level basis (i.e. the monthly premium and benefit payments are fixed at the same amount for the life of the policy) or indexed, where the level of benefits, and monthly premium, are inflation linked. This can protect the real value of the cover provided, and the cost of living increases we have seen over recent months are a timely reminder of the importance of protecting future payments against rising inflation. Many family income benefit policies also pay out on diagnosis of a terminal illness, and some policies allow the monthly payments to be commuted to a lump sum payment, if the surviving family feel this would be more helpful in their circumstances.

 

Cost-effective cover

Many people consider affordability as being one of the main barriers to holding adequate life insurance. Indeed, research carried out by Canada Life in 2019 confirmed that 27% of respondents felt the cost of the premiums was the main reason for not taking out cover. Family income benefit is often more cost effective than lump sum term assurance, as the total amount paid out by the policy depends on when the policyholder dies. If they die in the early years of the policy, the total payout will be more than if they die nearer the end of the term of the policy. Because the total amount paid decreases over time, it’s cheaper than an equivalent single lump sum life insurance policy which runs for the same period.

 

Specific situations where cover can assist

As we have established, the most common use of a family income benefit policy will be to provide families with cost-effective cover to enable the surviving family to maintain their standard of living in the event of death. Typically, policies would be put in place to provide a term of insurance until the youngest child leaves higher education.

In addition, however, there are many scenarios where family income benefit could be a very sensible solution for specific protection needs. One such situation is to cover divorce maintenance payments, which would potentially cease in the event of the death of a divorced parent. By taking out a family income benefit policy, the benefits could continue to provide the maintenance payments, thus enabling the ongoing standard of living the children enjoy to be maintained.

In a similar vein, family income benefit can be useful to cover education costs, in particular if a child is privately educated. By taking out a policy that covers the ongoing educational costs, this could mean a child being able to stay in private education or could potentially even provide ongoing funding through university.

Another scenario where family income benefit could be helpful is to cover the cost of care. Many individuals are full-time carers for loved ones, and in the event of death of the carer, this could leave the individual being cared for facing the need to pay the cost of finding alternative care. By taking out family income benefit, the monthly payments for providing ongoing care could be covered.

 

Seek our advice

Whilst many individuals hold adequate cover to pay off outstanding mortgages and other liabilities, the ongoing costs of living are often ignored. Family income benefit can be a cost-effective way to provide a regular income in the event of death and help maintain a family’s standard of living. If you would like more information on this type of policy, then speak to one of our advisers at FAS, who can take an independent look across the whole of the protection market, and provide advice on the most appropriate solution.

 

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

 

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.