Investment

1 July 2009

Reader Writes:
When my financial adviser prepares an illustration for me on my investments I find them virtually impossible to understand. How useful are they?

The basic description of the word illustration is to 'remove obscurity'. Hardly.

The FSA sought to reduce commission bias with products and create a fair and open illustration so you, the consumer, could directly compare what you were paying, and also so advisers who were being paid obscene commission would be under pressure to reduce that commission.

It has had a benefit in that commissions on many products have been slashed and the consumer is considerably better off. For example commission on a pension that was once £1000 is now near £100.

It has not been fully successful however, and whilst this is a complex column you should consider its contents carefully if you are considering a financial product, particularly if it's an investment bond or a structured product.

Firstly structured products: These are the arrangements you see highlighted in windows with 'x % growth over six years and 100% capital protection at maturity'. Or alternatively - 'y% income over the same period'. They are sold as simple risk efficient plans that offer you capital security and a positive return, and more often than not are described as not having 'any up front or explicit charges'. What a bucket of nonsense that is.

Their complex nature is such that the charges are hidden into the profit at outset so the profit is wielded off to the product provider before you see it. The commission for the adviser is also hidden in there. So you, as a consumer invest and believe you have had your advice for free. Not at all, and the complexity of these arrangements is such that you will never know how much you have actually been charged. A great way to be sure to avoid such an arrangement is to use an independent financial adviser who charges a fee, that way there is no bias to use a commission wielding product.

Next, the obscurity of investment bond illustrations, probably the most oversold investment since toxic assets became 'all the rage'. When advisers illustrate an investment they show growth at 4%, 6% and 8%, basically to highlight what will happen to your money if you had returned these levels and the impact of charges. Most of you don’t get to this point anyway because it all looks like a pile of spaghetti numbers, but continue to do so at your peril for it will cost you a fortune. For example a few pages in you will see that the cost of investing 'could bring the investment growth down from 6% to 3.4%' - quite a typical illustration on a bond - or 43% over five years as I prefer to put it.

The unscrupulous will know you won't make it to those pages but even if you do it's still misleading. The FSA recently made it clear to all providers that the correct growth rate assumptions must be used for funds and to use a lower growth rate assumption where the expectation of return may be lower. For example when building a portfolio of higher grade fixed interests (lower risk and lower potential return) is it really appropriate to illustrate at 4%, 6% and 8%?

I asked a number of providers recently to provide illustrations for me. Only Standard life illustrated correctly by using the appropriate growth rates for illustrative purposes for the correct funds. Because fixed interests potentially return less, they should be illustrated at a lower figure. Whereas Standard life illustrated a fixed interest fund at 2.25%, 4% and 5.75%, other providers illustrated at the full growth rate, an amazing 78% higher thereby making the whole illustration process a complete fiasco.

Whilst these providers are all under pressure to correct this, they haven’t done so. And so, the next time you are being 'sold' an investment such as the above, present the adviser with this illustration and sit back and enjoy.

If you have an investment query call Peter on 0845 230 9876, e-mail info@wwfp.net

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.