Safety First Investing

Establishing your nest egg is only your first step in making sure you have everything in place for worry-free management of your affairs. Protective strategies you can use range from making sure your financial advisors are well qualified to putting effective trusts, wills and powers of attorney in place.

Perhaps the most reassuring move you can make is to ensure that any financial adviser you have is well equipped to help you grow, maintain and manage your assets.

Investment advice is available from a diverse range of people such as accountants, share brokers, lawyers, mortgage brokers, qualified and unqualified financial planners and insurance salespeople. The best strategy, always, is to look for those with the best qualifications.
Because anyone has been able to set themselves up as a financial adviser in the past, it is vital to spend some time checking credentials. You are looking for experience, credibility and independence. A good investment adviser should act as a filter, weeding out unsuitable investments from the myriad on offer and presenting only those that suit your investment plan and are compatible with your risk profile.
The government is currently moving to establish more rigorous controls on the financial advice industry in order to boost investors’ confidence that the people they go to for help have sufficient training, experience and expertise to do their job well. Meanwhile, it’s wise to check whether any prospective adviser has CFP (Certified Financial Planner) after their name. This means that the planner will have at least two years of mentoring on their CV, and is subject to a code of ethics, practice standards and a formal complaints and disciplinary process. Many CFPs will be members of the Institute of Financial Advisers (IFA), which has more than 1400 members, or the Society of Independent Financial Advisers (SIFA) - but many will not.
If you are considering appointing such a professional, you have the right to request a written disclosure statement. This must be provided within five working days of your request. This statement should include information on these questions:
• What is the adviser’s experience and qualifications? If advisers lack experience, they may not have experienced downturns in the market and so may not be alert to signals indicating a reversal.
• Is the advice limited to the investment offered by only one or two financial organisations? You need to determine if the adviser has an investment strategy they can explain and tailor to your risk profile, or if they are really just a salesperson for a couple of investment funds or insurance products.
• Does the adviser only give advice on a particular type of investment? In this case, they are not qualified to give advice across your whole portfolio. In reality, they are sales-driven and only interested in promoting one product
• How will the adviser handle money received from you for investment? Is your money protected in the event of misappropriation? What records will be kept and what access will you have to this information?
• How does the adviser receive their income? Is it via brokerage from the financial organisations who provide the investment products they recommend, or is it via a fee that you pay? Most financial products have a brokerage and this is disclosed in the product prospectus. Typically advisers who charge fees will rebate the brokerage paid to the client.
You should also seek references of existing clients so you can contact them about the adviser’s service and professionalism. You need to clearly establish what the adviser’s services will cost you. Just the same as with managed funds, high fees will seriously affect your net wealth over the long term.
It is important that a financial adviser can address your changing circumstances as you age. There are considered to be three phases in a long retirement:
• The go-for-it phase – potentially the best time of your life, when you get to do all those things you never had time for previously.
• The slowing down phase – when you are not so active and prefer to spend more time relaxing and ‘taking life easy’.
• The final stage – when you need medical and nursing/hospital care;
Your adviser should be aware of these stages and adjust your investment to suit the different cash flow you will need at various times.
A major weakness of many clients is that they fail to monitor the performance of the planner. You need to know what your investment should have returned. If your return has not met the average for that type of investment, you should be asking why. It is relatively easy to ascertain the average return for the New Zealand or US or Australian share market. If your returns are substantially less, you will want to know what your adviser is going to do about it.
Whether using an adviser or handling your affairs yourself, you’ll need to decide how much of your capital you’ll draw down each year. That depends on how long you expect to live. If you follow comedian Steven Wright’s line of thought (‘I intend to live forever – so far, so good!’) then you need to have a long-term strategy. According to current life expectancies, if you draw down the capital at 10% each year you are likely to have exhausted it before you die.
A study has revealed that UK people average nearly 20 years in retirement. This is also the most expensive period of their life – retired people are spending over £400,000 between 65 and their year of death. This equates to more than a million NZ dollars or about $NZ53, 000 per year. Such levels of expenditure would exhaust most New Zealanders’ retirement savings long before the 20 years had elapsed.
To allow for such lengthy times in retirement, a prudent draw-down rate is vital. How much you take out in the early years of your retirement is more important than factors like your asset allocation in determining when you will run out of money. The safe withdrawal rate may be less than you think.
Those expecting a 20- to 25-year retirement should keep initial withdrawal in the 4% to 5% range. Those who retire early and who may, therefore, have 30 years or more in retirement ahead may need to reduce that to a 3% to 4% drawdown of their capital.
This can be increased by the rate of inflation each year, so that a $12,000 a year withdrawal from a $300,000 portfolio could be increased to $12,360 the next year (assuming 3% inflation). Retirees also need to consider cutting back further if their portfolio drops drastically in value. A big drop early in retirement is especially dangerous, since you would be drawing from a much smaller pool of assets, making it far more likely you will run out of cash. Those who take out just 3% a year can be pretty conservative with their investments, leaving most of their money in cash and bonds.
Having a majority of your savings in equities will be a greater risk, but a higher withdrawal rate is then possible. It has been calculated that with a 4% withdrawal rate, a $500,000 initial nest egg would probably still be worth around $400,000 after 30 years if the portfolio was invested 60% in equities, 30% in bonds and 10% in cash.
By contrast when the stock investments were reduced to 20% of the portfolio, the likely value was just $180,000. Many financial advisers recommend retirees should have at least 50% of their portfolio in stocks to generate returns that are substantial enough to offset the corrosive power of inflation.
However you invest, there’s a range of safeguards you can put in place to protect your assets. Establishing a family trust could be a smart move. If you own a business, a trust can protect personal assets from creditors in the event that it collapses. A trust may also:
• Avoid assets being included when applying for rest home subsidies
• Protect pensioners against any future means testing for universal superannuation or a ‘super’ surcharge
• Help you pass on property to offspring without death duties or capital gains taxes
• Protect your assets from falling into perceived ‘wrong’ hands, such as children’s ex-partners
• Enable income distribution to family members to achieve tax savings
You should put in into the trust appreciating assets like the family home, other property shares and quality art or jewellery. After an independent valuation, the assets are bought by the trust. The trust then owes the person who has sold the assets and this debt is forgiven at a rate of $27,000 per year. Amounts gifted above that figure will attract gift duty, so if you are thinking about setting up a family trust you should do so as soon as possible. It takes time to get all your assets shifted over. Once you are in your 60s you may not have time to ensure the necessary gifting programme is completed before your death.
Other aspects to consider include the challenge of selecting a neutral trustee. If this is someone in your immediate family, there is the distinct risk of disputes with other family members.
Lack of control is the main disadvantage of establishing a trust. Once it’s in place you no longer have a major say over its assets – you are handing over ownership. You may still have some influence over their use but you will not have total control. Also, the rules around keeping accurate records and minutes of trust dealings, completing IRD returns and keep documents safe for future reference, all have to be followed to avoid any future legal challenges to the trust’s integrity.
It’s also important to have an up-to-date will. There should be no contradiction between your updated will and trust deeds. If you die without a will, you are termed to be ‘intestate’ and your assets are divided up by law, as the court sees fit. Your assets may be frozen meantime, causing possible major headaches for your dependants, and it can take a lot of time and money to sort out your affairs.
You need to decide who will be your executor and trustee and what special instructions, if any, you might want to leave for them. You will also choose who will be your main beneficiaries and how your estate will be divided and, if you have children under 20, who will have guardianship of them. Remember too, that if you marry, have children or get divorced, you will need to update your will again as the previous one will no longer be valid.
It’s also a good idea to set up an enduring power of attorney (EPA). This is a legal document giving someone you trust the power to look after your interests if you are no longer capable of doing so yourself, due to incapacitation through injury or mental problems such as dementia. An EPA is much cheaper to draw up than a family trust. A lawyer can do it for around $200, the Public Trust for $100, or you can do it yourself. Without an EPA, the court will decide who your lawyer will be. This might result in decisions that conflict with your original intentions and in costs you had not envisaged. It will also take some time to put this structure into place, and your estate might suffer form lack of action in the meantime.
As with a family trust, you have to be very sure the person you choose to look after your affairs is ultra-trustworthy. Many are the horror stories of elderly people being ripped off by children or friends who take advantage of a trusted position to reward themselves or take the estate in a direction people would never have wanted. Because government may soon enact legislation in this area, lawyers setting up an EPA must act for the donor and be independent of the attorney receiving the power of attorney – a good move which should be a starting point if you consider setting up an EPA.
All of the above may sound like a lot to consider, but you’ll feel much more secure once you’ve given these things your attention. There’s nothing as satisfying in life as being prepared.

An article from the Summer edition of Plenty magazine, edited by Lindsay Dawson