December
2003
A
WORD OF ADVICE FOR 2004 – BEWARE HIDDEN AGENDAS
AND HIDDEN TAXES
Hidden Agendas
In
recent years we have seen many Banks, Insurance companies
and IFA networks fined for incorrectly selling financial
products to the UK consumer. I suspect that their "consultants"
are being asked to generate sales from client lists
without due consideration being given to individual
client circumstances. In other words the hidden agenda
is extra sales.
I believe that no amount of regulation will prevent
miss-selling unless in their heart of hearts, advisors
and their employers are working ethically. I have devised
a screening technique which will help separate the unscrupulous
from the genuine.
When approached by a sales person offering any form
of financial advice, and before discussing any of your
financial details, insist on receiving a signed copy
of their organisations code of ethics and ensure that
it clearly shows that your interests will come first.
Check
the organisation for independence. Are they subject
to product bias because they are tied to one provider?
Are they subject to product bias because their Head
Office or Network has agreed distribution deals with
major product providers? Are they paid by their clients
or paid by product providers?
Beware
investment solutions which involve large lump sums going
into a "product" like a bond of some description. These
give the illusion of being tax effective but frequently
are not because the product provider will be taxed on
income and gains.
Beware
investment solutions which would place a high proportion
of your invested assets with a single product or a single
provider.
Beware
any product whose outcome is linked to indices being
measured over a period of say 5 years from the date
of purchase. No one can predict the future, and to have
investment return depend on an index 60 months forward
from date of purchase is a very risky strategy. Flexibility
is the key to sound financial planning, and products
with no flexibility on exit deserve no place in your
investment portfolio.
And
finally but most importantly, you have to be entirely
comfortable with the combination of advisor and organisation
you are dealing with.
Hidden
Taxes
Nobody
likes paying tax, so much so that there is a whole sector
of the financial community dedicated to finding ways
for our tax paying corporations, businesses and private
individuals to legally minimise their tax exposure through
tax planning.
As a professional Financial Planner, I have identified
some "hidden taxes " that did not originate with the
Government or the Inland Revenue and are often ignored
by many who give financial advice. An awareness of these
and a strategy to deal with them could improve the financial
position of many.
Inflation
tax
We
tend to ignore inflation when it is seems to be under
control at around 2% per year, but when inflation is
low, interest rates also tend to be low. This is why
I regard inflation as a "hidden tax" on interest received.
If a saver receives interest of 4% and inflation is
running at 2%, inflation is the equivalent of a 50%
tax charge. This is why investing in real assets is
so important. Assets such as property and shares in
quoted companies have consistently outpaced inflation
over the years and still produce an element of income.
Of
course you need liquidity to deal with emergencies and
planned expenditures, so it is essential to have access
to liquid reserves to meet these. To this extent Inflation
tax is unavoidable but beyond these two elements, you
should look to have the balance of your investments
in asset classes which have proved resistant to inflation
over the long term.
Depreciation
Tax
We
Brits love our cars and we love to upgrade to new models
as often as we can. But now that cars are so reliable,
I wonder if buying a new car every 3 years makes as
much sense as it did say 25 years ago when build quality
was nothing like it is today. If a car depreciates to
zero over 10 years then depreciation tax is 10% per
year. If the same car depreciates by 50% over the first
3 years then an owner who upgrades his car every 3 years
pays depreciation tax at 16.3%. Whether you are a business
owner or a private individual, look at depreciation
as a tax and see what you can do to improve your position.
Appreciation
tax
There
is no appreciation tax or Capital Gains tax on our homes.
If we purchase a house to live in, the government does
not seek to tax gains when we sell it. Neither does
the government seek to collect tax on all gains realised
from business and investment assets. There are generous
annual allowances and time based reliefs which reduce
appreciation tax often to negligible proportions.
The
key therefore is to have substantially more capital
in appreciating assets than in depreciating assets.
As a rule of thumb I would be comfortable with a ratio
of 10 to 1, in other words aim to have 10% or less of
your net worth in depreciating assets.
Transaction
Tax
This
is the tax that is most difficult to detect. It is pretty
clear when buying or selling a property that there are
fees, stamp duty etc to be paid. As we tend to have
only a few property transactions in a lifetime, we quite
rightly view the transaction costs billed by our lawyer
as part of the transaction and do not give them much
further thought.
With
investment funds, such as unit trusts or pension funds,
transaction costs need further examination. First, transaction
costs are not billed; they are netted off in the price.
Second there are 3 levels:
•
Commission paid to the seller
• Management fees paid to the fund manager
• Brokerage, stamp duty etc paid by the fund manager
The
investment community trade shares every single day,
each doing their best to ensure that their fund is placed
to benefit, as they see it, from opportunities on the
buying side and threats on the selling side. This is
exactly as it should be except when we consider that
fund managers for the most part are buying and selling
to each other, because it is they who make up the bulk
of the buyers and sellers in the market. This is why
so few fund managers outperform their benchmark indices.
Even if they do possess investment insights that could
add value (and there is evidence that the majority don’t),
after transaction costs this value is reduced or even
negative.
The
key for investors is find ways of participating in the
various asset classes in a way that effectively reduces
transaction costs. This is easier said than done, but
managing down transaction costs in a low inflation low
return era is a key component of total return.