Tuesday 30 November 2010

The outlook for corporate bonds

With the Bank of England base interest rate still stuck at 0.5% and looking like it'll remain there for some time yet, do corporate bonds hold some appeal?.

To get a feel for where bonds might head in future it helps to understand the main factors that affect bond prices.


What affects bond prices?


Gilts and corporate bonds are basically IOUs issued by governments and companies that promise to pay regular interest at a fixed rate before paying back the sum borrowed at a future date (called 'redemption'). So the following factors are likely to have the biggest impact on a bond's price:


Financial strength

When you lend someone money your key concern should be whether they'll pay you back. It's no different with bonds. When a government or company gets into financial difficulties there's a greater chance they're fail to pay interest and/or your money at redemption, so the price of their bonds will usually fall to reflect the increased risk. This is what's happened recently to bonds issued by the Irish Government.


Interest rates

Because bonds pay a fixed rate of interest their price is sensitive to interest rate movements elsewhere. For example, if interest rates rise and you can earn more interest via a savings account, you'd want to pay a lower price for bonds as their fixed rate will look relatively less attractive than before.


Inflation

The higher inflation, the less future interest payments and return of money at redemption will buy compared to today. So if inflation is expected to rise then bond prices are likely to fall, as they become less attractive.


Confidence in other investments

Bonds issued by robust governments are generally seen as being pretty safe in the scheme of things. This means they're often in demand when stockmarkets are other investment types are looking shaky - and rising demand usually means higher prices.


You'll generally find that bonds issued by riskier companies (often called 'high yield' or 'junk' bonds) are most influenced by changes in perceived financial strength while those issued by safer governments and companies (called 'investment grade') are more sensitive to anticipated interest rate and inflationary movements. Also bonds with shorter periods to redemption tend to be less sensitive to interest and inflation rate movements than those with longer redemption dates.


Currency movements will also obviously affect bonds not issued in pounds sterling.


How much income are bonds paying at the moment?


Income is fixed but a bond's price isn't, so the income you'll receive is best measured by a 'yield' calculation. 'Running yield' is the annual income divided by the bond's price and 'redemption yield' also takes into account any gain or loss you'll make at redemption if the price you pay for the bond is different to the redemption price.


For example, BT has a bond paying 8.5p annual income redeeming at 100p in December 2016. Its current price is 122p, so the running yield is 6.9% (8.5/122), but this doesn't take into account the 22p loss you'll make at redemption. The redemption yield, which builds this in, is about 4.3%.


Here are a few redemption yields (before deduction of tax) at the time of writing to give a flavour for how they vary depending on the financial strength of the issuer and the period until redemption:






























IssuerRedemption DateRedemption Yield
UK Government7 Dec 20110.6%
UK Government7 Sept 20203.4%
Marks & Spencer7 Nov 20112.3%
Halifax17 Jan 20145.1%
Tesco13 Dec 20194.3%
Provident Financial14 April 20206.8%
Source: bondscape 20/11/10.

How's recent performance been?


Let's take a look at the main IMA unit trust bond sectors:






















Sector1 year return3 year return
UK Gilt2.9%18.7%
£ Corporate Bond6.2%11.0%
£ High Yield Bond13.1%19.5%
Global Bonds5.1%31.5%
Source: Trustnet 20/11/10. Returns shown bid to bid with net income reinvested.

So, compared to cash, quite reasonable overall.


What's the outlook?


That really depends on your views for interest rates, inflation and the economy in general.


I'm fairly negative on the prospects for the UK economy and believe that interest rates will continue to remain low for at least another couple of years. High oil prices have been the main inflationary driver this year and provided its price doesn't surge again then inflation should start to fall next year, despite the imminent VAT rise. Some argue that governments printing more money (called 'quantitative easing') will push up inflation, but I'm less convinced as I'm not sure much of this money will actually end up being spent.


This would seem to be reasonably good news for corporate bonds shorter term.


However, if economies do struggle then companies and governments will probably find the going tougher, increasing concerns over their financial strength hence pushing down bond prices (although the very safest government bonds might benefit as more investors flock to perceived safety).


As for the next 5-10 years it's hard not to believe that interest rates won't increase, which could push down bond prices longer term, although the possibility of a more rosy economic outlook and lower inflation could help offset the impact.


So overall I'm quite indifferent. I don't see bonds delivering exciting returns but I doubt higher quality bonds will crash either.


Is it worth buying corporate bonds at the moment?


I think it's generally worth holding some in portfolios to hedge other investment types, but as per above I find it hard to get excited by prospects for the next few years.


And with the fixed rate on some savings accounts currently higher than the redemption yield on gilts and higher quality corporate bonds over 5 years, there's a disincentive to buy shorter-dated bonds unless you think their price will rise so you can sell at a profit before redemption.


There is more to bond investing than I can realistically cover in an article, but hopefully this gives you a clear idea of the main principals and what to consider when making bond investment decisions.

Read this article at http://www.candidmoney.com/articles/article177.aspx

Friday 26 November 2010

Most helpful bank

When your bank starts sending a few forest's worth of paperwork are they being helpful or simply wasting a lot of money and time?.

I’ve been sent a personal annual statement by NatWest. Twelve pages plus a four page cover. I didn’t ask for it, and for the life of me I don’t know what it is for. It would be helpful if they could send me a tax voucher every April. They don’t. It would be helpful if they reminded me from time what rate was being paid on my savings account, which information is not to be found in this book. It is not helpful to learn that the fifth biggest area of debit card spend was Trenance Chocolate (holiday in Cornwall), and I did not wish to be reminded how much I spend on wine. The list of Direct Debits and Standing Orders is a useful check, but I already have my own list anyway.


This exercise must be costing the bank a fortune. I doubt it will be a selling point for new customers, and I can’t see that it would stop existing customers from defecting, if that is what they had made up their minds to do. The service I get from NatWest is great. The Direct Debits pay the bills. The ATM disgorges tenners to order . I ‘phone the branch once in a blue moon, and they are always as helpful as they are polite. I have no complaints whatsoever.


Except that someone somewhere seems to want to ram down my throat his or her belief that they are the most helpful bank. I can’t know, because I don’t have accounts with all the others. Methinks they doth protest too much.

Read this article at http://www.candidmoney.com/articles/article176.aspx

Tuesday 23 November 2010

Are Irish ETFs safe?

Question
Everyone writes how efficient, cheap and sensible ETFs are but no one ever seems to write about how safe and secure they are. Probably the most popular, iShares run by Blackrock, are domiciled in Dublin. I assume they are not covered by the FSA Compensation Scheme. Are they at risk if the Irish economy continues to melt down? ( I don't just mean ones tracking the Irish economy!)Answer
You're right, iShares exchange traded funds (ETFs) are not covered by the Financial Services Compensation Scheme (FSCS) due to them being domiciled in Ireland rather than the UK. This means that in the very unlikely event your money vanishes (for a reason other than poor investment performance) you won't be entitled to any compensation.

So what are the risks?

Well, the most obvious is that someone runs off with your money. Fortunately investment funds, including ETFs, must place fund assets with a third party, called a 'custodian'. Custodians, usually large banks, must ring fence the money/assets to ensure they're held for the benefit of investors in the fund and no-one else. This means that iShares, for example, can't take money from its funds (other than agreed charges) for its own use. If the custodian goes bust your money should still be safe as its held in a separate 'segregated' account, independent of the bank's own money - although there's no guarantee.

A potentially bigger risk is where an ETF uses an investment bank to provide the index tracking - so-called 'counterparty' risk.

When an ETF tracks an index it will generally either buy all the shares that comprise the Index (e.g. iShares FTSE 100 ETF) or agree a deal with a third party who'll provide the tracking, called a 'swap-based' or 'synthetic' ETF (e.g. ETFS Energy DJ-UBSCI). In the case of the former the fund owns the underlying shares so should be safe in the scheme of things. In the latter case the fund is relying on a third party ('counterparty') to provide the returns, if the counterparty goes bust the fund could lose money (this happened when Lehman Brothers, a popular counterparty, bit the dust).

However, there are some provisos re: counterparty risk. Under fund (UCITS III) rules counterparty risk can be no more than 10% of the fund value. So if the worst happens it will hurt, but shouldn't be a disaster. Secondly, some ETFs hold extra assets (called 'collateral') to compensate for counter-party risk, reducing the likelihood of losing money if a counter party defaults.

You should find details of the custodian, counterparties and collateral levels (if relevant) in an ETF's prospectus, so take a look before investing to ensure you're comfortable.

Does the dire state of Irish finances pose additional risk to ETFs domiciled in Dublin?

I suppose it could if the custodian or counterparty is an Irish Bank, as if the bank goes bust there is a risk you could lose money. iShares uses 'The Governor and Company of the Bank or Ireland' as custodian on its Dublin ETFs, which gives some cause for concern. However, as the chances of the EU allowing an Irish Bank to go bust seem pretty much zilch, I wouldn't lose sleep over it.

Read this Q and A at http://www.candidmoney.com/questions/question325.aspx

Monday 22 November 2010

Switch my Skandia pension?

Question
I have a personal pension (PP2) of about £42,000 with Skandia taken out in 1994 with a single premium. Skandia makes an admin charge of .75% per year over and above the underlying annual fund management charge. However, Skandia also attributes a loyalty bonus of 1% for every 5 years the contributions are held. So, the Skandia admin charge is effectively lowered by 0.2% a year to 0.55%. It also makes a maintenance charge of £45 per year.

I will probably draw the pension in about 10 years time and am considering transferring the pension to Skandia's investment solutions collective retirement account (CRA) for the duration. This has a similar maintenance charge (c.£52 a year), but no administrative charge, thus saving 0.55% p.a.. There are no penalties for the internal transfer and I would also keep any loyalty bonus accumulated. So, at first sight, it seems an attractive option, especially given that it has a greater choice of funds.

However, when I look at the list of funds for each product, the annual charge on the individual funds is frequently lower for the PP2 than for the CRA, e.g. Perpetual High Income 1.3% vs 1.5%. Aberdeen Emerging Markets 1.3% vs 1.75%. In addition, the PP2 fund management charge is shown as a TER, whereas the CRA shows an AMC. So, although I can't make an exact comparison, it seems that the charges may, in some instances, be lower with my current PP2.

Then again, if I look at the 3 year performance of the Perpetual fund, the CRA has returned 38.42% vs the PP2's 36.32%; and the 3 year performance on the Aberdeen Emerging Markets is virtually identical. Given that these figures are before the 0.55% admin charge on the PP2, then the CRA is looking cheaper again.

Is there any way to sort out whether it is best to stick with the PP2 or move to the CRA?

PS I have only recently discovered your website and find it comprehensive, clear and full of good advice. Thank you!Answer
The comparison you've made is sensible and as your examples show it looks like six of one and half a dozen of the other.

Perhaps start by gauging whether you're more likely to buy an annuity with the pension fund in 10 years time or instead leave the fund invested and draw an income. If the latter then fund choice could be more important as the money is likely to remain invested well beyond 10 years. Plus, even a small cost saving via the Collective Retirement Account (CRA) would start to make a difference longer term.

You're right that you need to compare total expense ratios (TERs) to ensure an accurate comparison. The Skandia CRA fund list I've just looked at ( here) shows an 'Add Fund Expenses' column, simply add these to the annual management charge to get the TER. You can then more accurately compare the funds you're considering.

As for the variation in performance data for the same fund held in each pension plan there doesn't seem to be much rhyme or reason as to why, assuming both sets of figures exclude initial charges. Annual fund charges (the TER) should obviously account for the difference, but this doesn't seem to add up based on your examples. Nevertheless, as the CRA appears to fare better, even before the 0.55% admin charge is deducted from the personal pension (PP2), it would seem to have the upper hand.

If you're not using a financial adviser then another factor in the CRA's favour is the possibility of getting a trail commission rebate via a discount broker. Most funds on the platform pay annual trail commission, typically 0.5%. Discount broker Club Finance charges 0.1% a year in return for re-investing all trail commissions, which could potentially save you around 0.4% a year.

And even if you don't use a discount broker CRA has the potential advantage of including some low cost tracker funds (especially those managed by Blackrock).

But while cost is important, the bigger decision is how to successfully invest your pension fund. If you plan to buy an annuity in 10 years time then try to progressively reduce risk as retirement approaches - you don't want any market crashes to impair your retirement prospects. Drawing an income from your pension should give you greater investment freedom (because you'll be invested for longer), but it's still important to bear in mind how much risk you're comfortable taking and the level of income you'll eventually need to draw, then choose funds accordingly.

Good luck!

Read this Q and A at http://www.candidmoney.com/questions/question324.aspx

Bricks and policies

Why with-profits investments should be consigned to the dustbin of history..

I’ve been off air for a while, largely due to yet more building works. Building and financial services have much in common. Both have their own language which means nothing at all to anyone who is not a member of the relevant priesthood. Both are heavily regulated, and most of the problems occur well after the sale. The difference is that with financial services, if you really have been done down there’s a chance of redress.


Anyway, the porch extension is more or less finished and very pretty it is too. When people are in and out of your house for a couple of months, you get talking. Builder Harry (not his real name) duly discovered that I was of the financial services persuasion. Next thing I know he is handing me a mortgage endowment plan update. It didn’t mean a fat lot to him, but he really did not like the red ink. A couple of quick sums (Justin’s calculators are a boon) suggested that in real terms he is likely to get back what he put in. He will not be unhappy if that is indeed the outcome, but he is 20 years into the plan and to this day he has no idea what has been happening to his cash.


When will the Government bite the bullet, rewrite the Insurance Companies Acts, and consign with profits to the dustbin of history?


Changing the subject. Last month I wrote that inflation would be bad news for those of us who had saved, and that it was probably on its way. Sure enough, Obama is printing dollars and the Euro politicians are trying to figure out how to hold the Euro together. The answer, of course, is to inflate away the debts (put another way, steal from savers) which is what our Government is going to do. Methinks however that the Germans may not go along with the plan. Good for them. Awkward for lots of others.

Read this article at http://www.candidmoney.com/articles/article174.aspx

Friday 19 November 2010

The outlook for house prices

Will house prices crash? Fall a bit? Stand still? Or even rise?.

I thought I'd write about house prices because it seems, to me, that we're heading towards something of a Mexican standoff between buyers and sellers.


Why house prices should fall

In the current climate there are a number of factors that make falling house prices seem almost inevitable:


Taxes & unemployment both look set to rise

If you lose your job you're unlikely to go out and buy a home, plus the threat of unemployment will probably deter many from buying their first home or upgrading their existing until the prospects for our economy look a bit rosier, which could take a while. Both factors will reduce demand for housing, putting downward pressure on prices.


A tough economic climate will also, sadly, see a rise in repossessions. If this happens on a large enough scale it will likely push down property prices due to increased supply and desperate sellers - as has already happened in the US.


Prices have become over-inflated

The average house price is currently about six times higher than average earnings - double the mid 1990s level. Cheap borrowing has fuelled a self-perpetuating bubble, with many only too happy to borrow excessively and jump on the rising house price bandwagon. At some point more expensive borrowing will firmly burst the bubble, but for now interest rates look set to remain low so I think the more important point is the barrier to entry that high prices present for first time buyers.


It generally tough to borrow more than three times earnings at the moment, so average earners will struggle to buy average homes unless they've saved up a massive deposit. And without the prospect of soaring prices and future profits tempting them to buy, this end of the market could continue to dry up. Again, resulting in lower demand.


People expect them to

If you expect the price of something to fall then you'll either wait and buy when the price has fallen or offer a lower price now. Either way, this puts downward pressure on house prices.


Why they might not, by much anyway


Sellers are reticent to drop their price

Having seen their home soar in value, many sellers are reluctant to reduce their asking price to realistic levels. Or, if they've made little gain (or a loss) and have a large mortgage they probably can't afford to. As their home is unlikely to sell, it reduces the supply of housing that realistically could, helping to keep prices firm.


Interest rates look set to stay low

Despite grim economic prospects, if interest rates remain low then the majority of homeowners will continue comfortably affording their mortgage - reducing the risk of financial pressures forcing them to sell. It also means that those with sufficient earnings/deposits can afford to pay the current high prices - although they obviously might choose not to.


Resurgence in buy to lets

Low interest rates, decent rental yields and an uncertain investment outlook have sparked a resurgence in buy to let investing. With rental yields currently around 5% and high demand due to more people postponing a house purchase, some investors are favouring buy to let investments over stockmarkets and cash in the bank. This is boosting demand for suitable properties at the low to mid end of the market, which could mean prices being more robust than expected.


High cost to move

In the past it's been common to move house in order to trade up or down the housing ladder, either realising a juicy profit or hoping to make one. Such profits have outweighed the hefty costs of moving, which can run into tens of thousands of pounds after paying stamp duty, estate agent and conveyancing fees. But without the lure of rising prices many will simply stay put, unless they really need to relocate or downsize. This will reduce both supply and demand, but fewer properties coming to market should provide some support for prices.


What I think will probably happen


I have little doubt that house prices will generally fall by at least 10-20% over the next couple of years and maybe even more beyond (especially if interest rates rise). But I expect this will be gradual rather than a crash for the simple reason there will be so few serious sellers in the housing market.


House prices can only fall if they're actually sold and therein lies the problem. After prices fell during 2008/09 many potential sellers simply didn't bother, thwarting the supply of decent properties. Buyers wanting to buy a nice home suddenly found they were in competition with each other as there wasn't enough good stuff to go around, which pushed up prices. This led to a mini resurgence in prices earlier this year, prompting those potential sellers who'd been sitting on the fence to put their properties on the market, often at unrealistically high prices. The resulting over supply has since pulled back sale prices and we now seem to be hitting an impasse.


A quick surf on 'rightmove' (if you like rightmove, try out www.property-bee.com) suggests there are plenty of properties for sale, but few nice ones at sensible prices (if you believe prices are more likely to fall than rise). There are also few serious buyers, because they either can't get a mortgage, are holding off until prices fall or can't sell their existing home.


So I think we'll see a few exceptionally nice homes still sell fairly quickly at high(ish) prices to the few buyers who really want them. Some decent properties that would have sold quickly in the past will probably sell, in time, provided the sellers are happy to accept low offers that reflect an anticipated price drop (these types of sale will drive down the main house price indices). But volumes will be low by historical standards. And the vast majority of properties, either unpleasant or where sellers are stubborn on price, will simply remain unsold.


I think a crash would only occur if we see a massive spike in forced sellers (i.e. repossessions). While this has occurred in parts of the US, the UK has a far better social security safety net so I can't see the same happening here.


As a parting thought - I doubt prices will fall significantly long term as we're stuck in a generation that's obsessed with their home being an investment and if the population grows then so will demand. So we might start to see a fundamental shift towards renting rather than trying to jump on the property ladder, as is the norm in Continental Europe.


Oh, and if you're about to buy a home then bargain very hard!

Read this article at http://www.candidmoney.com/articles/article173.aspx

Wednesday 17 November 2010

Discretionary trust tax calculations?

Question
I am a new Trustee of a Nil Rate Discretionary and Acccumulation Trust of which the Settlor has only set up one trust. I wish to pay the interest income of this Trust to Beneficieries however I wish to retain sufficient of the income in the trust to deal with the tax liability.

Having calculated the 20% which is due on the first £1,000.00 and setting this aside with the 50% tax on the rest of the interest income,this produces a figure of the likely tax due. If then using the tax pool calculater I put in the total income and presumably this figure, includes the tax deducted at source, realised during the tax year and then insert the possible payment of the remaining income after tax I am left with a tax shortfall.

My question is, is this extra tax which has to be paid above the above calculated amount of tax due or is this shortfall included in the above tax figure. In the case of the former I can only pay the remaining income after further deduction of this amount of tax whereas in the latter case I can safely pay out all the remaining income in a particular tax year?Answer
For the benefit of other readers, a 'tax pool' is the name HMRC gives to the record of how much income tax a discretionary trust has paid versus the 50% tax assumed to have been paid by the trust (called a 'tax credit') on any income it distributes to beneficiaries (e.g. children/grandchildren).

Because non, basic and higher rate taxpaying beneficiaries can reclaim some or all of the 50% tax already (deemed to have been) deducted, the tax pool prevents more tax being reclaimed by a beneficiary than was actually paid by the trust (i.e. it stops the taxman from losing money).

When there's a tax pool shortfall, i.e. the trust has paid less tax than the 50% tax credits attached to beneficiary income payments, this is normally due to one or both of the following reasons:

1. As you've said, a discretionary trust must pay 20% tax on the first £1,000 of income it receives then 50% on the remainder, so this is the tax that enters the tax pool. However, because all income paid to beneficiaries is deemed to have been taxed at 50%, the tax pool may have up to 30% shortfall on the first £1,000 of income.

Example: the trust receives £3,000 of interest (I've assumed it's paid gross), which it pays to beneficiaries as £1,500 with an attached £1,500 tax credit (50% tax). The trust pays income tax of £1,200 on the £3,000 received (20% x £1,000 plus 50% x £2,000). However, because the £1,500 paid to beneficiaries is assumed to have had £1,500 (50% tax) deducted, a £300 tax pool shortfall must be paid by the trust.

2. When a discretionary trust receives dividends they're taxed at 42.5% of the gross dividend (divide the dividend received by 0.9), of which 10% is non-refundable, so only 32.5% enters the tax pool. And if this falls within the first £1,000 of income then the trust doesn't pay tax, so no tax enters the tax pool.

Example: the trust receives £3,000 of dividends (equal to £3,333 of gross dividend) which it pays to beneficiaries as £3,000 with an attached £1,500 tax credit (50% tax). The trust pays income tax of £758 on the £3,000 received (32.5% x £3,333, no tax on first £1,000 of gross dividend). However, because the £1,500 paid to beneficiaries is assumed to have had £1,500 (50% tax) deducted, a £742 tax pool shortfall that must be paid by the trust.

I know the calculations can get a bit messy, but I hope this makes sense. The key is to remember that the trust must have paid 50% tax (or the equivalent of, if dividends) on all income distributed to beneficiaries. So when the HMRC tax pool calculator shows a tax pool shortfall it must be paid in addition to the usual tax paid by the trust, or the income distribution to beneficiariesshould be reduced until the shortfall is wiped out if the trust doesn't want to pay extra tax.

As an aside, ensure you're offsetting all allowable expenses against trust income - you can deduct certain 'trust management' expenses incurred by trustees in carrying out their duties, most commonly the costs of accounting for the trust's income. Take a look at a useful HMRC guide here.

Also, beneficiaries should make sure they reclaim tax on the income received, where appropriate. They should receive a completed form R185 from the trustees every tax year detailing the income the trust has paid along with the tax credit. They can use these figures to apply for the appropriate tax refund via a self-assessment tax return or HMRC R40 claim form.

To work out their potential tax refund they simply need to calculate how much income tax they would personally pay on the income received (adding back the tax deducted by the trust to get a gross income for this purpose) then subtract from the tax already deducted by the trust (i.e. the tax credit). The balance is the amount reclaimable.

Read this Q and A at http://www.candidmoney.com/questions/question323.aspx

Tuesday 16 November 2010

The Irish problem

Ireland's financial problems could see the country going bust. How did things get so bad? And how might they affect the UK?.

Ireland's been in the news the last few days due to its financial problems, sparking debate over whether it'll follow Greece in needing an EU bailout. Let's take a look and gauge the size and implications of Ireland's mounting debt.



What's the problem?


After several years of boom Ireland has been heading towards bust since the credit crunch. Government debt has been growing fast, thanks in no small part to bailing out banks, and continues to rise. Ireland's ongoing Budget deficit is prompting fears over its ability to repay debt, sending the yields on Irish Government bonds soaring. This creates a vicious circle, just as it did with Greece, because it becomes too expensive for the Irish government to issue more debt (i.e. borrow further) leaving little choice but to either secure an EU bailout or risk going bust when the money runs out. The Irish government is maintaining it has enough cash to see it through until mid 2011 by which time Budget cuts will have eased the situation. But, as we'll see, this might be a tad optimistic...




How bad is it?


At the end of September 2010 the Irish national debt stood at €88.6 billion. This might sound like peanuts compared to the UK's £953 billion of debt, but the Irish economy is about one tenth the size of the UK's (when measured by output, i.e. GDP). More importantly, Ireland's debt is growing at a faster pace than the UK's - over the last two years it's soared by 75% (€38.2 billion), compared to about 50% in the UK.



The real problem is that the Irish Government will very likely need to borrow more money to keep its head above water, but with markets increasing sceptical that Ireland can repay its debts the rate of interest being demanded has soared. At the time of writing the yield on 10 year Irish Government bonds is around 8.2% (almost double a year ago), versus just 2.5% for equivalent German Government bonds. If Ireland is forced to borrow more at these levels the cost of debt interest will become overwhelming, creating a downward spiral.



The Wall Street Journal reckons the Irish Government had €22.4 billion of cash at the end of October, which could last up to 8 months. But it could also run out a lot sooner unless hard hitting spending cuts and tax hikes don't stifle slash the deficit without stifling economic growth (which looks unlikely), in which case it'll have little choice but to follow Greece in seeking an EU bailout.



How did Ireland get into such a mess?


It's the usual story of a country believing its own hype and spending far too much cheap borrowed money in the good times, creating an unsustainable bubble that eventually bursts (not dissimilar to the UK, but on a more aggressive scale). Banks lent too freely prompting a flood of money into the property market. House building and prices soared (Ireland built half as many homes as the UK in 2007 despite having one thirteenth the population), so when an increasing number of borrowers found they couldn't afford to keep up their mortgage repayments the house of cards started to collapse. This left Irish banks taking a massive hit from 'toxic' debts and the Government having to step in with a bailout package believed to total around €40 billion - pushing Government debt to unsustainable levels and prompting markets to demand a sky high rate of interest on Irish bonds.



Plunging tax revenues as a result of recession have then rubbed salt into Ireland's wounds.



Solutions?


The Irish Government plans to reduce its 2011 Budget by €6 billion more than previous projections via spending cuts and tax rises in a bid to manage its debt. The trouble is the Government projections assume the Irish economy grows by 1.75% next year and unemployment of 13.25% (it was 14.1% at the end of September). This seems overly optimistic to me, especially given the looming Budget cuts, and I can't see it happening.



I think it's almost inevitable the EU will have to step in with a bailout and that Ireland's road to economic recovery could be long and very expensive.



How might this affect the UK?


If an EU bailout is required then the bulk will come via the eurozone countries, so the UK's contribution is likely to be relatively small. But Ireland's troubles could hit us harder in other ways.



The UK banks who've lent around £143 billion money to Irish borrowers could suffer from rising bad debts. RBS alone has £53.3 billion of Irish loans on its books.



British exports to Europe, already falling, could further decline in light of Ireland's woes. Austerity measures in Ireland and the strain of a EU bailout on constituent country finances will almost certainly be bad news for British exporters.



Conclusion


While not a major surprise, Ireland's troubles are bad news and a reminder of just how big a mess global economies are still in. Stockmarkets continue to surprise with their ignorance of the dark cloud overhead, or maybe I'm just too pessimitic...

Read this article at http://www.candidmoney.com/articles/article172.aspx

Monday 15 November 2010

Do we need to change our wills?

Question
My husband and I made our wills in 1997. The contents and our wishes have remained the same except I wonder if there should be mention of the Nil Rate Band so that the allowance for the first spouse could pass on to the second. I wonder if we should 'equalise our estate' or if the NRB would pass on automatically?Answer
There should be no need to update your wills as any unused nil rate band on the death of the first spouse (or civil partner) is claimed on the death of the second - so in effect it passes on automatically.

In order to claim any unused nil rate band on the death of the second spouse the executors of the estate should:
  1. Calculate the percentage of unused nil rate band on the first death. Obviously, if everything is passed to the surviving spouse then 100% of the nil rate band will be available. Suppose the nil rate band on first death was £325,000 and £65,000 of this was used via gifts were made to other family members, then 80% of the nil rate band will be available to pass on to the surviving spouse.
  2. Collate documents relating to the death including copies of the will and grant of probate.
  3. Send these documents along with form IHT402 to HMRC to claim the unused nil rate band. The nil rate band available for transfer will be calculated as a percentage of the prevailing band at the time of second death, e.g. if the nil rate band was £400,000 on second then £320,000 (80%) could be transferred on our example.


However, I'd double check whether your wills contain instructions to use discretionary trusts that utilise your nil rate bands, as these were common before the rules changed (on 9 October 2007) as a means of utilising both nil rate bands. Unless you have specific needs (e.g. putting assets in trust that you think will grow faster than the nil rate band) then this part of the will is probably no longer required, in which case just make sure your wills are compatible with the new rules (whoever originally wrote them should be able to tell you very quickly).

Read this Q and A at http://www.candidmoney.com/questions/question322.aspx

Tuesday 9 November 2010

How can I invest safely?

Question
I have just sold my house and find myself in the unusual situation of having £400,000 and not quite sure where to put it. I have got as far as thinking of putting £50k in various bank accounts for the moment. I do have plans to buy a boat next year and a Buy to Let as soon as I find a good property, but this will take up around £220,000 and may not be spent for some months- so needs a safe home for the time being.

This of course leaves around £180,000 which I need to invest. I don't need £110,000 for around 8 years so can lock this up within reason-save in emergency- for that period, leaving a further £70k to invest. I am currently on a low income so would look forward to some sort of return but not risk the capital as I retire in the next year or so. I would appreciate your thoughts.
Answer
Spreading the money across various bank accounts within the £50,000 Financial Services Compensation Scheme (FSCS) limit was a sensible move. Just remember that the compensation applies per institution - and some own several banks - so could be worth double checking you're fully covered. Take a look at the list of institutions that own more than one bank on our savings page http://www.candidmoney.com/saving/default.aspx .
The compensation limit is also due to rise to €100,000 (around £84,000) from next year.

As for investing some of the money, if you want to avoid risking your capital (and I don't blame you in the current climate) then your options will be limited.

The obvious starting point is savings. At the time of writing you can get around 4.5% fixed (before tax) on a 5 year account, falling to 4.15% on a 3 year fixed rate account. I wouldn't be too hesitant to lock into a fixed rate as our ailing economy is a big disincentive for the Bank of England to raise interest rates, just check whether an account allows access to your money in an emergency (if relevant), as many don't.

And If you're a taxpayer then using your cash ISA allowance, £5,100 for the current tax year, will save you a bit of tax on interest paid.

If you want stockmarket exposure without the risk then a capital protected stockmarket bond might appeal. For example, the Santander Stockmarket Bond Issue 2 (150% option) returns 150% of FTSE 100 growth over 6 years, capped at 40%. So your maximum equivalent return is 5.78% a year. Is the potential extra return over cash worth the risk that you might get a lower return or even just the return of your initial investment? I'm not convinced, but it's a personal decision. Also bear in mind that these investments are only ever as safe as the bank offering the guarantees.

Similar plans with some risk unsurprisingly pay higher potential returns. For example, the Morgan Stanley FTSE Best Entry Growth Plan 7 offers double the growth of the FTSE 100 Index over 6 years and 2 weeks capped at 100%, a potential maximum equivalent return of 12.25% a year. However, if the index at maturity is lower than the start level by 50% or more your initial investment will be reduced by that percentage - i.e. there's a risk you could lose a lot of money. Any gains are taxed as capital gains which, under current tax rules means you can make up to £10,100 of gains before any tax is due. Although what the capital gains tax system in 6 years time will look like is anyone's guess.

Other than these you could consider corporate bond, commercial property and zero dividend preference shares, all of which should generally be less risky than stockmarket investment, in theory at least (note: the returns on zeros are linked to stockmarkets). However, you could still lose money so I'd be wary unless you're comfortable with this possibility if things don't turn out in your favour - and with markets as uncertain as they are at present I'd suggest being careful.

So sorry, no clever solution I'm afraid. But that's the harsh reality of investing at the moment. There's a lot of potential risk out there and while I'm sure some investment areas will end up doing well over the next few years, others won't. Given it's impossible to accurately predict winners and losers then unless you're prepared to risk your capital probably better to play safe.

Read this Q and A at http://www.candidmoney.com/questions/question320.aspx

Monday 8 November 2010

Do investment charges matter?

Investment fund charges are back in the papers following the launch of the 'low cost' Fundsmith Equity Fund. To what extent do they matter?.

I was quite bemused to see press coverage at the weekend heralding the new 'low cost' Fundsmith Equity Fund, which charges 1% a year (plus an estimated 0.15-0.25% extra annual costs).


It's an interesting idea, but the 1% annual charge is simply due to the fund not charging the usual 0.5% trail commission when bought direct. This is a welcome move but, given the majority of funds are sold via third parties, Fundsmith's profit margin is probably not much different to most other fund managers.


And investors can buy most actively managed funds for around 1% a year by using discount brokers who rebate all trail commission (see our ISA Discounts Action Plan for more details).


However, this seems an opportune time to re-visit investment charges and ask to what extent they matter?


There seem to be two distinct camps when it comes to investment fund charges. Those who obsess, generally buying the cheapest funds they can find, and those (often financial advisers) who argue that performance is far more important. Actually, I suppose there's also a third - those who don't care or bother to check how much they're paying (the majority I suspect!).


I agree that performance after charges is what really matters. But without the aid of a crystal ball it's impossible to be certain about the future performance of a fund, so charges should be an important consideration when choosing investments.


Why it's hard to pick consistent winners


Over the last year 41% of active fund managers in the UK All Companies sector beat the FTSE All Share Index, the proportion falls to around 37% over 5 years. This is more or less on par with what you'd expect, after charges, if managers picked stocks at random - so it looks like the majority aren't adding value. And only 1 fund (SVM UK Growth) out of 205 beat the index in each of those 5 years (see more stats on our trackers page).


The reason I mention these figures is that they highlight the difficulty of picking consistent winners - an expensive top performer in the past could end up being an expensive failure in the future.


What difference can charges make?


Invest £10,000 into a fund with a 3% initial and 1.6% annual charge for 20 years and it'll be worth £23,394 assuming 6% annual growth. Sounds fairly impressive. But charges reduced the return by a whopping £8,678, i.e. your fund would have grown to £32,072 without charges - you can try more scenarios using our Fund Charges Impact Calculator.


So yes, they can make a big difference, especially over longer periods of time. Of course future performance can too but, unlike charges, it's an unknown quantity.


How much should I pay?


You should be able to avoid paying initial charges on most funds these days by using a discount broker, although the norm seems to be 3-5% for actively managed funds.


If you invest in a tracker fund and pay more than 0.5% a year then you're probably paying too much. There are exceptions, some niche indices might be more expensive, but when mainstream tracker funds like Virgin UK Index Tracking charge 1% a year it's well over the odds.


Actively managed stockmarket funds should come in at around 1.5% a year while corporate bond funds should be nearer 1%, although you'll probably end up paying an additional 0.1-0.2% a year via extra charges, so look at the total expense ratio (TER) figure which includes these. If the TER is more than 0.2% above the fund's annual management charge then be wary (read more about TERs & fund charges on our unit trusts page).


As previously mentioned, using a low cost discount broker who rebates trail commission should cut these annual charges by up to 0.5%, so it's quite possible to own actively managed funds for around 1% a year. Incidentally, in the above example this would increase your return after 20 years from £23,394 to £26,533.


Oh, and watch out for performance fees of about one fifth of all returns (on top of usual charges) that seem to be the norm for absolute return funds - way too high but sadly little alternative if you want this type of fund.


Do I need advice?


This is an important question as using a discount broker usually means having to make your own decisions. And there's a worrying trend amongst financial advisers to try and charge a 1% annual fee for their services (which I think is high), of which around half typically comes via trail commission.


With a bit of common sense I think most people have as much chance of choosing winning funds as an adviser. Even those companies who spend a lot of money and time researching funds still get it wrong sometimes.


But where a good adviser can add value is by ensuring a sensible spread of investment with good tax planning. For inexperienced investors this is valuable and the benefits will likely outweigh modest charges, but if you know what you're doing I'd be tempted to use a discount broker and pocket the commissions yourself.


Active or passive funds?


This is an age old debate and in my view there's no definitive answer - they both have their place. Take a look at our trackers page for more on this debate.


Conclusion


Don't ignore charges. Your first concern should be picking a decent investment that complements your existing portfolio. But then ensure charges are reasonable and in areas where active managers often struggle to beat the index then consider a low cost tracker, if available. And if you're comfortable choosing tax efficient investments and monitoring them yourself then use a discount broker who rebates trail commission.

Read this article at http://www.candidmoney.com/articles/article171.aspx

Friday 5 November 2010

University to cost over £100k?

The Government has now set out its plans for reforming university fees and loans. It doesn't make happy reading for students to be..

The new plans will affect students starting higher education in 2012 and mean a university education could end up costing some students over £100,000 by the time their loans are eventually repaid.


Tuition fees


At the moment students must pay up to £3,290 towards tuition fees for the current academic year. From 2012 this will rise to £6,000 a year, with the possibility of some universities charging up to £9,000. So 3 years at university could cost between £18,000 and £27,000 in tuition fees alone.


Will many universities charge above £6,000? Too soon to tell, but logic suggests that if they can while still filling places then they will. To charge above £6,000 universities will have to show they give opportunities to a wide range of students, but this is unlikely to be a string deterrent.


Rather than pay for tuition fees upfront, students can roll these into a loan that's repaid when they start working.


Living costs


Students from families where total annual income is below £25,000 will get an annual £3,250 non-repayable grant, with partial grants being given where income is up to £42,000.


Students can also take a maintenance loan of up to £5,500 a year (depending on family income) to help towards living costs. Full details of these loans have yet to be published, but they'll be added to the student's overall loan.


Student loans


Interest is charged at a rate equal to inflation (measured by the Retail Price Index - RPI) from the day the money is lent, regardless of the student's income. Once a graduate earns above £21,000 a year extra interest will progressively be added, hitting a maximum of RPI plus 3% when they earn £41,000 or more.


Loan repayments are made at 9% of income over £21,000 a year, with any remaining balance written off after 30 years.


Students who wish to repay their loan more quickly could face a penalty for doing so, as the Government is contemplating an early redemption charge, possibly 5% of the extra amount repaid. You'd expect greedy banks to do something like this, but not the Government. It should be encouraging the repayment of debt rather than penalising graduates for doing so.


How much could a university education end up costing?


The decision to go to university will become increasingly debateable for many children, as it could end up costing them a fortune.


The projections below assume average inflation (RPI) of 3%, annual salary increases of 5% and an annual maintenance loan of £5,500 for 3 years:



































Graduation

Salary
£6,000 Tuition Fees£9,000 Tuition Fees
time to repaytotal costtime to repaytotal cost
£20,00030 years

(£102,229 written off)
£62,98030 years

(£158,232 written off)
£62,980
£25,00030 years

(£41,881 written off)
£92,78730 years

(£99,583 written off)
£92,787
£30,00027 years 4 mths£99,09330 years

(£32,217 written off)
£122,685
£35,00021 years 11 mths£78,89227 years£120,416
£40,00018 years 2 mths£67,78622 years 5 mths£100,089

With Government finances as stretched as they are, shifting higher education costs onto a more commercial footing is probably an unfortunate price that has to be paid. But it could leave future generations of graduates saddled with a lot of debt - and that's before they buy a home and/or start a family. I'm starting to feel very fortunate that my university education (which seems a distant memory now) was free...

Read this article at http://www.candidmoney.com/articles/article170.aspx

Searching for higher SIPP returns?

Question
I have money in a SIPP that I need to invest in funds rather than as it is now in cash earning zero (or minus 3% with inflation).

My target is 10% return pa.If I can get the monies earning that level I can draw some monies down without burning the capital.

What would you advise?

First in what asset classes and then more specifically in which funds?

My thinking is that whilst Far East and Emerging markets would seem to hold one of the only hopes for growth over the next 12/24 months are they not overcooked?Are not too many people expecting the same and therefore prices too high?

My own thinking on equities is that good companies will earn 5% on dividends but you can't be sure given current volatility that you won't lose the 5% or even more with market price falls.

So where to go?...,please?

Its a genuine question and I have a real need.Answer
You're certainly not alone in looking for better returns than cash, especially within a SIPP where cash returns are generally appalling at the moment.

The problem is, these are difficult, volatile times. The types of investment that could potentially return 10% a year could quite easily lose 10% or more a year too. So it's really a question of how much risk you're prepared to take and for how long.

I agree that the Far East and emerging markets appear to have more scope for growth than Western economies, but that's not to say their stockmarkets will definitely rise over the next couple of years. Some growth is will already be priced in and if global economies generally slow these stockmarkets could still lose money.

I also agree that good dividends are appealing but that the risk of falling markets could still leave you with losses overall.

Unless your timescale is 5-10 years or you're happy to take a lot of risk I'd be very wary of investing in stockmarkets. You might end up making some easy money over the next couple of years, but equally you could lose a lot too - regardless of which market you choose.

One way to try and reduce this risk is to use absolute return funds, which generally try to profit from both rising and falling share prices. Standard Life Global Absolute Return Strategies has had more success (so far) than most, but there's still risk. Success depends on the fund manager correctly guessing where markets are headed and history suggests that no manager gets it right all the time. So while absolute return funds should generally reduce risk versus conventional stockmarket funds, you could still end up losing money. Plus they're usually expensive. Take a look at this article I wrote back in the summer for more info.

Other assets such as commodities and commercial property have been doing well this year, but for how long is anyone's guess. I'm a fan of holding commodities longer term, but think the potential volatility makes them very high risk for a 1-2 year bet. Commercial property should be more steady, but could still suffer if the economy slows down again - and with spending cuts and tax rises there's every chance that could happen.

So I'm afraid there is no magical solution. If your timescale is just a couple of years I'd stick to cash and least sleep peacefully knowing you won't lose money in absolute terms. You could chance absolute return funds, but I'd really take a minimum 5 year bet on these. Otherwise a combination of high dividend stocks/funds along with Far East, emerging markets and commodities (both hard and soft - take a look at our commodities page for more info) exposure should bode well over 10 years, but that's not to say you won't make losses shorter term.

Good luck whatever you decide.

Read this Q and A at http://www.candidmoney.com/questions/question319.aspx

Thursday 4 November 2010

Will pumping more money into the US economy work?

Can the US finally wake up its economy by injecting another $1 trillion? Or is this more an act of desperation than calculation?.

The US Federal Reserve (which has a similar role to our Bank of England) has announced it will pump $600 billion into the ailing US economy over the next 8 months along with the $250-300 billion it expects to receive from repayments on debt and mortgage-backed securities it owns.


This move, called quantitative easing ('QE2' in this instance), is intended to get the US economy moving again. But it's a bit like pouring petrol onto a smouldering bonfire; while it'll stir up some flames quite quickly, there's a risk they'll die out rather than get the bonfire roaring again.


How bad are things in the US?


Unemployment is sticking at around 9.6% and economic growth remains slow, at an annual rate of 2% for the third quarter. The economy isn't collapsing, but it's not really going anywhere either and this is a big worry for the Fed.


The US housing market is also in crisis, estimates suggest 930,000 homes are currently being foreclosed (i.e. in the process of being repossessed).


How does the Fed pump money into the economy?


It prints money then uses this to buy government bonds, mostly from banks. It then hopes that the banks either invest this money, or lend it to customers who spend it, so that it finds its way into the economy.


Hasn't it already pumped lots of money into the US economy?


Yes. The Fed announced a $600 billion injection in November 2008 that increased to £1.8 trillion 4 months later when it became clear it wasn't enough.


Is the Fed throwing good money after bad?


Maybe. But while the initial quantitative easing hasn't got the US economy firing on all cylinders again, the present situation could be worse still had the injection not happened.


Trouble is, the US economy is in a rut and printing more money is really the Fed's only viable option to try and get things moving again. Cutting interest rates (which encourages spending by making borrowing cheaper) is not an option given US rates have been stuck at just 0.25% since December 2008.


What are the risks?


If banks and consumers decide to save most of the extra money rather than lend/spend it, then it will do little to stimulate the economy and the Fed's plan would fail.


And if the extra dollars are spent then prices could rise (e.g. if my economy has £100 and produces 100 widgets they'd be priced £1 each. If I double the money supply to £200 but still only produce 100 widget their price would likely rise to £2, equal to 100% inflation).


This would be bad as rising inflation is the last thing the Fed needs right now. Because high inflation is generally undesirable (it stifles investment) the Fed would normally raise interest rates to keep it at bay (i.e. discourage spending by increasing the cost of borrowing), but raising interest rates at the moment could be the straw that breaks the camel's back as it will discourage spending at a time when the economy needs it more than ever.


Printing extra money could also weaken US currency as there's more of it in circulation (in the same way the price of food usually falls when there's more available). A weaker dollar helps US exports as they'll be cheaper (although other countries may retaliate and devalue their currencies so the US doesn't gain a competitive advantage), but may be seen as a sign of weakness and reduce foreign investment in the US.


How will US quantitative easing affect stockmarkets and other investments?


In the very short term stockmarkets will jump for joy in the expectation that some of the money will ultimately be used to buy shares. And they'll also be hoping the money will increase spending and boost company profits. The price of US government bonds (Treasuries) will also probably rise in anticipation of the Fed's spending spree.


But whether the initial excitement lasts is another matter. This will really depend on whether the Fed's plan works.


A weaker dollar is bad news for UK investors with US investments, as it reduces the value when converted back into pounds. But a weak dollar could be good news for gold and other assets priced in dollars, as it reduces the price tag for foreign investors - although this would pile more upward pressure on inflation.


So, will it work?


I do hope so, but I have my doubts. While pumping $950-1,000 billion into the US economy will undoubtedly make some difference, I'm not sure the difference will be big enough. Evidence suggests both banks and customers are becoming increasingly cautious, so the majority of the money may not end up being spent - doing little to boost the economy. And if lots of the money is spent then inflation could rise, discouraging further spending/investment and potentially slowing the economy once more...

Read this article at http://www.candidmoney.com/articles/article169.aspx

Can mum give us her home to avoid inheritance tax?

Question
My sister and I are trying to ascertain how we can avoid paying a large inheritance tax. My father died 5 years ago leaving my mum with business property presently valued at £600,000.00 and a home presently valued at £400,000.00.

We realise that the nil rate tax band is £325,000.00 and we have 65% of my fathers nil rate band left to use.

We have calculated that in the event of my mum's death this will leave us with an inheritance tax bill of £200,000.00.

Mum would be happy to put her home into our names but I believe technically she should then pay us rent.

Is this a viable option? I know the total effect relies on her surviving 7 years but what rent would she have to pay and in reality how would this work please?

Any other ideas?Answer
The key here is whether the business property is exempt from inheritance tax.

Under current inheritance tax rules a business or an interest in a business is usually exempt from inheritance tax, provided the deceased owned it for at least the two years prior to their death.

However, there are exceptions. Businesses that invest in shares or land/property are excluded, as are those whose shares are listed on a stock exchange. Also, assets owned by the business that are not used wholly by the business may not qualify.

In simple terms, if the business is an investment company or rental property it won't qualify. But if it's a bona fide trading business, e.g. manufacturing, professional services etc. then it probably will. You can read more details on the HMRC website.

Given what's at stake I think it would be well worth speaking to an accountant to clarify the position if you think the business property might be exempt.

If the business property is exempt then your mother's inheritance tax nil rate band, coupled with the remaining balance of your father's, should cover her home.

Otherwise, the challenge is to move your mother's assets out of her estate where practical. Provided she lives for at least 7 years after gifting assets they will fall outside of her estate for inheritance tax purposes. However, if she continues to derive any benefit from them (e.g. she continues to live in the home she's gifted to you) then she must pay rent at the prevailing market rate (you should be able to get an appropriate figure from a local estate agent) else HMRC will not recognise the gift.

If she has surplus income or can sell some of the business assets then this could work in her favour, as paying rent will move more assets out of her estate. But it obviously may not be practical.

She could sell the business assets if they don't qualify for business property relief then gift some of the money to you and your sister, but selling may incur capital gains tax so again you'll need to consult an accountant. And if she relys on an income from the business then this will need to be replaced somehow.

If she ends up with a large sum of money in her estate and would like to try and remove some without having to live another 7 years then a discounted gift trust is an option - although as they can pay financial advisers hefty sales commissions she'll need to be wary of mis-selling (and HMRC could disregard it if your mother didn't expect to live for at least 7 years when taking out the trust). Take a look at this earlier answer to find out more.

Given the potential complexities of this situation I think your mother could benefit from professional advice - an accountant would be a starting point. Nevertheless, I hope my answer makes things a bit clearer and points you all the right direction.

Read this Q and A at http://www.candidmoney.com/questions/question317.aspx

Can I set up my own bank?

Question
Is it possible to get better returns for my money by opening my own bank compared to the traditional savings accounts?Answer
The concept of running your own retail bank is simple: lend to your customers at a higher rate than you pay on their savings then bolt-on as many extra fees as you can get away with. But in practice you'll probably need millions of pounds to set up the infrastructure and the ability to jump through lots of regulatory hoops if you're to launch a 'proper' bank.

There are other more accessible options though, which retain some of this concept.

You could lend out money to individuals, which should earn you a better rate of interest than you'll get on your savings via a bank. The drawback with this approach is if you lend to someone and they don't pay you back you'll lose your savings - potentially high risk.

Web based services such as Zopa try to match up lenders and borrowers and help reduce risk by spreading your money across lots of borrowers, reducing the impact of bad debts. It's still not without risk and the interest you receive is taxable, but it's an interesting idea that can work for some - read our full review for more info.

If you don't mind a lot more work then you could consider setting up a credit union. These are local co-operatives owned and run by their members, which focus on savings and loans. There are already a number of these dotted around the UK, providing services to an estimated three quarters of a million people. Launching one is no walk in the park, as you'll need to be regulated by the Financial Services Authority and it could take a year or more to set up. But if you know a group of like minded people in your local community it can work well. You can read more on the Association of British Credit Unions website.

Setting up a bank is a nice idea though. Let's face it, most of us could probably do a better job than those bank bosses who've pocketed millions over the last few years while running their businesses into the ground.

Read this Q and A at http://www.candidmoney.com/questions/question316.aspx

Wednesday 3 November 2010

Precious metal?

The price of silver has soared about 40% this year. Is precious metal a solid investment opportunity? Or are the price rises an unsustainable bubble that will burst?.

When it comes to investing in precious metals, gold is by far the most well known and popular (you can read my recent article re: gold here). But there are other precious metals open to investors - let's take a quick look along with the factors affecting price.


Silver


What is it?

A brilliant white soft metal that is largely mined in South America and China and is an excellent electrical conductor. It has always been viewed as a poor relation to gold, because it's far more plentiful in supply


Supply

Last year around 22,000 tonnes of silver was mined out of the ground, compared to just 2,500 tonnes of gold. Silver supply was further boosted by 5,160 tonnes of scrap silver being recycled.


Demand

In 2009 about 40% of the overall silver supply was used in industry, where its electrical conduction properties make it a popular raw material (e.g. in electrical components and batteries). The next biggest area of demand was jewellery, accounting for around 18% of supply, followed by investment at about 15%. Photographic use accounted for just over 9%, but is on the decline as the use of digital camera technology grows.


Price

At the time of writing silver is trading at just under $25 per oz, compared to $18 at the beginning of the year and $11 at the beginning of 2009. So why the meteoric rise? The simple answer seems to be soaring investment demand.


Industrial demand fell 20% last year and, while recovering, is still below 2008 levels (when the silver price averaged $15), so this clearly doesn't account for the bulk of the price rise. Neither does jewellery or photographic use, where the trend is downwards.


On the other hand investment demand (aided by a weaker US dollar = cheaper for non-US investors) has gone through the roof, rising from 1,500 tonnes in 2008 to over 4,200 in 2009 and reports (as well as the silver price) suggest it continues to rise.


Outlook

The trouble with investment demand is that its fickle. Whereas industrial demand tends to be reasonably steady, investment demand can sometimes vanish as quickly as it came. The driver behind the growth in investment demand seems to be safe haven investing due to uncertainty over the global economy, much like gold. So if the economic outlook deteriorates further perhaps the silver price will go higher still, but as and when the global outlook stabilises the price of silver could come crashing back down, although growth in industrial demand may soften the blow.


Investing short term is definitely a gamble and I'm not sure there's sufficient fundamental demand to support the price at these levels longer term. Supply is plentiful and gold tends to profit more from growing emerging markets jewellery demand than silver.


Platinum


What is it?

A grey-white metal that is one of the rarest elements on Earth and very resistant to corrosion and wear.


Supply

184 tonnes of platinum was mined in 2009, slightly lower than average and less than one tenth of the gold dug out of the ground. Three quarters of this came from South Africa, while recycled scrap platinum added 44 tonnes to overall supply.


Demand

In recent times the greatest demand for platinum had come from the auto industry, as it's used in the manufacture of catalytic converters. However, declining vehicle sales and a greater use of palladium has hurt platinum demand from this sector, falling from 129 tonnes in 2007 to 69 last year.


Meanwhile platinum jewellery demand has been growing, from 66 to 94 tonnes over the same period. And, while still low in absolute terms, investment demand has grown four-fold over the period, from 5 to 20 tonnes.


Price

The price, at the time of writing, is about $1,710 per oz. This compares to $1,500 at the beginning of this year and $900-£$1,000 in early 2008.


The rises appear to primarily be driven by rising jewellery demand (especially from China) and, to a lesser extent, investment - despite falling demand from car makers.


Outlook

While the investment effect has played its part in rising prices, the fundamentals for platinum look more solid than silver. Supply is very low and is typically a little less than demand. And auto industry demand should increase over time as car sales in emerging markets such as China and India grow (especially if catalytic converters become compulsory in these markets). However, expect greater demand to be partially offset by more and more recycling, as an increasing number of cars with catalytic converters are scrapped in the West.


Jewellery demand should also continue to grow, especially from emerging markets, provided global economic growth doesn't slow down too severely.


In many ways investing in platinum is a bet on emerging markets, hence it's one I like longer term. But I still fear speculative investors will cause some price volatility shorter term.


Palladium


What is it?

A silvery white metal that is similar to platinum, but lighter (i.e. less dense).


Supply

2009 mined supply was 221 tonnes, with Russia being the largest supplier followed by South Africa. Recycled scrap palladium added 45 tonnes to this figure. Mined supply fell by 17% between 2007 and 2009, partly due to falling prices (as less incentive to mine).


Demand

Like platinum, palladium is used in the manufacture of vehicle catalytic converters and, at 126 tonnes in 2009 (over half of all palladium demand), this is by far the biggest source of demand. Unlike platinum, auto industry demand only fell slightly during 2009 and appears to be increasing a little this year.


Other sources of demand are varied, but jewellery weighed in at 25 tonnes last year (17% down on 2008) while investment more than doubled to 19.5 tonnes in 2009 versus 2007. Nevertheless, there's still been an excess supply in recent years.


Price

At the time of writing the palladium price is about $640 per oz, versus $420 at the start of this year. It did reach over $500 in 2008 but fell back to just $185 at the start of 2009.


For a metal that has been in excess supply the last few years such price rises seem strange. Higher expected demand from the auto industry (as the industry recovers and substitutes palladium for platinum to save money) might account for some of the recent price rise, but much higher demand from investors this year looks like the main culprit.


Outlook

While long term auto industry growth bodes well for palladium, I worry that the recent investment-driven price rise will be unsustainable if/when those investors decide to put their money elsewhere. The difference between demand and supply is not as tight as platinum, in fact an excess supply of palladium has been the norm in recent years.


Speculative investors might continue to push up the price shorter term, but I'd hold off investing until the price falls back down to earth then maybe buy if growing demand from car makers appears sustainable longer term.


Quick summary


Precious metals can make a good long term investment (short term too if you're lucky!). But it's vital to understand what drives supply and demand for each metal then take a view on where this might head in future.


There seems little doubt that investment demand has driven up prices this year, possibly to unsustainable levels, so please think very carefully before jumping on the bandwagon. Yes, returns this year look very sexy and might continue if fears over global economies grow, but if investor demand softens there's quite a long way for prices to fall.


Sources: Silver data - The Silver Institute. Platinum & Palladium data - Johnson Matthey

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Tuesday 2 November 2010

Will I lose extra state pension?

Question
Can you please help. I have read about the proposed increased state pension at 65 . I am currently 57, 58 in January 2011. I was relying on my state pension at 65 to be £199.27 per week, as I paid high rates of tax and N.I. whilst working for 37 years. Will this still be the case or will it be reduced under the proposed new rules?Answer
I'm afraid it's too early to tell as at present there are no firm proposals, other than the Government vaguely saying it would like to introduce a flat £140 weekly state pension by 2015.

If plans for a flat state pension do go ahead I think there's a reasonable chance existing SERPs/S2P benefits that take the total state pension over £140 per week (or whatever it ends up being) will be preserved, if for no other reason than it would cause immense anger amongst those affected - of which the majority may well be potential Tory voters.

As soon as there is any concrete news I'll put an update on the site (although you can bet it'll be all over TV and the newspapers).

At least you'll just escape the planned increase in state pension retirement from 65 to 66. The age will gradually increase to 66 between December 2018 and April 2020, affecting men born after 5 December 1953 and women born after 5 April 1953 (the reason for the difference is that the retirement age for men and women will harmonised at 65 by November 2018).

Read this Q and A at http://www.candidmoney.com/questions/question315.aspx