In my last article I suggested that the most effective form
of saving was undoubtedly a disciplined one where a fixed
contribution is invested on a regular basis over a long period.
But I also indicated that there were a number of pitfalls.
What are these?
Ability to maintain contributions
This is perhaps the most important requirement of a plan and
one which too often is not fully understood at the outset.
If you have a company pension plan and you leave that company
your contributions to the plan cease but you are not normally
subject to any penalty. Not so with the majority of life-linked
savings plans. These are long term contracts which have high
sales and marketing costs. These costs are generally recovered
over the life of the plan. But if the plan is surrendered
or suspended early the life company recovers its costs by
levying additional charges or penalties. If you have a ten
year plan and you stop contributions after two years, even
if you do not encash those contributions until maturity, you
are unlikely to get back the full amount you invested.
The impact of charges
How do the life companies recoup their costs? Firstly there
is the initial charge or ‘bid-offer’ spread. This
can take as much as 7% out of each new contribution for the
life of the plan. Over time this is less significant since
if a unit is held for 15 years the cost averages out at less
than half a percent per annum but it does illustrate the importance
of treating such an investment as long term. People often
dislike paying charges but when you think about it there is
little difference between buying a financial product or a
new car. When you take the car out of the showroom it immediately
loses at least 15% of its value. Worse, it keeps losing whereas
a financial investment product will normally grow in value.
Other charges in savings plans include management, administration
and fund charges. All in all these can add up to 2% to 4%
per annum. They are generally ‘hidden’ so you
see only the net value of the investment.
Other factors that affect values
People embark on long term savings plans because they want
to see a higher return on their money than if they left it
in the bank. But in order to get a higher return you have
to invest in assets such as stock market funds. The problem
here is that these assets do not make money every year. Over
the long term they have always outperformed cash but they
can go through periods of decline such as we saw between March
2000 and March 2003. Some people who saw the value of their
investments fall by more than 40% during this period decided
to call it a day and cash in their plans. But by so doing
they took a double whammy of losses in market value and penalties
for early encashment. On the other hand, those who soldiered
on and maintained their contributions have generally recovered
those losses and their plans are back on course to produce
solid gains. They will also have benefited from ‘cost
averaging’ as they continued to buy into the market
when prices were low.
Has anything changed in recent years?
The long bear market caused a severe loss of confidence in
unit-linked savings plans. In order to maintain levels of
business most life companies introduced bonus incentives which
drastically reduced the effect of charges. This meant cutting
into profits and resulted in several life companies such as
Old Mutual and Scottish Provident pulling out of the market.
The stronger and more aggressive companies have survived,
however, and some of the bonus schemes are still in place
so anyone embarking on a new plan now is likely to fare much
better than one who began a plan in the mid to late 90’s.
Are these plans suitable for expats in Bali?
They are certainly appropriate for ‘career’ expats
in Bali as they are anywhere in the world. By ‘career’
expats I mean those with international employers and a high
degree of job security and mobility such as senior hotel staff.
(Exceptions may be nationals of certain countries such as
the US who plan to return home as it may be difficult to continue
funding plans from these countries.) For expats who have chosen
to live in Bali specifically and without a degree of job or
income security the situation is different. If a regular income
cannot be guaranteed it may be unwise to commit to a long
term savings contract, tempting though the eventual benefits
may seem. This does not mean that those without a regular
income should be excluded. But it does mean a different strategy
is required. The income of people in business for themselves
often fluctuates between feast and famine. Provided that the
‘feast’ stage is sufficient a good technique is
to store part of the proceeds in a ‘reserve’ fund
which in turn can then fund a regular investment plan. The
reserve fund must always be large enough however to sustain
the plan during potentially long periods of ‘famine’.
Conclusion
Many expats in Bali are failing to make adequate provision
for their financial future or are depending on income from
sources that may be vulnerable to economic or political factors.
There is likely to be a great divide in the future, not just
in Bali but globally, between those who have managed their
financial planning and those who haven’t. A disciplined,
regular savings plan is one of the best ways to end up on
the right side of that divide but if the conditions I have
described cannot be met then it is better to lower one’s
goals and seek more modest but flexible ways to save.
Colin Bloodworth is a senior consultant with Financial Partners
International. The views expressed are his own. No investment
decisions should be taken without proper advice. If you have
any questions you may contact the writer at colin.bloodworth@financial-partners.biz
