You might think that the answer to the above question is an obvious YES! But, controversially, I believe that With-Profits still have a part to play for many investors.
There have been some pretty high-profile media campaigns putting the boot into with-profits. In particular, the Daily Mail thinks everyone was miss-sold a mortgage endowment policy and that they are all terrible.
But, making your saving or investing decisions based on newspaper headlines is a very bad idea. In fact, with-profits can be good for regular savers over the long term but bad news for people with a lump sum to invest.
The failure of mortgage endowment policies
Let’s get with-profit mortgage endowments out of the way. This special class of policies was created back in the 1980s to compete with conventional repayment mortgages where you are guaranteed to pay off the capital in 25 years.
Life insurers behaved like lemmings. They competed by lowering premiums, and claiming that by achieving faster investment growth their policies would still pay off a mortgage. The music stopped when they projected investment returns at 11% a year. Instead they have averaged nearer 6% since 1990. That is where the shortfalls have come from.
But the failure of some of these low-cost endowments to achieve its aim says nothing about the merits of with-profits for regular savings plans such as personal or stakeholder pension plans. Millions of pension policies are in force where premiums are going into with-profit plans. What of them?
With-profit pension saving plans have been winners
My first table tells you the answer. A recent Moneyfacts survey shows that, over the five, ten, 15 and 20 years to last May, with-profits pension plans returned MORE - in most cases a truckload more - than unit-linked plans linked to balanced managed funds. The results are for the average fund of both types. Over 20 years, £100 per month produced £42,965 in a unit-linked plan and £70,214 in a with-profits plan. Rubbish performance? I don’t think so!
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With-profits and Unit-linked regular savings plan results | |
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£100 per month saving to July 2004 |
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| 5 years |
10 years |
15 years |
20 years
|
Unit-Linked Balanced Managed Fund
|
5,563 |
12,542 |
24,831 |
42,965 |
Annual return
|
-3.60% |
0.70% |
3.98%
|
5.29% |
| With-Profits |
| Annual return |
Source: Moneyfacts
Now it is true that bonus rates on with-profits policies have fallen and are still falling. They will probably keep on falling over the next few years. This is because the life insurers’ investment performance could not actually turn £100 a month into £70,214 over 20 years.
That payout reflects the way bonuses were raised in the 1990s in expectation of big returns from the stock market. Those returns haven’t materialised. So the final amount paid out will be adjusted down through lower bonuses until it is closer to the real underlying investment performance of the fund. But, even so, in a few years’ time I expect the payout on a 20-year plan will still be more than the £42,965 delivered by our unit-linked plan.
With-profits are still a sound choice for regular savers
I think it is clear that, if you have a with-profits pension plan with a reasonable life insurer, you have had a pretty good deal - better than you would have got from other forms of saving. And, if you have such a plan, you will sacrifice a chunk of the potential payout if you terminate it early.
So, in general, my advice is not to do this but to keep your plan going. And if you are thinking about starting a stakeholder pension, I think a good with-profits plan is, in my view, an excellent choice. Standard Life tops most advisers’ lists.
Lump sum investors should avoid with-profits bonds
Now let’s look at lump sum investments – see Table 2. Here what I’m comparing is the average with-profits bond and the average UK Equity Income unit trust.
And this comparison is open to criticism, because with-profits bonds never have all their money in shares but spread it into fixed interest and property. However, many of the people who bought with-profits bonds could have put some of their money into a UK Equity Income fund and some into a cash deposit, and the result would have been better.
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With-profits bonds and UK Equity Income Funds lump sum results | | | | |
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£10,000 initial investment to May 2004 |
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| 2 years |
3 years |
5 years |
10 years
|
| With-profits bond |
10,514 |
10,924 |
12,014 |
17,696 |
Annual return
|
2.50% |
3.00% |
3.70% |
5.90% |
| UK Equity Income Fund |
| Annual return |
|
Source: Moneyfacts
With-profits bonds were designed to reduce volatility
The with-profits bond was a late 1980s invention. Life insurers realised that the public wanted the higher returns of the stock market but didn’t like prices yo-yoing up and down. So they used the with-profits ‘smoothing’ system and bonuses to give the public some exposure to the stock market with all the volatility. They sold bundles of these bonds to cautious investors from the mid-1990s on.
As you can see from Table 2, with-profit bond returns have been pathetic over the ten years to May 2004. Most investors would have done better with a decent deposit account. And the real issue shows up in the one-year and ten-year figures. When you invest in a with-profits bond you will never benefit from the bonanza years when the stock market performs really well.
Over the last year, you would have gained over 11% in an Equity Income Fund, and over the ten-year term that fund could have produced £5,000 more on a £10,000 investment than a with-profits bond. This is precisely because the stock market is mad, bad and sometimes dangerous. It has years when it slumps and years when it rockets. If that worries you, the answer is simple: put some of your money in a nice safe high-interest account and some into an Equity Income Fund.
Investors die by a thousand bonus cuts
Investors who hold with-profits bonds have seen bonuses slashed in recent y
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