The introduction of the Financial Services Act 1986 led some commentators to predict the demise, wit...
The introduction of the Financial Services Act 1986 led some commentators to predict the demise, within two or three years, of the IFA sector. And yet here we are, more than a decade later, thriving with increased market share in many areas. Nevertheless, we have to recognise that the sector is continually under threat.
We have only to look at the rules for stakeholder to see they pose a bigger potential threat to the mainstream income of the majority of IFAs than the 'little local difficulties' we have experienced in respect of transfers. The commitment to decision trees and charges too slim to allow for significant commission to be paid, are just some of the factors that combine to make the IFA's role increasingly difficult.
But the IFA sector seems to thrive on such adversity, possibly because most IFAs are entrepreneurs, who enjoy a challenge. And, to be fair, the Government is helping us by making things so complicated that consumers really do need professional help. Just look at Isas, compared with the old Peps and Tessas, and you can see for yourself why so many now turn to an IFA for help.
Inherent factors within the investment market also make it difficult for consumers to form a strategy - even with the help of a decision tree - unaided. Take, for example, risk. Consumers might ask themselves whether they are risk averse in which case strategy 'X' is needed - or are they prepared to take a 'punt' in order to have the chance of a better return - in which case strategy 'Y' will be better.
But, as every investment professional knows, there is no such single entity as risk. In fact, even at the most basic level, there are at least three different types of risk: investments might fail to deliver real long-term growth; they might fail to provide the desired benefit; or their value may be too volatile.
Because of the inherent contradictions within each of these aspects, they need to be considered together, bearing in mind the circumstances of each investor, to achieve a suitable investment strategy.
Most investors, if not all, look for real growth over the longer term. It is not just that they want their money to do better than had they simply stuffed five-pound notes under the mattress (hoping they are neither burgled or their house burnt down). Investors want to see their money grow above the rate of inflation, so that when they need it, it has a greater purchasing power than when it was put in. Investing for the future is not the same as a squirrel putting nuts aside for the winter, it is about planting acorns that can grow into oak trees to provide us with shade in later life - or if there is a storm.
Different forms of investment have delivered vastly varying growth rates over the last few decades. Equities often outperforming most other investments, over the longer term. In particular, gilts and property have often failed to match the performance of shares - in the former case, by as much as 4% to 6% per year over a 15-year period. And cash deposits have often been spectacular under-performers.
Many people invest in order to achieve a specific goal, such as to pay for school fees, repay a loan, or to cover the costs of a special holiday. Where the investor is saving to repay a mortgage, perhaps by an endowment plan, or through an Isa, then failure of the investment to perform can be of significant importance. It may even result in an inability to clear the debt.
Saving for retirement
Similarly, those saving towards retirement may have a pre-determined level of income in mind. Notwithstanding the low annuity rates currently on offer, the failure of the fund to grow at the anticipated rate will also mean that the chances of receiving the desired pension are limited.
Any investment strategy that involves little or no risk will similarly offer a smaller chance of growth. However, for many there will be a trade off of growth potential for some degree of certainty. For example, the use of gilts and bonds usually offer lower return, but can provide greater certainty over the return that will be achieved. It is for this reason that with-profit funds use these instruments, as well as equities - to underwrite the guaranteed basic sum assured and bonuses to date.
The third risk, which might prove unacceptable to many, is that of fluctuating investment values. Of course, this need not be a problem unless the redemption date is fixed and there is no mechanism to dampen down the volatility as the date nears. As the value of equities and other investments can fluctuate on a daily basis, they may not always be suitable for those investments nearing a fixed maturity date. This is because there is insufficient time for values to recover from a downturn. Normally this is not a problem, as even after a major stock market crash, average values have historically recovered within a year or less. But close to redemption, there is little time for a recovery.
Particularly if an annuity is to be purchased, there may be some merit in switching gradually into gilts, on which annuity rates are partly based. Some investment performance is likely to be lost, but so will some of the volatility be ironed out.
In other words, an investment strategy should balance the need for certainty of return, with the acceptance of volatility and the need for long term growth. Increasingly, individuals are coming to realise that talking to an independent financial adviser is a good way of clarifying their objectives and getting impartial advice. No amount of decision trees will ever help the average consumer to balance the different types of risk and assess how they are affected.
There is, however a new potential threat - one that may further reinforce the need for independent advice. And, for once, this major potential hazard comes not from the government (at least not directly), but from the Stock Exchange itself. It threatens to dramatically increase the impact on volat
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