Money: Don't be afraid of the euro

Edmund Tirbutt looks at the likely consequences for financial planning

IT IS usually a waste of time to worry about an unknown future. But when it comes to financial planning it can be positively foolish, resulting in selling assets at the wrong time and paying unnecessary charges.

The launch of the euro across most of Europe on 1 January next year will have a massive effect on everyone in the UK whenever we travel abroad (see box for the most obvious changes). But no one knows what the big picture will be. Experts are divided about the long-term effects of the single currency. Opinions span the spectrum: some predict a period of unprecedented stability and prosperity, while others fear that there will be economic chaos.

Private investors should try not to lose too much sleep over the possible personal finance implications of the UK either joining, or refusing to join, the single European currency. Even if we do elect to join, we won't be going in until at least 2002.

Anyone who sticks to the rule that they are investing for the long term, and adopts a broad spread of risk, should find themselves able to make their financial plans flexible enough to cope with most eventualities. Fiona Price, senior partner at Fiona Price & Partners, a London independent financial adviser, says: "It's very difficult and possibly hazardous to make plans on the basis of one economic position. The idea is to build up a portfolio of different savings and investments that offer different advantages with regard to tax, possible economic change and alterations to your own circumstances."

Those who have held well-diversified portfolios for the long term have survived the effects of major economic upheavals. Most who bought shares just before the 1987 stock market crash, for example, will not be too far short of doubling their money by now.

An even more relevant example was when Britain switched from a system of fixed exchange rates to floating exchange rates in 1972. Roderic Mather, director of BWD Rensburg, stockbrokers, says: "In many ways one could argue that the move involved as much potential trauma as the idea of joining or abstaining from a single currency.

"It produced a fair amount of volatility in the UK stock market around the time, but the market eventually took the entire episode in its stride. There was less in the way of global investment in those days, but portfolios diversified between different asset classes were not too badly affected."

Most predictions as to how the British or continental European economies will perform following the launch of the single currency are little more than guesswork. There is much to be said for not making any asset allocation changes at this stage. You should have an annual financial review with a professional adviser so changes can be made when more information becomes available.

The possible exceptions to this rule are aspects of financial planning that are highly sensitive to future interest-rate levels. This will include fixed-rate mortgages, gilts and other fixed-interest investments, and retirement annuities.

The only assumption that it seems reasonable to make about the entire single currency episode is that it should result in a sustained period of lower interest rates. The consensus is that UK base rates will average around 4 per cent if we join and around 5 or 6 per cent even if we don't.

Many financial planning experts are advising against taking out fixed- rate mortgages for periods of longer than three years as this could mean becoming locked into unattractively high rates.

Some, however, point out that fixed rates reflect money market expectations that rates will fall, and argue that five-year deals at around 6 per cent represent good value considering they are 2.5 percentage points below many variable rates.

They stress also that fixed-rate mortgages remain valuable as they allow you to plan your outgoings with certainty.

Retirement planning is another area to be considered. Lower interest rates mean lower gilt yields, leading in turn to lower annuity rates as conventional annuity providers cover their commitments primarily by investing in gilts.

At first glance this sounds like bad news for those nearing retirement who have personal pension plans or who are members of a company scheme that operates on a similar "money purchase" basis. They have to use the pot of money they have built up over the years to buy an annuity - a regular income for the rest of their lives. The level of this income is determined partly by annuity rates at the time of purchase.

But this is also partly influenced by the size of the pot of money available to buy the annuity. This should rise in value to offset the effects of falling annuity rates. This is because rising gilt prices, which go hand in hand with falling gilt yields, have traditionally been accompanied by rising equity prices. Furthermore, equities have always tended to outperform gilts in the long term. Billy Burrows, managing director of William Burrows Annuities, says: "Those who have been hoping annuity rates will rise should not defer taking their pensions any longer, but at the same time people shouldn't be looking to bring forward retirement dates.

"Rising fund values should counteract falling annuity rates and there's no point in having to pay tax on your pension when you can leave it to roll up tax-free."

It is possible, of course, that fund values and annuity rates could fall together, so there is much to be said for not having all one's eggs in the same basket. Anyone coming up to retirement should consider other, more flexible, forms of pension arrangement such as phased retirement and income drawdown. Both of these schemes allow you to leave the pension fund relatively untouched, so you are not forced to buy an annuity at a time when rates are poor.

It is, of course, possible that lower interest rates will never materialise: events do not always follow the scripts written by the experts. If interest rates do soar unexpectedly, those who have just started taking their pension may find they do not lose out quite as heavily as they feared.

That is because annuity rates have declined steadily throughout the 1990s. The hope that they may return to the attractive levels of the late 1980s is becoming increasingly forlorn.

Insurance companies have been adjusting their mortality tables to allow for the fact that people are living longer. And a number of insurers now offer impaired life annuities providing attractive annuity rates to those with a shorter-than-average life expectancy.

This "cherry picking" of some annuity customers (who traditionally subsidised those who lived for many years in retirement) has stopped the standard annuity providers from offering generally attractive terms.

You can't avoid the euro ...

q From next year you will be able to pay in euros when you go on holiday in Europe. There won't be any euro money - you'll use your credit card (Mastercard and Visa) and debit cards (carrying the Maestro and Cirrus symbols).

q Until 2002 you will still be able to pay in local currency instead of euros. After 1 July 2002 there won't be any local money: each national version of the euro will be slightly different and will carry the international symbol on one side and a local design on the other.

q Citibank and Cater Allen are planning to have bank accounts run in euros ready for 1 January 1999. Other banks are expected to follow. The accounts are aimed at UK residents who are European nationals or UK citizens who are frequent travellers in Europe.

q Thomas Cook is planning to issue euro travellers' cheques from early next year.

q The countries signed up to join the euro at launch are: France, Germany, the Netherlands, Spain, Austria, Belgium, Finland, Ireland, Italy, Luxembourg and Portugal. Holding back for the moment are the United Kingdom, Denmark, Sweden and Greece.