self emplyed pensions options?

dunstonh

Since we're on the subject of risk, I wonder whether Moneysavers might like some help on which products are risky and which aren't - and perhaps also in due course on ways to manage and reduce risk?

Risk assessment is really an advice area. In fact, in reality, its probably the one of the most important advice areas. Plus who says people want to reduce risk?

sneekymum

Too right Dunstonh - if people want to know generally about risk in investment the best bet is to recommend some books they could read about it.

If they want to know specifically then this is not the place...

oceanblue_3

I agree with dunstonh - this is one of the most challenging aspects of financial planning. To refer to it as "investment risk" is not precise enough; if we're going to attempt to educate via this site, then let's be precise: what we really mean is "investment volatility at the wrong time".
The question is this: how do we avoid "investment volatility at the wrong time"?

EdInvestor

DH

dunstonh wrote:

Risk assessment is really an advice area. Plus who says people want to reduce risk?

I guess you can be forgiven for not knowing people want to reduce risk.I mean most risk-averse people I know wouldn't dream of going anywhere near an IFA, and if one came anywhere near them, would probably run like hell in the opposite direction

I'm not talking about the advice area: advisers assess the consumer's risk profile, whereas I'm talking about the consumer assessing the risk profile of an investment.

I mean if you walk into a car showroom or an estate agent with chequebook in hand wanting to spend your hard earned, you don't expect the salesman to sit you down and find out if you're a suitable person to buy a car or a house, do you?

They would only do that if you needed to borrow money - a mortgage to buy the house, for instance.

What I mean is the current "advice" process is not,I think, really very helpful in enabling consumers to invest successfully and that's part of the reason we have all these misselling scandals.

Any thoughts on how to change and improve this situation should be welcome IMHO. Otherwise the entire country is going to end up with savings accounts and houses, that's it.

I doubt this will really work long term, what do you think?

oceanblue_3

[I guess you can be forgiven for not knowing people want to reduce risk.I mean most risk-averse people I know wouldn't dream of going anywhere near an IFA, and if one came anywhere near them, would probably run like hell in the opposite direction /QUOTE]

Editor, I'm glad you've decided to grace this topic with your typically trenchant and maturely considered comments. I should imagine the greater risk is that somebody might even be influenced by what you say.

As dunstonh intimated, the risk of volatility inherent in all asset classes can be a useful friend - as long as it doesn't affect your portfolio at the wrong time.

If the equity markets have taught us anything over the last five years, it is this:

1) get your timing right

2) diversify

1) Bearing in mind that you won't know if you've got your timing right until it's too late, all you can seek to achieve is a mitigation of its potential damage.
With a long-term savings product like a pension plan, the monthly contribution approach applied by most of us is a useful defence against market volatility because it gives us multiple puchasing opportunities - this creates an effect usually referred to as "pound-cost averaging".

This is a simple concept, and not everybody agrees with it, but it is worth taking on board, if only because it has an interesting theoretical underpinning:
if you buy £5,000 of investment units on January 1st, you may be getting those units cheaply or you may be getting them expensively, depending on whether the price of the units is higher or lower on February 1st.

If, on the other hand, you buy £500 of units every month for 10 months, regardless of what happens to the unit price in that period, you will automatically average out your cost of acquisition. Some units will be bought too expensively, others very cheaply, but because your monthly allocation is based on an amount spent (£500), and not on a number of units, you will always be buying more of them when they are cheap.

However, critics of pound-cost averaging argue that if you have a lump sum to invest, it is better to invest it all at once rather than piecemeal over several years. The reason is that markets tend to rise over time, so it makes no sense to leave money out of the market.

Nevertheless, pound-cost averaging is a way of avoiding both specific risk and market risk, and it is best suited to those who do not have a lump sum but do have regular savings which they can drip feed into the market.

Clearly, applying this approach does not guarantee a gain, but it does help to mitigate the potential impact of market volatility.

Getting your timing right as you approach retirement is equally important. If you have a pension plan, and you choose to "vest" your benefits at a predetermined date (your 65th birthday), then the preceding 5 years should see a gradual switching of your existing fund and, possibly, continuing contributions, to less volatile areas: cash funds and gilt funds, for example.

2) Diversification across the 4 main asset classes (cash, gilts/corporate bonds, equities, and commercial property) is also likely to reduce the impact of market volatility since the individual characteristics of these asset classes lead to their returns not being correlated to each other: if your portfolio consists only of equity funds then, broadly speaking, their returns will mirror the ebb and flow of the equity market.

If, on the other hand, your portfolio consists only of equity funds and gilt/high grade corporate bond funds, whose returns tend not to be correlated, their diverging returns will simply cancel each other out.

The introduction of a commercial property fund as an additional asset class is very useful as it brings a degree of "non-correlation" to the portfolio - we all know what has happened to equity markets over the last 10 years, but a brief glance at the trustnet website will demonstrate what property pension funds, for example, have done during the same period: there is no correlation to equity markets.

Simple, really:

be aware of the dangers and opportunities posed by investment volatility,

understand how the main asset classes interact,

choose an investment vehicle that has a very broad choice of funds.

EdInvestor

Very good OB, this kind of discussion can be very helpful A couple of comments;

1.On market timing, obviously the idea is to buy low and sell high - but as we know many people do it the other way round: it's the herd instinct Pound cost averaging might help a bit, but is an expensive way to do it, and I certainly wouldn't do it if I had a lump sum.

Getting your timing right as you approach retirement is equally important. If you have a pension plan, and you choose to "vest" your benefits at a predetermined date (your 65th birthday), then the preceding 5 years should see a gradual switching of your existing fund and, possibly, continuing contributions, to less volatile areas: cash funds and gilt funds, for example.

This "lifestyling" idea as they call it looks good in theory. But, what if you were due to retire in 2007. If you followed this plan, you would lock in your retirement fund right at the bottom of the market crash and wouldn't benefit from any of the growth since it began to recover. IMHO much more flexinility is needed - and people need to start paying attention to their retirement financing arrangments at least 5 and maybe 10 years in advance of the date to be sure they get it right.

2.On asset diversification, I quite agree.

But I have one question.Do we really need bonds/gilts? I ask because the markets are hard to understand and more risky than they look (IMHO) - whereas the returns compared with cash don't seem to be worth it.

Is a combination of cash,equities and commercial property enough? What about residential property ( ie BTL)? Where does that fit in?

oceanblue_3

Editor says "2.On asset diversification, I quite agree.

But I have one question.Do we really need bonds/gilts? I ask because the markets are hard to understand and more risky than they look (IMHO) - whereas the returns compared with cash don't seem to be worth it.

Is a combination of cash,equities and commercial property enough? What about residential property ( ie BTL)? Where does that fit in?"

Perhaps this is where the need for advice becomes more apparent: just because the markets are hard to understand, it doesn't mean they are impossible to understand. Again, studying the Trustnet website should help develop familiarity with the interaction between the varying grades of issued debt, from gilts to investment grade corporate bonds to sub-investment grade corporate bonds.
I disagree with your comment about debt versus cash: some of the most enduringly successful funds have provided returns that make cash look rather too pedestrian.
As far as BTL in a SIPP is concerned (just to take that specific example for the time being), it depends on finding a company that will want to provide that facility at a worthwhile cost to the investor.
Furthermore, if BTL assets account for a substantial part of an investor's portfolio, then the diversification we are seeking to achieve may not be attained. Potentially, this will elevate the risk of "investment volatility at the wrong time", not least beacause of the vagaries of the property market.
I'm not saying it's wrong, it's just that BTL investment appears, to the inexperienced eye, to be very straightforward.........we are all familiar with houses, and we all know how the residential property market has behaved over the last few years. I would contend that a good deal of energy and tenacity are required to make BTL a worthwhile activity.

sneekymum

Editor wrote:

But I have one question.Do we really need bonds/gilts? I ask because the markets are hard to understand and more risky than they look (IMHO) - whereas the returns compared with cash don't seem to be worth it.

I like Cash - Equity Funds - Commercial Property Funds - and National Savings Certificates.

But I'm talking savings not pensions...

ReportInvestor

Good to see that diversification .

You're actually talking investments, not just cash savings - picking up ob's point about precise terminology in our agreed goal of public pensions' education.

A pension is a long term investment, albeit with a particular goal, within a pension wrapper .

One widespread problem that financial education needs to tackle is that many people don't think of their personal pension / stakeholder / FSAVC as an investment, never mind their most important investment. It usually is.

EdInvestor

Hi SM

sneekymum wrote:

I like Cash - Equity Funds - Commercial Property Funds - and National Savings Certificates. But I'm talking savings not pensions...

That's a good asset mix IMHO - cash, equities, commercial property (I think national savings is like cash?)

Asset allocation for savings is the same as it is for pensions.