This article was published in the February issue of Master Investor Magazine
As one of the UK's best-loved Independent Financial Advisers (IFA), Alan Steel knows a thing or two about managing money. As you'd expect of a Scotsman, he's also famously outspoken and is not one to pull any punches. Our Editor, James Faulkner, caught up with him to talk pensions, ISAs and all things investment.
James Faulkner: As the owner-manager of a successful IFA firm, you have a finger on the financial pulse of the nation. Are Brits getting better or worse at managing their money?
Alan Steel: I started giving independent financial advice in January 1973, so I've seen a lot of change over the last 46 years – in terms of financial products, tax laws, levels and exemptions, inflation rates, interest rates, pension laws, regulatory regimes, economics, and asset investments. But one thing remains ever constant. The vast majority of adults in the UK continue to be confused when it comes to money matters, continue to make big financial mistakes, allow their emotions to get in the way, and far too few reach their later years in a state of comfortable financial independence.
I recall a survey around 1976 which established that only 4% of retirees reckoned they'd done the best they could in terms of planning for retirement. And only the other day another such survey came to the same conclusion. Only 1 in 25! Forty-two years later – no progress. Shocking.
JF: You rose to fame when you successfully identified the Equitable Life scandal. Since then, we've had George Osborne's "Pensions Freedom" reforms, which have led some to fall prey to some unscrupulous outfits that persuade them to transfer their pensions into some very questionable schemes. Are there any other disasters out there waiting to happen?
AS: This allowed them to mis-sell for years, with an obsession on creating new business at any cost. After we disclosed the truth in April 1997, the only parties to pay attention were Equitable Life and their lawyers. Having managed to shut us up with bully-boy threats, they continued to mis-sell for another three years, destroying the retirement plans of thousands, most of whom have not been recompensed by successive governments and regulators.
There's an old Latin warning – caveat emptor – which relates to buying financial products and which translates as "buyer beware". Sadly, right now there's never been a better time to pay heed to that advice.
“IT’S PLAIN TO SEE THAT TOO MANY ADVISERS SEE THE CHANCE TO POCKET EXTRA CHARGES FOR DOING NOTHING.”
A lot of column inches are taken up with "pension scammers" and "questionable investments" (like parking spaces in the Sahara, or apartments in far flung islands). But what's much worse is the fact that the bulk of the billions of pounds flowing out of cautiously managed final salary pension schemes have been directed by regulated advisers into funds run by legitimate long-established UK financial institutions, on the back of reports to the investors that often are misleading regarding risks on investment returns and longevity issues.
With ridiculous up-front charges and a continuing 1% annual charge to the advisers – on top of other management and admin fees – and the members possibly taking out income that is unstainable over the long haul, all it needs is for a couple of years of falling stock markets together with rising interest rates to decimate these defined benefit transfer values. When this happens I shudder to think of the compensation levels sought, and the impact it will have on the industry. It will be the worst financial scandal by far.
That aside, I'm also concerned that those investors rushing headlong into UK Index trackers because they're cheap will also find themselves cheated. Apart from the fact that the FTSE 100, or FTSE All Share has been a poor place to be these last 20 years, it's plain to see that too many advisers see the chance to pocket extra charges for doing nothing. For example, by sticking client money into "cheap trackers" then adding on platform costs of say 0.35% and a windfall for them-selves in the form of a 1% annual "management" fee on top. What's being managed exactly? I'd reckon the proverbial will eventually hit the fan. And it won't be nice.
“I SHUDDER TO THINK OF THE COMPENSATION LEVELS SOUGHT, AND THE IMPACT IT WILL HAVE ON THE INDUSTRY. IT WILL BE THE WORST FINANCIAL SCANDAL BY FAR.”
JF: Despite the downside of "Pensions Freedom", I presume you're in favour of the greater flexibility when it comes to pensions? Are there any particular characteristics of the new system that our readers might not be aware of and might be able to benefit from?
AS: We have always said – and still believe – that there should have been a guaranteed level of pension income required for every investor, before any balance of fund could go into "flexible drawdown". Then there would have been a protection against what's going on.
We are only in favour of flexible drawdown for those investors approaching retirement who either are experienced investors or who have substantial other savings (usually the same people). This whole area is so complex that those contemplating heading into Freedom, or Freedoom, as we prefer to call it, should sit down with advisers who really do understand what's what and who do care about their reputation.
It is not a binary choice. There are ways you can mix and match to protect against risks and minimise taxes. There are dangers in old type plans, not to mention little- known methods of minimising taxes at 75. Complex issues like these don't fit with much-publicised Freedoms.
JF: With the end of the tax year almost upon us, where should our priorities lie when topping up our ISAs and pensions? Obviously, a lot of this depends on someone's own individual circumstances, but are there any rules of thumb we can apply when prioritising our investments into the two big tax wrappers?
AS: In 1957 Professor C N Parkinson published The Parkinson Laws. In it he said that the UK tax system was designed to tax income when we're living and capital when we die. And, therefore, he reckoned the role of a tax planner was to show you how to reverse them – i.e. create only capital when you're alive and leave only income when you die. If you do, you won't pay tax! Magic.
However, if you think about it, HMRC would much prefer that you earn as much taxable income as possible in order that they can tax as much as possible at the top rate of income tax, with the hope that you also invest in assets (property/shares etc.) so as to be liable to inheritance tax (IHT) as well.
Despite the bad press, and attempts by successive chancellors of the exchequer supported by HMRC, pension plans make a great deal of sense in amassing wealth and avoiding tax. You get a mark-up in year one, thanks to HMRC, of up to almost 82%, the total is invested in a tax wrapper completely free of CGT, reinvested income avoids high rates of income tax, a quarter can be paid out tax free when you approach retirement years, and significant freedoms from IHT are available on death. What's not to like? Charges? They are no different than those applying to ISAs, investment and unit trusts etc.
ISAs of course don't attract tax relief, but they avoid CGT too, and are very useful in providing an income free of personal tax. Pension plans and ISAs make a great partnership for savers with patience wishing to create tax effective levels of income in their later years. Those lucky enough to have surplus funds available may wish also to benefit from the significant annual CGT tax exemptions using portfolios of shares, or mutual funds like investment/unit trusts.
As to which funds to use, that depends on what age you are and what risks you're prepared to take. Again, this is an area where it's best to work with professionals who have your best interests at heart, but I'd say the most underrated equity-type investments that help round out peaks and troughs of stock-market cycles are "equity income funds". A selection of the best performers over the last 10 to 20 years are likely to continue to excel.
JF: What are the biggest mistakes people make when planning for their financial future? And how can they avoid them?
AS: They listen too much to the doomsayers in the media. Bad news sells. And with the internet and 24-hour news vying for our attention, you can be assured that bad news has increased umpteen-fold.
Secondly there's the problem of a lack of perspective that's common. Plenty of time "to worry about that". I call it Broccoli and Chocolate. We all know brocolli's better for us but, hey, chocolate's much more fun. Plenty of time. Except thereisn't. The earlier you learn to defer instant gratification the better. Compound interest, said Albert Einstein, is the greatest discovery of mankind.
And the easiest way to understand why is to learn the Rule of 72. So you have surplus money in deposit, and your return is 0.5% after tax. Divide that into 72 and you get 144. That's 144 years to double your money, ignoring inflation. Aargghh!
“PENSION PLANS MAKE A GREAT DEAL OF SENSE IN AMASSING WEALTH AND AVOIDING TAX.”
Find out how to earn, say, 8% with no tax, and you're doubling your savings every nine years. Achieve that return inside a pension plan with additional tax relief mark-up and it's faster still. Be prepared to take risk over longer periods, adding in reinvested income, or backing small cap funds, and the doubling will happen faster still.
The hardest thing of all is not to get emotionally involved. Our brains were designed thousands of years ago to cope with the dangers of life then. We have a panic button which springs to life at perceived danger. When stock markets fall or recessions are predicted, we panic-sell. In our office we have a simple message on the wall in our client rooms. It says "Greed/Buy, Fear/Sell, Repeat Until Broke". For those who recognise these words, please go and find a trusted adviser to stand between you and your emotions.
JF: My generation are notoriously unprepared when it comes to catering for their retirement and general financial well-being. What needs to change in order to make millennials take better care of their finances?
AS: I've lost count of the number of times I've seen this said. Let me assure you that having been involved in independent financial advice since January 1973 and having advised thousands of folks from those my own age, to their mums and dads and grandparents, it's always been the same. Thanks to the lack of perspective, or Broccoli and Chocolate – call it human nature – the tendency is for us to say we want to retire at 50 or 55. But we wake up to the enormity of the goal too late, usually around our early 40s.
So the answer is simple. Go and sit down with an experienced and recommended IFA, who will help you set your financial goals, and show you how to achieve them, revisiting your plans every year, kicking ass along the way.
JF: But it's not just the millennials that are unprepared. According to PensionBee, the average pension pot in the UK is just £21,441. That's not going to go very far at all in retirement. Will auto-enrolment make a difference to Britain's pension crisis, or are many of us simply doomed to work longer and retire on worse terms than previous generations?
AS: Auto-enrolment has to make a difference, but it won't bridge the gap. Interestingly if £21,441 is the average private pension pot today with that generation having lived through the best 50 odd years in financial history, it's hard to imagine it can get worse for your generation.
There is a choice. Go on moaning about how bad things are, go on spending on stuff you could do without, go on preferring chocolate, and any money left just stick in deposit because you believe the Bah Humbugs. Or be determined to be different.
There are two distinct periods in your adult life: one where you are in production, creating income; and the second where you stop creating income from work and you're in consumption mode. The quality of your life in the latter part will depend entirely on the decisions you made in the first phase. Simple.
JF: At Alan Steel Asset Management (ASAM) you try to identify secular trends and then put your clients in funds where you believe the manager has an edge. Which trends do you think will shape the world in 2019 and beyond, and can you point our readers towards any funds that you believe might be worth a look?
AS: If I've learned anything over my 46 years as an IFA and the previous four or so spent failing in my attempt to be an actuary, it's that no matter what "problems" and "bearish predictions" are around, it's not a good idea to bet against the ability of the human race to find answers and create real progress. George Bernard Shaw said something similar.
We will always have cycles, business cycles, stock market cycles, interest rate cycles etc. But life will go on.
Despite Trump and Brexit, to name but two "worries", I have no doubt that those investors who embrace risk will be the ones in future who enjoy a fruitful retirement.
With the incredible rate of progress in tackling health issues as folks live longer, I'd say healthcare is a sector well worth following. Elsewhere, despite the China tariff worries, it seems to me that businesses selling goods and services to greater Asia will outperform. Meanwhile, for those with patience and prepared to disconnect their cerebral panic buttons, smaller company funds, both here and overseas, are oversold right now, yet over most rolling 10-year periods they outperform their bigger cousins. I'd back that sector to do well.
And finally, be aware that when we do have another recession/bear market, each one in history has been a time of opportunity, not a time to run to "safety" screaming. Next time will be no different, despite what the doomsayers say.
JF: Isn't one of the biggest problems with pensions (and ISAs?) that they're vulnerable to meddling from the government. Wouldn't a Corbyn government be likely to tax ISAs and slash pensions tax relief? In which case all bets are off?
AS: They said this before Blair came to power. And you couldn't have had a more incompetent government than those in the early 1970s when inflation got to 26% per annum, income taxes to 98%, Estate Duty rates to 75%. Savers were crushed by taxes and the government had to go cap in hand to the IMF. If we can survive that we can survive anything. There's no point in not taking advantage of current opportunities just in case somebody in future is a baddie.
“I HAVE NO DOUBT THAT THOSE INVESTORS WHO EMBRACE RISK WILL BE THE ONES IN FUTURE WHO ENJOY A FRUITFUL RETIREMENT.”
JF: As you say, too many people are distracted by the "noise" that's created by the mainstream media, which focuses almost exclusively on the risks and threats to your prosperity. Given that we're exposed to constant bombardment from social media and 24-hour news, how can investors chart a course over the long term without getting distracted by Brexit or Trump's trade war or whatever else is in store for us further down the line?
AS: Stop reading "shock horror" headlines in newspapers or websites that are only interested in catching your eye. Don't watch Bad News at Ten. And apply nullius in verba – take nobody's word for it! There are funds out there that don't settle for average but which spend enormous time and resource finding excellent global or smaller companies worth investing in. Businesses who thrive whatever the political landscape. Investment Trusts and some Unit Trust (OIEC) managers have been proven over time to succeed with this approach. I highly recommend their process and contrarian stance. It's lowtaxed Broccoli. And good for your wealth.