Picture the scene. You want to save money on a regular basis for a little nest egg in the future. So, you contact your independent financial adviser and search the web to see how big that nest egg could be. Regardless of how much and for how long you intend to save, chances are that you will be given an illustration of how much you could get back. '£' signs appear before your eyes and out comes the pen, itching to sign.
In all seriousness, every provider of insurance and/or savings policies has an obligation to provide you with an illustration. These must show what you could get back at the end of the policy, based on three different rates of growth. For most policies, growth rates will be shown as 4%, 6% and 8%. For policies that get tax benefits from the Government (such as pensions), growth rates will be shown as 5%, 7% and 9%. So, which growth rate should you be looking at?
Well, there are general guidelines to follow, such as, the higher the level of risk you take, the higher the level of potential returns (but losses as well). In general, if you put your money into a bank or building society instant access deposit account, you may get around 4% interest per year. This type of saving carries virtually no risk to the money you put in. This example shows the lower end of the risk scale, and therefore lowers the chance of spectacular returns. This is where the 4% and 5% illustration projections come in.
Moving towards the other end of the scale and the 8% and 9% illustration projections, you need to ask yourself where these levels of returns are to be found. The answer is that returns of this size are still possible but, in these days of low interest rates and low inflation, bigger returns generally come at a price. This means that you could lose some or all of your original investment.
Over the last year, returns from different types of investments have averaged between double minus figures for equity investments and an average of 6% for property type investments. Other investments came somewhere in the middle.
The question is still there - which is the right growth rate for me? Well, help is at hand and, because everyone has a different view of the investment markets and different level of risk that is acceptable to them, here are my general tips:
1. When you are given an illustration it can be so tempting to look straight for the 8% and 9% projections. Look at all of the projections given and don't discount the fact that you could get more or less than any of the figures shown.
2. Be realistic . As everyone knows, there is no such thing as a free lunch and that goes for investing too. You generally cannot get high returns without accepting a level of risk to your money.
3. Weigh up the risks versus the potential rewards . For example, if you are being offered a return of 4% with a degree of risk to your capital, is it worth it? Could you get this return from an investment with a lower degree of risk?
4. Increase returns without taking extra risk. The way to do this is to invest tax efficiently. For example, if you have cash on deposit you are likely to be paying tax on the interest. If the money was held tax efficiently on deposit, you would pay no tax on the interest and benefit from bigger returns.
5. If you need to generate income from an investment, consider taking the income annually rather than monthly. If you can afford to do this, you may get a higher level of return.
6. Be prepared for markets to change. This is always happening at home and abroad. It is your money and you should be aware of how changes will affect it.
7. Understand what you have bought and make sure you keep a regular check on it. You don't have to read the financial press every day but you should check on progress occasionally. If you are concerned that the level of risk is too high or don't understand - ASK! Your adviser is there to help you.
8. Depending on where you intend to invest your money, have a quick look at how investments in that sector have performed. Don't get side-tracked by the headline returns some have provided - look at the average performance in good times and bad. This should give you an indication.
When you have decided on the level of risk you are prepared to take, you should be realistic in the rate of growth you hope to achieve. Don't forget that interest rates and inflation move and so do investment sectors and markets. They will all affect the returns you get on your savings. Be aware of what is happening in the markets when you come to take your money out. This could also affect what you get back. If you are prepared to take unlimited risk with your money and invest it in high risk investments, you should be aiming for the 8%/9% growth figures.
If you are not prepared to take on investments where there is a risk to the money you invested, you should be aiming for the 4%/5% growth figures. If you are prepared to take on investments and see a degree of loss to the money you invested, but do not want losses to be unlimited, you should be aiming for the 6%/7% growth figures. If you need help choosing savings and investments, please contact us.
If you are happy to do it yourself, use our policy search facilities.