Yellowtail Blog

I cannot get over the sheer number and complexity of the charges available under the AXA Estate Planning Bond that I wrote about recently. How can anything that is meant to be so simple end up as complicated as it is?

This is a financial product that has charging options A through to H (seven in all because option E is not available). The option offered to our client by her bank, Barclays, looked like this:-

Invest £200,000 and AXA will notionally inflate the investment value to £207,000 (how?), well this sounds good, clearly money for nothing. However, there is an establishment charge of 0.625% of the original investment each quarter over 5 years. Put like this it doesn’t sound much does it, and after all they’ve given an extra £7,000 to invest.

But hang on a minute, 0.625% each quarter, that’s 2.5% per year, or put another way £5,000 based on the original £200,000 investment. And then they take this for five years, which amounts to an establishment charge of, wait for it…£25,000. By now that £7,000 extra investment doesn’t sound quite so generous does it?

So, just to set up this bond AXA want to take a net £18,000 from which they’ll pay (in this particular case) Barclays £12,000. Nice work if you can get it. Add onto this the fund annual management charge of 0.5% per annum, that’s a further £1035 each year on the original £207,000 and then another quarterly administration charge of £17.50.

So having worked my way through this little lot, there’s only another six different combinations of charges to wade through. This is one product we’ll be staying well away from.

A client (a lady of over 80 years) recently sold a house and deposited rather a lot of money in her Barclays account. On her next visit to her branch she was approached by their financial adviser and she expressed concern about inheritance tax. He then explained how she could make a £200,000 gift into an insurance bond, thus reducing her estate by £200,000 whilst allowing her to retain the income. This sounded too good to be true, she was interested.

Following the meeting she received a large pack through the post with details of such a bond from AXA, the insurance company. Not understanding a thing the brochure was saying she finally called me for my opinion. I was scratching my head wondering how to immediately pass £200,000 out of the estate, give her access to the income, and be tax efficient from an inheritance tax position. Unable to come up with the answer I asked to see the documents.

OK, let’s cut to the chase here, it doesn’t work as described. The bond is a “Discounted Gift Scheme” and at her age if she were to make this £200,000 there would be a “discount” of slightly more than £72,000. In inheritance tax terms the saving would be nearly £30,000.

Leaving aside whether this would work or not I was struck by three things, the complexity of the charging structure, and the amount of commission that Barclays were going to take, and the effect of charges over the life of the investment.

Let’s deal with the commission first. Twelve Grand! So you walk into a branch, have a quick chat, perhaps followed by another quick chat, sign the paperwork and they sting you for £12,000! Is this simply daylight robbery? Compared to our charges it is.

Next, the charging structure. There are seven, yes seven different charging structures for this bond, none of which I could fully understand. It seemed to me however that our client would be faced with an “establishment charge of 0.625% of the original investment amount for each quarter over the first five years which amounts to a whopping 12.5% or one eighth of your investment wiped out in establishment charges, not to mention the ongoing annual management charges.

This doesn’t seem to be good inheritance tax planning to me, you’re either paying the government or you’re paying AXA and Barclays. With a bit of planning and some fee based advice we can achieve a better result at a fraction of the cost – result, less tax to pay and more money in the hands of the beneficiaries.

HIPS, the much maligned Home Information Packs will finally become a requirement for all residential properties marketed after 14th December. They were originally scheduled to be rolled out in full on 1st June 2007 but were initially restricted to properties with more than 3 bedrooms.

With increased talk of a property slowdown, and even some saying there will be a meltdown, is the government merely exacerbating the state of the property market, or does it have something else up its sleeve?

The threat that sellers may be reluctant to put their property on the market because of the costs of having a HIP may be playing into the government’s hands. After all, a slow down in supply of property would mean that the dwindling demand remains buoyed up, and prices would perhaps hover rather than crash.

Yes this is a cynical view but remember that we’re dealing with politicians. These are folk that would like very much to avoid an economic collapse on their watch. So much bad economic news around, such as Northern Rock and the loss of 25 million people’s personal details, means that the government wants to avoid any more PR disasters. A property crash would be the end for this government, roll out the HIPs they cry.

It all started last week when a fund manager type gave us brief presentation. He showed us an in-house “work in progress” giving the returns of various asset classes over a 30 year period. Alongside each asset class were two different average annual growth rates, which I thought odd so I asked him for an explanation. “Too complicated for me old chap” came the reply, “but one is the arithmetic mean and the other is the geometric mean”.

What are they? Well if you started with £100 and in year one it fell to £80, you would have suffered a 20% fall. If in year two it recovered up to the original £100 it would have grown by 25%. A fund manager might claim that minus 20% in year one followed by a plus 25% in year 2 means an overall gain of 5% approximately equivalent to 2.5% per year. This in simple terms is the arithmetic mean.

The geometric mean takes the same start and end figures but would conclude that to, start with £100 and end with £100 the average rate of return would be 0%. OK so this is a very simplistic exercise but it illustrates a point.

My concern is that the arithmetic mean figures for various investment indices show deliciously high average annual returns, perhaps enough to encourage inexperienced investors that it was a risk worth taking for such high average returns.

Eventually we received a copy of the “work in progress” which had been turned into a “sales aid”. Funnily enough the average rates of return for the various indices was only represented by their arithmetic mean – thus overstating the actual returns that might have been achieved by investors.

Fortunately for our clients, when we undertake our analysis we use the geometric mean.

I’ve just come back from an interesting morning with JP Morgan discussing behavioural finance, the science of behaviour in financial markets and decision making.

Consider the following scenarios: If you have £1,000 and are presented with 2 options, which one would you take? (You must take one). The first option means a loss of £500, no more and no less. The second option is that on the single toss of a coin you will either keep your £1,000 or you will lose the lot, which one will you take?

Most groups of people that I have encountered show that the majority of people take option one, preferring to keep a guaranteed £500 rather than possibly lose it all.

The second question is similar but instead you are starting with £2,000 and you can either a) voluntarily give up £500 or you can b) toss a coin to either keep your £2,000 or lose £1,000.  In my experience (and this is borne out through other studies and research) the majority of people will take the second option, even though the probability of a negative outcome is exactly the same as in the first scenario.

Interesting but it doesn’t exactly answer why supermarket trolleys appear to be getting larger. However, the following might. A recent study by a major UK supermarket asked shoppers the following question: “when did they know when to stop shopping?”

By far and away the most popular answer was not related to shopping lists or budgets, but was in fact simply that the shopping trolley had become full. The supermarket’s answer therefore was to increase the size of the trolley and hey presto, a significantly increased turnover. Are we equally irrational in our investing decisions as we are when out shopping?

Dennis Hall advises an agricultural researcher as part of a financial makeover in The Times.

SARAH COOK enjoys an attractive rural lifestyle. She lives in a £250,000 three-bedroom house in a Cambridgeshire village with her 11-year-old son and works in agricultural research. However, two financial concerns are encroaching on this idyll.

The main worry is that Sarah has no way of paying off all the capital on the interest-only part of her mortgage. “I don’t know whether I should increase my monthly payments or use some of my savings to reduce the deficit,” she says.

Read the rest of this article on The Times website.