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Caution to the winds

A fortnight ago, I recalled the tale of a 70-year-old pensioner who popped into his local highstreet bank to moan about the dismal 0.1 per cent interest he was getting on a sizeable cash Isa and asked them how they could help.

The bank asked him to fill out a questionnaire to assess his risk and, perhaps not surprisingly, it turned out he was a cautious investor. When I talked to him, he said he did not really want to risk losing any of his money – after all it had been in cash for several years – he just wanted to get some sort of return, perhaps 4 or 5 per cent at best over the next four or so years. His car might have packed up by then, so he might need access to some readies.

Yet I was surprised with the portfolio the bank had planned for the customer – a customer who had never invested in a unit trust or Oeic, let alone knowing about hedging, derivatives, currency swaps or generating alpha. The bank suggested that a quarter of the portfolio should be split into five funds – Fidelity special situations, JPM emerging markets, Fidelity South-east Asia, JPM natural resources and Blackrock UK smaller companies.

There is nothing wrong with these funds per se – they are frequently tipped by financial advisers, especially for savers hoping to capitalise on long-term growth opportunities. But is the mix suitable for a 70-year-old cautious investor? JPM natural resources manager Ian Henderson readily admits that his fund is volatile.

To be fair to the bank’s adviser, the main chunk of the portfolio – around 60 per cent – was to be split between three cautious funds. But again the choice of funds appeared odd. One fund (a multi-manager fund) was barely two years old and had yet to outperform its benchmark – it will not surprise you to learn that this fund was a tied product.

A second fund in this core segment of the portfolio, which made up a hefty 25 per cent overall, was in the Fidelity new multi-asset defensive fund. I am not questioning its manager Trevor Greetham but this fund is a new type, is barely nine months old and has just £6m under management.

Should a cautious investor be putting a five-figure sum into an unproven fund (and, let’s face it, an unpopular one at present), when there other cautious funds with track records available?

The third cautious fund was JPM cautious total return. Here is a fund that has proved to be one of the better sellers in the absolute return space but it has had one or two hiccups along the way.

On checking the customer’s overall asset allocation for his portfolio, a little under half was exposed to equities. The bank informed the pensioner that he would pay a 4 per cent charge in the first year although he seemed unaware that there would be an ongoing annual management charge too.

This portfolio bamboozled the bank customer and left him thinking he might get a return of around 5 per cent a year for the next five years. It might well do. It might even do better but it could do a lot worse and lose him money. Given the circumstances, you have to question the bank’s motives.

When I talked to him, he said he would settle for a cash Isa paying around 3 to 4 per cent over the next four years. The return would be tax-free, his capital would be safe and he would not be spending thousands of pounds a year in charges. But guess what? The bank, unlike some of its rivals, does not have such a product.

Paul Farrow is personal finance editor at the Telegraph Media Group


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There are 13 comments at the moment, we would love to hear your opinion too.

  1. Typical Bank story – horrible.
    “Abandon hope all yee who enter” should be above the door.

  2. The market in assisting bank customers with their complaints is massive, I have some spare time.

  3. I am bored out of my skull with people who really don’t understand what risk is. For heavens sake risk is not “the loss of X, X in this case being capital”. Risk is the mathematic potential for an event to occur over a given period of time. When a person losses money its called a “loss”!!!!!!!!!!!!!

    You then state that he is happy to have a return of 1% per annum which is not sufficient to out perform inflation. So in fact what you are saying is that he is happy to make a loss for the next 4 years. Hmmmmmmmmm, that really shounds like great financial advice to me.

    So let’s put this into perspective. Risk is “omnipresent” which means it’s always present, always has been and always will be. In having probably all of his funds in a single asset class has meant that he suffered probably already suffered a loss of X over a period of Y through the fundamentals of the asset class.

    What you are saying is not that he does not want to take a “risk”, not that he and you know what “risk” is but that he wants the benefit, both intellectually and fiscally of having an amount of capital that does not seem to change in value, even though it has changed in value.

    Instead of moaning and making judgements perhaps it would be a better use of time to really study the investment process and what the terms really mean and not what some fool tells you they mean.

    Sadly I need to remain discreet about who I am but I am really totally fed up with the level of ignorance over the simple terms of “risk” and “loss”.

  4. A very common tale, not dissimilar to the one featured on last week’s edition of MoneyBox on Radio 4. After alarming falls in the value of her portfolio and several attempts to get hold of the original Barclays bank “adviser”, the (risk averse) investor agreed that the best way to prevent further losses would be to liquidate everything.

    Nine months and many attempts to find out what was happening later, her request had still not been actioned.

    This is just one of many, many such cases happening all the time with banks. The FSA is fully aware of the situation but whenever it starts to make noises about moving in on such practices, the banks call up the Treasury and tell them to call off the dogs, otherwise they’ll up sticks and relocate outside the UK. That will cost the UK a lot of jobs and tax revenues, so the Treasury calls up the FSA and instructs it to back off.

    As the FSA is an instrument of government, it duly complies and redirects its firepower at the IFA sector. It isn’t the old school tie thing ~ it’s corruption, pure and simple.

  5. Mr Stevens I think you will find that folk are in fact not “risk averse” but in fact “loss averse” since they really don’t know what risk is.

    What they don’t want to do is to “loose money” which is a “loss”. They are clueless about risk for a number of reasons the most obvious being that simply because the amount of money they have in their bank account is the same does not mean it has the same purchasing power.

    Thus if the mathematic possibility and probability of the consequence of an event is always present over any given period of time then as defined by Apriori analysis (which states that the market and investments have a constant risk rating of 0.33 since there are only three possible outcomes of a) profit, b) loss and c) no change)) then by Relative Frequency analysis (the potential for a loss event to happen over a specified period of time and in retrospect how many times such a loss event has happened over a previous period of time), then Subjective Probability analysis (a range of assumptions over a specified period ranging from the highly probable loss event to the highly improbable loss event) topped off with perhaps the most relevant being Haller (named after the economics professor who defined risk as “the possibility that the positive expectations of a goal oriented society will not be fulfilled” .

    So what does this tell us? Well for a start it says that most financial advisers and product providers and the folk with the money don’t understand risk and loss. Risk is probability and loss is consequence. It also tells us that simply because a person has X of capital today and the same X of capital at a specified point in the future does not mean that a loss has not occurred.

    I think that if I read another “blah blah blah risk graded funds blah blah blah low risk blah blah blah cautious blah blah blah high risk” method of assessing what is good and bad financial advice that I will turn into a pillar of salt at my own behest.

    Or maybe I am being over critical in thinking that product providers and financial advisers should be able to explain the difference between probability and outcome. I can and perhaps that is why the folk I have educated have never ever lost any money EVER.

  6. Be honest
    an adviser cannot assist a cautious client – leave the money in the bank
    the charges on the above funds will mean he is very unlikely to benefit from this investment
    we all know it
    take a smaller sum off him and invest in a proper equity fund- or a spread of blue chips with a good dividend record

    reality is the latter solution will not make the same commission so we go into these complex solutions to hide the real purpose- which is take the max commission- the reason why letter of this complex solution will be full of mumbo jumbo- In some ways the old guy should buy it- if it loses money he can complain- and FOS desevedly will give him his money back- that would be pretty good advice 🙂

  7. I can see Mr City’s point, but as Paul Farrow has said the old gentlman has not got what he thinks he has and a complaint is likely if the face value drops.
    Without a fact find and a lifetime cashflow forecast, we can’t identify whether the old boy even needs to expose his money to equities and whether this discussion has taken place….

  8. (Note to moderators: apologies if this comes through twice, had some error messages.)

    How exactly would Mr City prefer that people tell him that they don’t want to invest in the stockmarket? “I don’t want a capital loss” makes perfect sense if you are talking in nominal terms, but apparently talking in nominal terms with Mr City is Not Allowed, like asking a posh sommelier what beers he’s got on tap – he will pretend not to understand what you’re talking about.

    “I am a low risk investor” is also perfectly understandable using the definition of risk commonly understood by financial advisers and investors, but because economists use a different definition of risk he can’t use that either.

    Is Mr City’s problem, in fact, that he doesn’t want to be told by anyone that they would prefer not to invest in the stock market?

    He seems to be want to use inflation as a stick to scare investors away from cash with, ignoring the fact that inflation reduces the return you get from equities just as much as it does cash. If your pensioner holds cash for 4 years, he will lose money from inflation, but if he holds equities instead, and they go down, he will lose money from falling values *and* inflation.

    That they might go up and will go up if he holds onto them long enough is irrelevant when it’s clear he’s neither looking to gamble nor to invest for longer than 4 years.

  9. It’s a dilemma but there is a large difference between “investing” and “saving”. Saving really means holding cash in my experience. Although I am a qualified broker that is not what I do anymore so I am not 100% focussed on listed securities, be they individual stocks or mutual funds, so I am not blindly saying that in order to create wealth and financial independence a person must “exchange their cash for shares or stock” by buying shares in listed companies through a stock exchange.

    Clearly there are other ways of making money where the value of assets can move up, down or stay the same. But high quality debt such as gilts or cash is rarely priced at a discount to inflation plus tax and it’s never priced at a discount to longevity plus inflation and tax. Never never ever ever. What holding cash does is to create a false image of stability and security in that it seems not to vary in value when of course it does. It is also incorrectly perceived to be free of the potential for loss which is course it is not.

    The fact is that companies do not really share their profits with banks and banks don’t share their profits with cash deposit holders. They share it with their shareholders and banks (that are listed) share their profits with shareholders. It’s a simple concept and a hard fact for some to learn. Likewise the UK Government will not issue a Gilt with a yield massively above the net cost of debt, being the Bank of England base rate, since the Government also does not want to share its profits with tax payers either.

    What I am therefore saying is that cash is not loss free and that in fact of the 0.33 risk outcomes that all three are in play and that a loss can be made. In fact in many cases holding cash 100% guarantees that a loss will be made, especially over a long period of time. The problem is that folk without the intellectual ability to synthesise such complex concepts into clear facts and form a plan of action around those facts are not able to understand the true facts of financial life. And in many cases they are unable to understand what an IFA (to use the term in a general way) does and that volatility is a great way to make money. This makes the IFA frustrated because the IFA can’t communicate with the individual feels frustrated because they can’t understand the IFA

    So in answer to a previous point if a person can’t understand that holding cash is not a loss free process that in fact that they can’t be helped. I totally agree that such folk should be left to their own devices as they can’t be helped. Personally I did not become financially independent by getting a return of 1% a year on my personal wealth.

    I really wish that I could come clean and say who I am but that is just not possible at the moment. But facts are facts and any person in the UK that wants to become financially independent can’t achieve that goal by holding cash. It’s that simple.

  10. It’s not just Banks that do this, I worked for 3 IFA’s and all of them would have put him in a bond – only iquestion is whether to take 3% + 0.5% or 7% commission.

  11. blimey Mr City, good emails and comments all of which seem to be true. However, cash does have its place. I would suggest though that a 70 year old is probalby going to be as financially independent as he is ever going to be. He may want a small return on his investment over the next few years, however he might need the capital to remain at least nominally the same in order to provide the funds to buy a car.

    It seems that the problem that you have here is not that there has been a mis-understanding between risk and loss, it seems that the issue has been that a client has gone into a bank with £20-30K and the chap in the bank has worked out the best way to cream of 4% in order to hit his target.

    Perhaps the adviser is aware of the risks invoved to him of not hitting his target and doesn’t wish to risk the loss of his job.

  12. It depends what the client wants…does he need the income or does he want the ISA for capital growth. Dare I say sometimes some of the deposit based capital protected structured products might be suitable for some of his ISA portfolio, or he could if it’s big enough ask a professional investment manager to manage the ISA portfolio in a Cautious manager as long as he doesn’t need access to the capital for at least 5years. Of course then there’s IHT considerations..ISA portfolios form part of someone’s estate….whereas a gift into a Bond in Trust could fall outside his Estate after 7 yrs and there’s some protection against care fees.

    Of course I’m sure the bank advisers went into all of his financial details so that they could discuss the options open to him.

    I find if you discuss the options available the pros and cons, together you can form an opinion of the best way forward. Why do we have to sell something to a client???!! Surely it’s about working with clients to acheive their goals!

  13. Thanks Dave. It has taken me a lot of years to really understand the real motivation and thought processes of investors and savers. The pure technical knowledge took much less time to accumulate.

    I define an investor as a person who is largely positive about the future and can see that significant returns can be made by holding the stock (no matter what form) of companies that are and will be successful because they are making the products and services that we want to purchase and investing the ones that we don’t yet have. After all who does not want to be part of something successful? Always remember the great Henry Ford (love him or hate him) when he was asked about asking his customers what they want. “If I had asked people what they wanted, they would have said faster horses.”. Yes there was profit in horses but there was more profit in cars. Personally I love being a part of something successful which is why I own more equity assets that debt assets. That will also be the case be it at age 50 as I am now or age 80 as I will be in 30 years.

    A saver on the other hand is someone that is largely negative about the future and sees little potential or possibility in the creation of revenues from the activities of companies. I say that because if you are negative about the future why would you want to own companies that are trading into doom and gloom? If you are negative you want to maintain your position and not go backwards. One of the reasons for this is that such a person has never gone forwards enough to allow themselves to go backwards. A saver wants (and may require) stability. It is often argued that a saver who only has cash assets can’t afford asset volatility. Personally I think that is hogwash. Personally I can’t allow myself to waste my time and IQ worrying about getting 1% a year on my assets rather than 2%. What a total waste of intellect that would be. I would and do focus on trying to spot what is going to go up in value by say 1,000% and then buying it before it goes up by 1,000%.

    I am of the view that the ill informed tend to back on the mantra of risk and out comes the time worn phrases of “loss averse investor” or “low risk investor”. What such folk really should be known as are “asset volatility averse” because they really can’t afford any negative change in asset value (which could be the case) more likely can’t accept such a change intellectually. Of course I am not sure how you can pick companies on the basis that they will not grow in value and not invent a new product that we all want to buy. So perhaps its best that they just stay as they are.

    I agree totally that where a person has a short term liability such as the paying of regular bills that that is best done from cash assets. I also agree that if a person has made a return of say 1,000% that it makes sense to move from asset creation to wealth preservation for some of that 1,000%. I also agree that where a person knows when and how they will need their money that they should be in cash. Personally if I could see into the future like those who know when they are going to need their money can I would be reaching for the FT to check share and index prices and buying companies as fast as possible.

    You make a good point about the cost of financial advice. My advice costs money and if folk are not prepared to pay for my advice then they don’t get my advice. It’s that simple for me. For a lot of us a Single Premium Whole Life Assurance Policy is a great way to manage our investments. So are mutual funds with profits taxed as capital and not income. I have a few myself and they work very well for me. I fully understand about the commission issue but what about a person who has never made anything other than a few percent a year after tax who loses money year after year. The cost of 4% is actually great value to such a person.

    When you boil it down making money and becoming financially independent is not easy. It takes intelligence, hard work, determination, skill, application, diligence, focus, motivation, instinct, feel, effort, insight, drive, dedication, discipline and sometimes guile, cunning and dare I say it greed. But of course checking to see which bank or building society will offer an extra 0.25% per annum is so very much easier. Personally I am 100% with Henry Ford.

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