Transcript: Financial Planning in Uncertain Times

Published in Investing on 8 November 2010

David Kuo talks to Antony Williams from Evolve FP.

You can listen to or download this podcast here.

 

David:

This is Money Talk, the weekly investing podcast from the Motley Fool. I am David Kuo, and with global economies in a state of flux, there has never been a more confusing time for investors to know the best place to pop their cash. But I know a man who can help – he is financial planner Antony Williams from Evolve FP. Welcome back to the Motley Fool, Antony.

Antony:

Good afternoon, David.

David:

Good afternoon to you. Now, let's start with the very basics, which is – what exactly is financial planning?

Antony:

Well really, the starting point of any financial plan is for us to work with our clients, or indeed clients to work with themselves, to really work out what it is that they want out of life, because really financial planning is about using money as a tool or an enabler to help us achieve our lifetime goals. So the starting point is, know where you want to go, and that links in with, know where you are currently. So it's a case of knowing what assets you've got, knowing what income you have, knowing your tax position, and then knowing where you want to get to in the end.

So I suppose to describe that, what I really mean is: what does financial independence look like to you? Does it mean sitting on a beach in the south of France, or does it mean a little cottage in Cumbria? Or does it mean something much more lavish? So it's really about knowing exactly where you want to go, and then putting a price on it.

David:

So is a financial planner different to an independent financial advisor?

Antony:

Well, the independent financial advisor tag is really just a regulatory term. It's what the Financial Services Authority uses to describe a certain type of professional advisor who advises independently across a range of financial products across the whole market, whereas a financial planner is more about working with a client almost as a coach, as a financial guide, to help work out what's important about money ...

David:

A friend, in other words?

Antony:

Well, a trusted advisor, definitely – someone who you can go to and ask the really tough questions, and know that you're going to get a truthful and honest and totally unbiased answer. That isn't just around which pension or which ISA I should buy; it's also around, well actually, what's realistic for me? What can I achieve in terms of financial independence? How much money can I expect to have in retirement? Should I be retiring now, or carry on working? That's not a decision around which pension or which ISA – that's around life decisions, really.

David:

So somebody who's coming up to you now, and says, "Antony – give me a nice, truthful answer to this. I've seen my financial plans deviate way off course at the moment, because of what's been happening with the global economic turmoil. What am I going to do?"

Antony:

Well certainly, if someone truly has got a financial plan, so they know that they're off course, then that's a really good question to ask, and it will be a case of working out how to get it back on course. Our experience is that most people don't really have that clear plan. But let's assume that someone does have a clear plan about how much money they actually need when they come to the point where they want to stop working, or reduce work. Then it's really a case of saying, well, OK – are we deviating from that just because of a short-term blip in financial markets? What we've seen over the last couple of years, the credit crunch, is no different to other events that have happened in the past in reality. It's just there's a different reason, and the media makes a big song and dance about it.

David:

It's a three year blip, Antony!

Antony:

There will be more three year blips in five, ten, fifteen, 20, 30, 40 years' time – we don't know when it will be, but there will be more. These things will happen – this is just how capitalism works. So we have to accept that this is what will happen. So the question then is, is it something which is temporary, or is it something which is long term? Are we saying that capitalism is dead? – well, I'd argue that that's pretty unlikely, and certainly if it is, we won't be worrying about how much money we've got in our pension funds. So if we believe that capitalism is here to stay, then we have to take the view that we're going to trust capitalism over time to get things right. What that really means is, make sure that your long term saving and investment strategy – so how much money you're putting away each month or each year, and how you're investing it when you put it away – makes sense over the long term. When we're talking about long term, we're talking about at least one economic cycle, so at least 12, 14, 15 years – not three or four years.

David:

Does the economic cycle still exist? – because according to Gordon Brown, it never existed, did it?

Antony:

There is clearly an economic cycle, because we all go through periods of fear and over-exuberance. It's just how humankind works.

David:

So what should be at the top of people's agenda at the moment? – the top of their to do list, right now, today, after listening to this podcast?

Antony:

Know where you're going – that's really the key to everything. Just be absolutely clear on what financial independence looks like to you: how much money you need, when you need it, how long it's going to last for, and then start putting in place a strategy for that, and just don't get sidetracked by the gimmicks and the short-term ideas that people come up with.

David:

But do people know the answer?

Antony:

Most people don't, no. That's very true, because most people don't have the time or the inclination, or indeed sometimes the ability to work it out, and that's definitely where a good financial planner can come in to help out. The technique that we tend to use with people is that, once we've worked out what people are looking for in life, and then put a price tag on that, it's really a sort of discounted cash flow exercise to bring back to today's money how much they actually need to be putting aside, either in capital terms or in regular savings.

David:

But isn't one of the problems at the moment, Antony, and that is that they had a financial plan, they had a target in mind, but because it deviated so far off course at the moment, they're saying to you – should I be taking more risk with my investments at the moment, because there is absolutely no way that I'm going to get from where I am now to where I wanted to be?

Antony:

Well certainly there are occasions where it may be appropriate to look at taking more risk, but not because of a short-term blip. If it's a case of, my genuine appetite for risk has changed – I now feel more comfortable with investing in higher risk investments, because I've got more experience, I've maybe got more money, I've got more income, I've got more time on my hands – yes, it may be appropriate to do that, but not just for the sake of taking risk. At the end of the day, risk and return do broadly go hand-in-hand, and therefore if you take more risk, you probably will expect, over the long run, higher returns.

So it's really a case of pricing up what your goals and aspirations are, working out how much money you need and what return you need between now and then, and then seeing whether the level of risk that you need to take in order to generate the sort of returns that you need is going to feel comfortable to you. If it is, then that's fine. What you do need to think about though is, as your time horizon shortens and you get older, and you get closer to the point when you're going to need to use those assets to produce what is effectively, provide for your standard of living, then you really do need to think about taking less risk at that point and changing your asset allocation strategy to reflect the shorter time horizon.

David:

But the thing is, according to the rule of 72, you take 72 and divide it by the expected rate of return of your investment. So let's say somebody who was quite happy with a certain amount of risk, and they think, well, I take 72 and divide it by something that's going to return me 10% a year. In other words, the money should double every seven years. Now they're saying, I really haven't got seven years – I'm going to need something that's going to increase even faster. Would you go along with that? Would you say, yes – you actually need something that's going to return you 20% a year now, and not the 10% you expected?

Antony:

You might need it, but the chances of getting it are pretty slim. Even a return of 10% per annum in the current environment, I'd say, is bordering on the optimistic for a sensible, diversified long-term investment strategy. If you're willing to punt, go down to the casino – 20% per annum might be realistic.

David:

But can you see where I'm coming from?

Antony:

Absolutely.

David:

I'm just saying that some people have deviated so far off course that they're thinking, I'm panicking now. There is no way I'm going to achieve that target, say, of a million pounds that I wanted to retire on, because of what's happened over the last few years. What do you say to these people?

Antony:

You have to accept on occasions that you're going to need to do something different, and that might well be not saying it's 60, but you're going to retire at 62, or 63 or 64, and that's a much more prudent way to deal with it, and actually doesn't really require a major change to your investment strategy to get to the point where you can meet your lifetime goals. The fact is that there is no such thing as a free lunch, and if you take more risk, yes, you might get there, but there's a damn good chance that you're not going to get there. I would strongly advise against taking lots of extra risk just to try and fix a gap.

David:

Now, some people might say, Antony, why don't I just go with the latest fad? I mean, listening to somebody like Jim Rogers, he is saying – gold, I mean gold is going to actually hit $2,000 an ounce. So why don't I just go with the latest fad, like Jim Rogers, and go and put my money into gold, and then just try and reap that return that he's promising?

Antony:

I'm sure Jim Rogers is probably a pretty wealthy man in his own right, and no doubt can afford to sit on a tropical beach somewhere. But if he really knew that that was what was going to happen, he wouldn't be telling his customers that that's the case, he'd just be using his own money to do it, gearing it up, and he'd be on that beach somewhere enjoying himself with a piña colada. The reality is that nobody knows. However much of a guru he may or may not be in the gold market, nobody knows whether that's going to happen or not. Gold as a part of a portfolio might be an appropriate diversifier, thinking about the sort of Armageddon scenario, but certainly people shouldn't be putting large proportions of their wealth in it, and arguably, if you're already investing in the UK stock market, as an example, you've already got exposure to gold and indeed commodities generally. So I think it's difficult to see how anybody should be taking that sort of bigger bet. That is what it would be – it would be a bet, not really a sensible investment decision.

David:

So you're saying it's actually a punt, rather than an investment?

Antony:

That would certainly be my view, absolutely. Nobody knows what's going to happen to the gold price. If they did, they'd be drinking gallons of piña colada on a tropical beach somewhere.

David:

OK, so moving away from gold, some people might say – why don't I just go and chase the high returns that I'm expecting from India and China? I mean, these are two big growth economies at the moment, so why don't I just allocate a bit more of my equity portfolio towards these two countries. Would you go along with that also?

Antony:

I think there's a strong argument for a long-term investor who's got the time to suffer the ups and downs of those more risky markets to have an allocations towards emerging economies in a general sense. The long-term potential for these economies is positive – there's no question about that. Their cost of capital is higher than the developed Western world, and in return investors would expect to get a higher return. Now, that won't come without some pain along the way. There'll be some corrections and there'll be some mistakes, where people have got the price of assets and securities in those markets wrong, but in the long run you'd expect a higher return – there's pretty much no question about that. Certainly we would recommend, for any investor who has even a modest appetite for risk, to have part of their equity allocation in emerging markets generically.

David:

And would you also advocate that somebody who hasn't got any exposure to bonds whatsoever, to put some of their money, or take some of the money out of equities, and put it into bonds at the moment?

Antony:

It depends a little bit on where they are in their investment time horizon, but broadly speaking, if you're nearer to the point when you're going to need to use your assets, we would definitely recommend exposure to bonds. If you're an 18 year old saving £50 a month in an ISA that your dad set up for you ...

David:

Are you talking about my son?

Antony:

Maybe! – then probably you shouldn't have any bond exposure, because the time horizon is such that, who cares if it goes down? Actually, even if it does, well because you're saving regularly, you're going to be picking up some more cheap priced assets along the way. But broadly speaking, someone where they're getting to the point where the money really matters – yes, bond exposure is absolutely essential to dampen the risks that you take by investing in real assets such as equities.

David:

Even though somebody is saying that – well, some experts are saying that the bond bubble is actually very apparent at the moment?

Antony:

Well again, the guys who say that, if they're sitting on a beach drinking piña colada, clearly they've got their calls right – I don't know.

David:

You like this piña colada?

Antony:

I do! – maybe it could be another cocktail, I don't know, but I certainly quite like a piña colada on an odd occasion. But the fact is that these guys may or may not know which way the bond markets are going. There will be one person on one side saying, well actually, bonds are still underpriced – we're going to see a significant stock market correction, we're going to see Armageddon – you need to have your money in a safe haven; and vice-versa – there'll be others that are saying, no – that time's gone, we need to think about a different approach. Our view is, we don't know the future, and therefore we need to have portfolios that are constructed for all weathers, so that we're looking at both the good and the bad side. But when we're investing in bonds, and this is, I think, the key thing that I would urge people to think about, is that generally speaking, bonds shouldn't be used as a means of trying to generate extra returns. They should be a means of dampening the volatility that comes from your high return assets, your equities. So by investing in higher quality, shorter-dated bonds, you do away with some of the bubble characteristics that you might get with longer-dated, lower-quality bonds, and just focus on the high quality dampening characteristics in a portfolio. They're never going to shoot the lights out, but they're never going to really underperform. They're just going to do something pretty dull that's a bit like putting your money in the bank – not quite, but similar.

David:

But bonds have had a pretty good run for the last 20 years, haven't they? I mean, in a earlier podcast, I had John Anderson from Gartmore in here, and he was saying that the bond market has done him pretty well over the last 20 years. But surely something that's gone on for 20 years, you cannot advocate anyone to put any more money into it, can you?

Antony:

Well, if you bought a long-dated bond now, when the only real way for interest rates is up, then you're absolutely right. But when you're investing in short-dated bonds, interest rate changes don't make anything like the difference to bond prices that they do in the long-dated market, and inflation isn't such a problem either. Really what you're doing is, you're saying, I just need to have some of my money in a pot that is a safe haven, that I can use to top up my equity exposure when equities go down, and I can use to hold my crystallised gains when my equities do well. That's basically all we use the bond element of our portfolios for. It's not there in itself to generate returns.

David:

So even though somebody who has seen the stock market, for instance, rise over the last 12, 13 months, you're advocating that they take some of that money out from equities and put it into bonds, even though the two of us agree that the bond market is looking a bit frothy at the moment?

Antony:

If they were long dated bonds and lower quality, I would completely concur that that would be a not particularly sensible thing to do.

David:

And not to carry on riding the stock market rise?

Antony:

Well, that's exactly the point, David. You could choose to do that, but the danger is that all of those gains that you've got in your portfolio end up being blown away by a stock market correction, which we may or may not see. If the economy suddenly looks like it's going to go off the edge of another cliff, those equity prices are going to get hit pretty badly. If you haven't crystallised some of those gains, it's not real. The point is, until you crystallise your gains, it's not real money – it's pretend money, it's play money. It's only when you put it into something secure that you know you've got it. So absolutely, as equity prices go up and your portfolio becomes out of balance again, we need to get back to that original asset allocation target weighting, and crystallise some of the gains from those high return assets.

David:

Now, one of the reasons why people have been putting money into these long dated bonds, these long dated gilts, is because of the fear of deflation. They're saying that, well, I know the bonds aren't paying me an awful lot, but if we did get deflation, or inflation at zero percent, these long dated gilts that are only paying say two, two and a quarter percent, will look pretty good under those circumstances. So how should people be factoring inflation or deflation into their financial plans at the moment?

Antony:

Well certainly our view is, it's pretty unlikely that we're going to see deflation. It's not really in the global economy's interest for that to happen. We've already seen a significant amount of commitment from central banks to pump plenty of cash into the economy. So our view is that deflation is by no stretch of the imagination the biggest risk; inflation is a much bigger risk, particularly over the time horizons that we're talking about for our clients. Maybe there will be deflation over a small number of years, but over the next 20, 30, 40 years, which is the time horizon of most private investors, thinking about achieving and maintaining financial independence – no. I think the likelihood of deflation over that time horizon is extremely slim, and therefore certainly anybody investing in long dated bonds has got to be prepared for some real terms devaluation of their assets.

David:

They may be right, though?

Antony:

They might be right, absolutely – there's always that chance.

David:

We might go through the 20 years of the Japan experience, where they had 20 years of deflation in Japan.

Antony:

That may well be the case. Our view is that that's pretty unlikely, with the amount of capital that's being pumped into the economy.

David:

So put yourself in the position of a Japanese financial planner 20 years ago, in the 1980s. He would be telling his clients exactly the same thing as what you're telling me now – inflation is going to be the bigger problem, and yet, of course, 20 years later that same client would be saying, hey – you got me out of this, and now I'm actually back into deflation.

Antony:

We could be wrong. I think the key difference between the situation 20 years ago in Japan and the situation here is that we're talking about a global situation, rather than a country-specific situation. We're not just talking about the UK being in a difficult period in financial terms, it is the global economy. Now clearly there are differences between East and West, but broadly speaking, the whole of the global economy has had some difficulties over the last couple of years.

David:

Now, the UK economy is having problems also, and we've already seen evidence of George Osborne swinging his axe at child benefit and he's likely to swing his axe even more as he goes through the comprehensive spending review. How should people factor that into their financial plans?

Antony:

Well, having cash there to cover the unforeseen is certainly the first step. You can't put all of your money into long-term investments that you're going to get caned if you decide to take the money out. You need to make sure that you've got cash there to cover differences in spending patterns over a one, two, three year period. So that's the first thing that people should do.

The other thing they should do is be prudent about what they're spending their own money on. In some respects, the government wants us to go out there and start pumping money into the economy, and yes, at a country level that makes sense, but at an individual level, having prudent spending plans is really what's required. I think that certainly we're going to see more attempts to cut the welfare bill over the coming months and years ahead. As far as the country's concerned, that is the right thing to do, I'm sure, but it is going to feel painful along the way. As David has said, I think today, we all need to share in that pain to make Britain a stronger place. That is unfortunately the reality of the situation, but it is also the reality elsewhere in the world, in most of the developed economies. So it's definitely something we're all going to have to share in.

David:

So can I just have a couple of words of advice from you for people of different age groups? – somebody who is 20 years of age now, just either in university or about to leave university – how should he be planning his future for the time he wants to retire at the age of 50, so another 30 years on for a 20 year old?

Antony:

Well, it's never too early to have those goals, and never too early to have a plan, and certainly never too early to start saving. So I think the first thing is, however small that saving strategy is, even if it's £25 a month, £50 a month – whatever someone can afford, that will make a massive difference in the long run. Having that return being compounded over decades will make life a lot easier in the long run, so that's definitely one thing I'd say for the younger person. The other thing that I'd say is, do that, but keep it really simple. Don't spend too much time trying to be the next Gordon Gekko ...

David:

Or Warren Buffett?

Antony:

... or Warren Buffett, exactly. Just go out there and make it really simple, and keep on track really.

David:

So what about a 40 year old? – somebody who's moving on in his years, 40 years of age. What should he be looking forward to, for the time when he wants to retire?

Antony:

Well, the 40 year old now, he would need to really start thinking about things a bit more carefully, because, assuming they've already had some sort of savings/investment strategy for the previous 20 years, they're going to now be at a point where they have a reasonable amount of capital. It might not seem that much at that point, but it really does make a difference then to make the right decisions. So it's the time to start thinking about the risk profile of your portfolio. If you have been investing in very risky assets previously, it's probably the time to start thinking about just ratcheting down those levels of risk a little bit, if you're thinking about using those assets in 10, 15, 20 years' time. So really that's the key there, and even more so – because the time horizon is shorter, any projections around the amount of assets that you're going to need when you're 55, 60, 65 are actually going to become more accurate then, because the time horizon is shorter. So it's even more important to price accurately your goals and objectives.

David:

And the 60 year old? – if a 60 year old knocked on your door, Antony, and said, "What am I going to do?"

Antony:

Really, not too dissimilar in some respects to the 40 year old, because the time horizon is still potentially relatively long – 20, 25 years.

David:

But if we believe what the government is saying, Antony, that 60 year old will never retire, will he?

Antony:

I think the concept of retirement has changed, and is continuing to change. In the past, the vast majority of people would work for a large institution, and the idea of retirement was basically your boss saying, "You're going now – it's 65, there is no more work." That doesn't happen these days, much more regularly in that retirement is more of a process or a phase, rather than a point in time. So it'll be a case of, well, at 60, 65, your dependence on your assets is likely to be gradually increasing for many people; for some people, immediately increasing when your boss does say, now's the time to go. But it's going to be gradually increasing, and so as the dependence on those assets increases, so will the need to think about derisking the strategy that you're taking, so that you can be more confident that the money will be there when you need it.

There comes a time also to think about whether actually to annuitise part of your asset pool. There's a lot of bad press around annuities and I can understand that, but actually, for some people, it is the right thing to do, particularly if you're a lower risk, more cautious, more nervous investor.

David:

But you need a fairly hefty pot these days. I mean, I was reading a report today that said that there are some parts of the UK where you would probably need an annual income of £36 or £35,000 a year to retire in?

Antony:

Absolutely. I'm not sure you need that amount of money – it's a question of choice, isn't it? But certainly, to have a good standard of living, that doesn't sound particularly unreasonable.

David:

On my back of an envelope calculation, it says that, in order to generate an income of £35,000, you would need a pot of about £700,000?

Antony:

I think it's probably a bit more than that actually. But you're absolutely right – that's a lot of money, but that's why saving £25 or £50 when you're 20 is going to make the difference. I think that's what people don't understand. £700,000 is a lot of capital – nobody's going to give you that lightly. It's going to be earned and it's got to be worked for over time.

David:

OK, and can we end on a positive note, Antony, and that is, your outlook for the UK economy in 2011, 2010 – 2011?

Antony:

Oh, it's going to be a tough period with the spending cuts.

David:

I said, end on a positive note, Antony!

Antony:

Unfortunately, I don't think I can. But I do think it's going to put us in a very strong position going forward, and I personally have a lot of faith in Britain, and the people of our country, and I really do think that we won't necessarily be the strongest economy or the strongest nation in the world, but we'll have a pretty positive place in it.

David:

Let's go out one further year – 2012 – are we going to win any gold medals at the Olympics?

Antony:

Oh, I'm sure we'll win some, but they'll all be ones that are sitting down sports, or involve shooting things.

David:

OK, well I'm glad we ended on a positive note, so thank you very much for coming in today – it's been an absolute delight. You're always welcome to come back here, because as you know, you were quite well liked; in fact, quite well respected by the Motley Fool audience.

Antony:

Well, thank you very much, David, and thanks for inviting me in.

David:

You're welcome. Now, it only remains for me to end today's podcast with a quote. Today's quote comes from – you'll like this one, I think you will like this one – it comes from a man called Laurence J Peter, who is best known for the Peter Principle. He says: "If you don't know where you are going, you will probably end up somewhere else."

Antony:

It sounds like a pretty good quote to me.

David:

Now, this has been Money Talk, I have been David Kuo, and my guest has been Antony Williams of Evolve FP. If you have a comment about today's show, you can post it on the Money Talk blog, which you can find at fool.co.uk/podcast, and if you have a suggestion for future shows, please email me at moneytalk@fool.co.uk. Until next week, pleasant planning!

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Comments

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TomJefs 08 Nov 2010 , 8:30pm

Thoughtful guy.

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