Secrets of Success: Pick well and with-profits can still work

For those of you with the stomach for getting into detailed statistical study of investment returns, there are some interesting figures to be extracted from the latest annual survey of with-profits endowment policies by the trade magazine
Money Management.

For those of you with the stomach for getting into detailed statistical study of investment returns, there are some interesting figures to be extracted from the latest annual survey of with-profits endowment policies by the trade magazine Money Management. They remind us about what is good and what is bad about the whole with-profits concept.

If you go solely by the headlines in the press, you will surely believe that with-profits as a concept is dead. Bonus rates and realised values for with-profits policies have been falling for years. Each year seems to bring fresh announcements of cuts. Worse still, some providers continue to levy a surrender penalty - euphemistically called a market value adjustment - if you try to take your money out before your policy has matured. Since the Equitable scandal broke five years ago, sales of with-profits policies have plummeted. Few financial advisers have the nerve to recommend them any more.

But in practice, however, the real picture about with-profits is not quite as simple as the headlines would have you believe. Millions of investors do still have their money tied up in with-profits policies that they rightly feel unable to abandon, if only because they also recognise there is no guarantee they would do any better by switching.

And while it is true that the whole concept of with-profits has taken a critical lambasting and has now in many respects become outdated, the performance record is not as uniformly bad as popular opinion would have you believe.

Take the level of returns recorded on maturing with-profits endowments as an example. The sums realised on these policies have certainly been falling. The average 10-year with-profits endowment policy maturing in February 2005, for example, produced a pitiful annual average rate of return of 2.7 per cent, just 0.1 per cent above the rate of inflation over the same period. Until five years ago, by comparison, the annual yield on 10-year with-profits policies was consistently between 9 and 10 per cent a year. The comparable figures for the average 25-year endowment - the kind most people use to support their mortgages - are nothing like as bad. But they too have fallen from a realised annual return of 12.4 per cent on policies maturing 10 years ago to 9.1 per cent for those maturing in February this year, a decline of around 25 per cent in five years.

However, there are two important caveats. One is that these are nominal, not absolute returns. If you take inflation into account, the picture changes. As the second chart shows, the downward trend is much steeper for 10-year endowments, but much less marked for the longer 25-year policies. While the average 10-year policy's realised yield has fallen from five per cent to zero, the comparable figure for 25-year policies is actually higher (at 4.5 per cent a year) than it was 10 years ago.

The second thing to emphasise is that the average figures conceal an extraordinarily wide range of performance by individual providers. The second chart shows the best and worst inflation-adjusted returns achieved in both the 10-year and 25-year endowment sectors. You can see that the best providers have paid out consistently good returns of more than six per cent a year in real terms, while the worst have been terrible, especially for shorter term policies.

The figures provide ammunition for both critics and supporters of the with-profits concept. The performance of many with-profits policies has been bad, something that can be attributed both to their relatively high costs and the indifferent investment performance of many life companies. In reality the with-profits concept, with its aim of smoothing returns through the stock and bond market cycles, only works as a long-term investment.

In up and down markets, 10 years is simply too short a period to allow smoothing to work in a cost-effective way. That is why the figures for 10-year policies are so much more volatile and unimpressive than their 25-year equivalents. The reason so many financial advisers continued for many years to push their clients into 10-year with-profits products may not be unrelated to the handsome upfront commissions life companies pay on these policies.

On the other hand, there is nothing wrong with the impressive rates of return that the best with-profits endowments have produced over time. A realised average real return of five to six per cent a year represents a more than acceptable return, particularly for the cautious investors at whom with-profits have historically been directed. Most sensible people, if offered such a return over 25 years, should grab it with open arms.

The paradox is that the longer you set out to invest for, the more important it becomes to pick a provider that you can trust to invest your money competently and cost-effectively over such a long period. This is tough and the job is more difficult because new technology has completely outmoded the old way of doing things.

The with-profits industry has failed to demonstrate that it merits the trust of investors. This overshadows the fact that a well-run low-cost smoothed investment fund is of itself a perfectly sound investment concept that can still deliver something of value to the lucky minority who pick wisely.

jd@intelligent-investor.co.uk

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

Arts and Entertainment
The eyes have it: Kate Bush
music
Arts and Entertainment
booksNovelist takes aim at Orwell's rules for writing plain English
Arts and Entertainment
Al Pacino in ‘The Humbling’, as an ageing actor
filmHam among the brilliance as actor premieres two films at festival
News
Fifi Trixibelle Geldof with her mother, Paula Yates, in 1985
people
PROMOTED VIDEO
Sport
Mario Balotelli in action during his Liverpool debut
football ...but he can't get on the scoresheet in impressive debut
Environment
Pigeons have been found with traces of cocaine and painkillers in their system
environmentCan species be 'de-extincted'?
Arts and Entertainment
booksExclusive extract from Howard Jacobson’s acclaimed new novel
News
i100
Arts and Entertainment
A Pilgrim’s Progress is described by its publisher as “the one-and-only definitive record” of David Hockney's life and works
people
Sport
Loic Remy signs for Chelsea
footballBlues wrap up deal on the eve of the transfer window
News
i100
Arts and Entertainment
Art
Arts and Entertainment
Elizabeth McGovern as Cora, Countess of Grantham and Richard E Grant as Simon Bricker
TV
Life and Style
Instagram daredevils get thousands of followers
techMeet the daredevil photographers redefining urban exploration with death-defying stunts
Arts and Entertainment
Diana Beard, nicknamed by the press as 'Dirty Diana'
TVDaughter says contestant was manipulated 'to boost ratings'
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    C# .NET Developer (PHP, Ruby, Open Source, Blogs)

    £40000 - £70000 per annum + Bonus+Benefits+Package: Harrington Starr: C# .NET ...

    Data Analyst/Developer (Good education, Data mining, modelling,

    £40000 - £70000 per annum + benefits+bonus+package: Harrington Starr: Data Ana...

    Law Costs

    Highly Attractive Salary: Austen Lloyd: BRISTOL - This is a very unusual law c...

    Network Engineer (CCNP, CCNA, Linux, OSPF, BGP, Multicast, WAN)

    £35000 per annum: Harrington Starr: Network Engineer (CCNP, CCNA, Linux, OSPF,...

    Day In a Page

    Alexander Fury: The designer names to look for at fashion week this season

    The big names to look for this fashion week

    This week, designers begin to show their spring 2015 collections in New York
    Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

    'I like Orwell's writing as much as the next talented mediocrity'

    Will Self takes aim at Orwell's rules for writing plain English
    Meet Afghanistan's middle-class paint-ballers

    Meet Afghanistan's middle-class paint-ballers

    Toy guns proving a popular diversion in a country flooded with the real thing
    Al Pacino wows Venice

    Al Pacino wows Venice

    Ham among the brilliance as actor premieres two films at festival
    Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

    Neil Lawson Baker interview

    ‘I’ve gained so much from art. It’s only right to give something back’.
    The other Mugabe who is lining up for the Zimbabwean presidency

    The other Mugabe who is lining up for the Zimbabwean presidency

    Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
    The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

    The model for a gadget launch

    Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
    Alice Roberts: She's done pretty well, for a boffin without a beard

    She's done pretty well, for a boffin without a beard

    Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
    Get well soon, Joan Rivers - an inspiration, whether she likes it or not

    Get well soon, Joan Rivers

    She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
    Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

    A fresh take on an old foe

    Doctor Who Into the Dalek more than compensated for last week's nonsensical offering
    Fashion walks away from the celebrity runway show

    Fashion walks away from the celebrity runway show

    As the collections start, fashion editor Alexander Fury finds video and the internet are proving more attractive
    Meet the stars of TV's Wolf Hall... and it's not the cast of the Tudor trilogy

    Meet the stars of TV's Wolf Hall...

    ... and it's not the cast of the Tudor trilogy
    Weekend at the Asylum: Europe's biggest steampunk convention heads to Lincoln

    Europe's biggest steampunk convention

    Jake Wallis Simons discovers how Victorian ray guns and the martial art of biscuit dunking are precisely what the 21st century needs
    Don't swallow the tripe – a user's guide to weasel words

    Don't swallow the tripe – a user's guide to weasel words

    Lying is dangerous and unnecessary. A new book explains the strategies needed to avoid it. John Rentoul on the art of 'uncommunication'
    Daddy, who was Richard Attenborough? Was the beloved thespian the last of the cross-generation stars?

    Daddy, who was Richard Attenborough?

    The atomisation of culture means that few of those we regard as stars are universally loved any more, says DJ Taylor