Everything we read tells us that withprofits is bad news – how do you answer that accusation?
Don't believe everything you read. We have to look at with-profits performance, and the performance of any other investment, in the light of world investment conditions and the last few years have been bad news for every type of investor.
Despite its recent recovery, the stockmarket has fallen by 35 per cent since its peak in 2000 and, yes, with-profits returns have fallen but in most cases by less than a direct stockmarket investment. With-profits has fared no worse and in many cases has continued to perform much better than other investments.
With-profits was designed, and is still relevant, for the many millions of investors who want decent growth but without the white-knuckle ride of direct stockmarket investment and who want to protect their investment yet expect a better return than a building society.
But some might say that with-profits has lost its way and is not working. I beg to differ. With-profits has not lost its way. It has stood the test of time – even during the worst stockmarket period since the First World War. On traditional with-profits, such as the ones in the traded endowment market, bonuses are still being added. Terminal bonuses may have been reduced or even suspended but, just as everyone believed in the 1980s that bonuses would go up for ever, they will not go down for ever.
The underlying value of traditional with-profits investments grew during a period where the investment world was falling apart. Let me give you some staggering statistics. For every policy term from 10 to 25 years, the best-performing with-profits endowment outperforms the best-performing managed fund, the average with-profits outperforms the average managed fund and even the worst-performing with-profits fund outperforms the worst-performing unit-linked fund. Across all terms, with-profits continues to outperform. So why has the press continuously attacked the product?
The real problem is with endowment mortgages where the policy has to hit a fixed target on a fixed date. This was fine in the 1980s and 1990s when investment returns were much higher but so were interest rates. As investment returns have fallen, these policies have had to work harder just to stand still and so many of them now have a shortfall.
The average 25-year endowment policy maturing last year produced a return of 9.8 per cent a year which I guess would be very acceptable to everyone. The problem is that if your policy had to achieve 12 per cent to repay the mortgage, you would have a shortfall.
It is not the endowment that is the problem, it is what it is being asked to do in a changing world. The fact that we sell so many traded endowment policies shows how attractive with-profits endowments are to low-risk investors.
What of the argument that, with investment returns falling, investors would be better just leaving their money in a society? At least it is safe there.
What price should you pay for safety? The cost of cash is terrifying. Obviously, everyone needs access to cash, some more than others, and you should always be comfortable with your levels of cash. However, having all your eggs in one basket, especially with the corrosive nature of cash, is not a good idea.
The highest return you will find on a society account is around 4.7 per cent. Well, a higher-rate taxpayer needs a return of 4.83 per cent just to stand still after tax and inflation and a basic-rate taxpayer needs 3.63 per cent. That is why I say too much of your money in cash is corrosive.
That is all very well but we have seen a stockmarket recovery in 2003. Why is with-profits now lagging behind?
The smoothing of with-profits effectively happens after the event so the current rate of return on with-profits has yet to keep up with the recovery of last year. In the same way, when the stockmarket fell by a similar amount in 2000, we only saw tiny cuts in bonus rates.
Fund managers want to be certain that any fall or recovery is not just a blip. If you want an investment that follows the stockmarket, invest in the stockmarket.
Do not forget that with-profits is a long-term investment, not one where you pop in and pop out again. Can withprofits survive or is it time to quit and invest elsewhere?
With-profits will survive and will be stronger for it. What first appealed to the investor about with-profits – long-term, lowrisk investment without stockmarket fluctuations – is still true and will remain true.
Is it time to quit? Well, I think it is quite irresponsible to suggest that investors get out of with-profits and suffer MVRs, some as high as 20 per cent. In fact, rather than quit, I would say now is the time to invest – it is a buyer's market.
In the same way, you would want to buy your BT shares at the bottom of the market, where prices are lowest. The falling bonus rates of recent years coupled with brighter investment prospects make it a perfect time to buy a traded endowment.
Indeed, with traditional with-profits, as bonus rates have fallen, the guaranteed values have continued to rise and now you can buy an investment where virtually all your capital is protected and you still have prospects for decent investment growth. You can speculate without the downside.
The problem is that you are describing the strengths of traditional with-profits and the very strengths you describe are the reasons why life offices have withdrawn traditional with-profits.
That is where IFAs can use traded endowment policies to access traditional with-profits and where they can take advantage of low bonus rates and very high levels of capital protection – speculate while controlling the downside.