In this blog post we will look at the main decisions an individual should consider before investing in a low interest rate environment. One of our longer posts but very relevant, non the less.
1) Value of Professional Advice
2) Current Investment Strategy
3) Your Capacity and Tolerance to Investment Risk
4) Requirement for Income (if any)
5) Timeframe
6) Health
7) Asset Classes
8) Product Options
9) Tax
10) Regulated vs Non Regulated Investments
11) Financial Broker Vs Tied Agent
1. Value of Professional Advice
Before making any investment, you should consider qualified financial advice, any investment has pros and cons and it is important for this to be explained simply and in English. A good broker will draw up an investment strategy that aligns to your financial goals, assess you risk attitude, create a set of recommendations and present them to you for consideration.
There will be a fee or commission involved but good advisors spend a lot of time and effort researching solutions for their clients and upskilling, the fee charged is not just for the couple of hours with you but for the professional experience and ongoing service provided.
2. Current Investment Strategy
If you are currently invested predominantly in deposits and are looking at alternatives that may provide a better than deposit return, then the cardinal rule is that the higher the potential return, the higher the potential loss, if you are not able to accept fluctuations in your savings then don’t invest in something that looks too good to be true.
If after reading that you are willing to invest a portion of your funds into a non-deposit investment then you should consider, leaving three to six months minimum on deposit for life’s emergencies. Consider how long you are willing to invest for and whether or not you will have access to the invested funds, will there be a penalty to access them and what is the probable worst case scenario.
3. Capacity and Tolerance to investment risk
Risk tolerance or attitude is your emotional capacity to withstand losses without panicking. Risk capacity, on the other hand, is your ability to absorb losses without affecting your lifestyle. Any investment decision should take both capacity and tolerance into account.
4. Requirement for Income (If any)
Some investments will allow you to draw an annual income. If you require an annual income from an investment, you should consider holding off drawing said income for the first 12 months to avoid paying fees and set up charges on money that will be taken out more or less immediately.
Other considerations here would be; do you require a fixed amount or a percentage, are there penalties for ad-hoc one-off withdrawals, it’s worth noting that some contracts will charge an exit penalty in the first five years for these one offs.
5. Timeframe
When investing in non-deposit options it is important to set a reasonable timeframe. If you are going to need your money within two or three years, I would suggest staying in deposits.
Your timeframe for investment should be a minimum of five years and preferably seven years plus.
6. Health
It should go without saying that your health should be considered when making any investment and if you are in quite poor health then you should consider leaving the funds on deposit or investing in joint names in certain circumstances, getting profession advice can help here.
7. Asset Classes:
Currently the main asset classes in Ireland today can be defined as:
• Cash/Deposits
• Bonds
• Equities
• Property
• Alternative
• Multi Asset Funds
Cash/Deposits: Funds on deposit in a bank, these are deemed to be low risk and current market leading rates in Ireland are historically low.
Cash/deposits are deemed to be the safest form of investment, however in the current low interest rate environment there are two potential risks, inflation eroding the real value of your savings, potential fee to hold funds on deposit, currently some institutional deposits are attracting a charge to hold funds, retail deposits are not currently charged but who knows what the future might bring.
Bonds: A bond is essentially a loan to a company or governments. Many governments and companies borrow money from investors to raise funds by issuing securities known as ‘bonds’ A bond works by an investor lending the government or company money who in turn promise to pay a rate of interest in addition to paying back the original loan amount when the bond matures.
While Bonds are low risk in relation to equities, property or alternatives they tend to produce lower but more stable returns than higher risk assets such as equities, property or alternatives there is still a risk these investments could go down in value. Another potential risk is that a company or government could default on its debt. Changes in interest rates can also cause the value of a bond to fall or rise.
Property: Property is a perennial Irish investment favourite, physical bricks and mortar, property equities or REIT’s, look to achieve rental income and capital growth, however they are illiquid assets and can suffer extreme falls in value, default on rent or in the case of property funds have a moratorium on exit of 6 months or more, which last happened in early 2020
Equities: are investments in company shares and traded on the stock market. Equities have the potential to make you money in two ways, capital growth through increases in the share price and income paid by way of dividends. Neither is guaranteed and there is always the risk that the share price will fall below the level at which you invested.
Direct investment in a single company is very risky, as you are reliant on just one company stock and have ‘put all your eggs in one basket’ so to speak, unless you are an experienced investor you should consider buying equities through an investment fund to spread your risk. Historically even with a higher level of volatility, Equities have outperformed all asset classes, however they can rise and fall quickly.
Alternatives: An alternative investment is deemed be an investment that is not one of the four traditional asset classes (Cash, Bonds, Property and Equities). Examples are Commodities such as gold, oil and copper, as well as investments in Wind, Agriculture, Forestry, Hedge Funds.
Multi Asset Funds are a blend of the above asset classes, which diversify an investment across many different asset classes based on a scaled risk approach eg ESMA 2-6 leaning from lower risk to quite risky.
The purpose of a Multi asset fund is to allow for a degree of flexibility in investment funds, traditional funds may only be able to invest in a specific asset class eg equities, so if a stock market falls, the fund may not be able to invest elsewhere, a multi asset fund allows for diversification by asset type and geographic area which theoretically reduces the risk to your funds in the event of a negative economic shock.
It is my view that a Multi Asset Fund that is properly aligned to you own investment risk profile and time frame should meet most people’s investment objectives.
8. Product Options
There are a myriad of investment options available to individuals however we have looked at the most common non deposit options and a selection of options on same. These are being listed based on a combination of Fund Charges/Investment Potential, Timeframe but are not an individual recommendation for investment, if you require further information, contact your broker.
Life Company Investment Bonds
These are provided by all the main life companies, Aviva, Irish Life, New Ireland Standard Life and Zurich, most companies offer what is known as an Easy Access option which will allow you to exit from the Investment Bond early with no exit penalties and a competitive charging structure. An example of this would be the Aviva Life Investment Bond E, which gives 101% allocation and no early exit penalties, the extra 1% allocation offsets the 1% government levy currently payable.
Tracker Bonds/Structured Products
Tracker bonds or Structured products used to be exclusively deposit based products with associated guarantees of same but are now mainly certificates also known as a debt security they often combine two or more assets, and sometimes multiple asset classes, to create a product that pays out based on the performance of those underlying assets. Structured products vary in complexity from simple to highly complex and most currently provide 85% to 95% Capital Protection. These are provided by companies such as BCP, Cantor Fitzgerald and a broker can advise you on the suitability of same
Life Company Hybrid Lump Sum/Monthly Premium Options
Investments Such as the Zurich Life Saving plus allow you to invest a fixed lump sum, minimum €7,500 and a monthly premium (minimum €100, maximum €2,500) into the one investment. This approach allows you to drip feed your funds into an investment, by way of a mechanism called Unit cost averaging to reduce the exposure to fluctuations in the price of the asset being bought.
9. Tax
Different taxes apply to different types of investments ,from Capital Gains Tax at 33% to Gross Rollup up on maturity or on 8th anniversary of 41%, in some circumstances a 1% government levy may apply. However, in light of minuscule deposit rates, the potential for growth may mitigate the tax and over times tax rates may drop thus providing further benefits. We are not tax advisers and a specialist opinion may need to be sought.
10. Regulated vs non-regulated investments
As a broker KM Financial only offer Regulated investments, there are major benefits to our clients because of this.
We offer regulated investments because A regulated investment will be covered under certain legislation and rules and are regulated by the Central Bank of Ireland (CBI) whereas a non-regulated investment is not subject to regulation by the CBI. This difference is important in the event of an investment failure or collapse of a firm providing an investment. Regulated products by their nature often have much higher levels of due diligence applied automatically due to the fact that they are regulated.
The Central Bank website details the compensation schemes that protect consumers of authorised firms as follows:
Deposit Guarantee Scheme
The Deposit Guarantee Scheme (DGS) protects you if you have money in a bank, building society or credit union that is unable to pay back your savings. This includes any money you have in your current account. The maximum you can claim under the DGS is €100,000 per person, per institution.
The DGS only protects savers who have deposits in financial firms authorised by the Central Bank of Ireland. Deposits held in institutions authorised by another EU Member State are covered by that country’s deposit guarantee scheme.
Investor Compensation Scheme
The Investor Compensation Scheme (ICS) protects clients of an investment firm that goes out of business. The scheme pays compensation when an investment firm authorised by the Central Bank is unable to return money or investment instruments it owes to consumers who invested with it. Such firms can include stockbrokers, investment managers, insurance brokers and agents. The maximum amount of compensation you can claim under the ICS is 90% of your net loss, up to a maximum of €20,000.
The ICS only pays you compensation when:
• A firm is put into liquidation by the High Court
or
• The Central Bank determines that the firm is unable to meet the claims of clients
The ICS doesn’t pay compensation if:
• You incur losses due to receiving bad investment advice
• Your investment is poorly managed
or
• Your investment performs poorly due to market conditions or other economic forces.
In the case of an investment that is eligible under both the ICS and the DGS, the Central Bank decides which scheme pays you compensation.
Investors considering investing in unregulated products should be aware that unregulated services are not subject to regulation by the Central Bank of Ireland. The main issue here is the advisor is not subject to the Consumer Protection Code [CPC]. The CPC imposes provisions on the advisor such as ‘Knowing the Customer’ and the ‘Suitability of the Product’. In practice, most advisors will follow CPC rules when dealing with customers.
Investors in unregulated products are not covered by the Investor Compensation Scheme. This scheme provides redress of up to €20,000 currently, where a client’s investment is lost because of the financial failure of a regulated firm that held the client’s funds.
Investors in unregulated investments will be covered by the Financial Ombudsman scheme in relation to the provision of investment advice given to them because this service is classified as a ‘financial service’.
Unlike regulated products, advisors are not required to hold Professional Indemnity Insurance [PI] in place for the provision of unregulated services. Before engaging an advisor on unregulated products, you should check if that advisor has extended their PI insurance to cover unregulated products.
Advisors are not required to disclose their commissions and fees arising from the sale of unregulated products.
11. Financial Broker versus tied agent
The difference is based on choice, no investment company has a solution for every circumstance. When you appoint a Financial Broker, they will research products and solutions that match your needs from the range of companies they deal with, providing a “fair analysis” of the relevant market.
A tied agent is a person who, under the full and unconditional responsibility of only one investment firm on whose behalf it acts, promotes investment and/or ancillary services to clients from that single investment firm.
Mike Knightson QFA, CFP®, RPA, MIIPM, SIA is a director of KM Financial www.kmfinancial.ie , he has over 20 years industry experience and the current Life Insurance Association Limerick regional chair, he can be contacted via email [email protected]