Money Q&A: Is it time to switch out of trackers?
Sunday 16 August 1998
Always remember there are costs involved in switching between investments. With PEPs there could be an extra long-term cost. Withdraw funds from a PEP and they are withdrawn for good - although you can always reinvest up to the current year's PEP allowance.
City fund managers switch between investments all the time. But whether they really add long-term value to their funds is another matter. Private investors playing the game should feel confident that they understand all the risks.
Past performance says that stock markets ride out short-term setbacks and rise in value in the long run. But past performance is not an infallible guide. The continuing abysmal showing of the Japanese stock market during the 1990s seems to confound the rules.
Over here, some commentators believe the "long-run" argument no longer holds. Falling inflation and deflation will depress share prices in the long run and other forms of investment may do better. Equally, plenty of pundits maintain the traditional argument, finding new reasons (end of the welfare state, more people saving in pensions) for investing in shares. Let's say you accept this but you are 100 per cent sure that there will be a 20 per cent fall in the stock market over the next few months. Ignoring costs, pure logic dictates that you switch to cash and reinvest in the market after the fall.
On the other hand, stock market investors are often told to put their money away and forget about it. They should wait for the regular statement from the fund manager and review their investment then.
Are you really considering a guaranteed stock market bond as an alternative? Find out exactly what is on offer. What is the true cost of the guarantee in terms of lost income or capital growth? Ask an adviser to compare the return on a guaranteed investment over its life with the return on your index-tracking fund, assuming stock market values double over that period.
Remember to take income payments into account as well as capital growth; insist the adviser makes a realistic adjustment for any averaging formula often found in guaranteed products.
Your final return could be based on the average stock market level over six months prior to maturity. That should produce a lower return on your money than the doubling of the stock market you are assuming for the index- tracking fund.
Suppose the market slides and you have to rely on the money-back guarantee? Are you prepared to take the risk of zero return? Maybe you would consider "protected" unit trusts that use derivatives to capture and lock in at least some stock market gains. Check performance statistics and assess the protection costs by way of lost performance. Ignore any boasts that a protected unit trust may have lost less money than others in a lean period. The whole point (surely) is that you don't want to lose anything?
Endow or repay?
We are first-time buyers with a bewildering array of fixed- rate and discounted mortgages to choose from. But we also have to choose between a capital-repayment and an endowment-backed, interest-only mortgage. A friend took out an endowment mortgage that costs pounds 30 less a month than the capital- repayment version. Your comments would be welcomed.
Understandably, you can see a big advantage in minimising your outgoings. You are hard-pressed first-time buyers. An endowment loan costing pounds 20 to pounds 30 a month less would make a useful difference to cash flow.
Get quotes for both types of loan, particularly for loans based on today's variable mortgage rates (including all costs). Total monthly outgoings on an endowment loan rise and fall disproportionately with interest rates. The more mortgage rates fall, the more an endowment mortgage is likely to be cheaper than a repayment mortgage. So it would be no surprise to find an endowment loan noticeably cheaper if the quote is based on a large but temporary interest rate discount.
For many borrowers it is a real shock adjusting to a standard variable rate when a special rate or fixed rate comes to an end. Some cannot switch easily to another low-cost deal because of hefty penalties.
Perhaps you take the view that we are in for an era of historically low mortgage rates. That would appear to give the advantage to the endowment mortgage. But insurance companies are now forecasting that some policies won't generate enough cash to pay off mortgages. That problem could well get worse if interest rates and investment returns fall further. In five or 10 years, you may discover that your endowment premiums are too low.
Write to the personal finance editor, 'Independent on Sunday', 1 Canada Square, Canary Wharf, London E14 5DL and include a phone number, or fax 0171 293 2096, or e-mail email@example.com. Do not enclose SAEs or any documents you wish to be returned. We cannot give personal replies or guarantee to answer letters. We accept no legal responsibility for advice given.
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