When With-Profits Becomes Without-Profits


Updated on 17 February 2009 | 11 Comments

With-profits funds were once very popular, as they allow investors to spread their risk. However, market crashes have exposed their weaknesses.

One of my relatives recently received a payout from his mortgage endowment policy. Over the past twenty years, he has faithfully paid his monthly premiums, part of which provide life cover, with the remainder being invested in a with-profits fund. In total, my relative paid in around £20,000 over twenty years.

My question for you is: how big was his payout? £25,000? £30,000? £40,000? In fact, he received a measly profit of £1,000, or 5% of the amount contributed. Frankly, this with-profits policy has been a dismal failure and he'd be richer had he deposited the £1,000 a year into a savings account from 1988 to 2008!

Why I hate with-profits policies

Personally, I've never bought a with-profits policy -- what's more, I never will. There are so many problems with these funds that I scarcely know where to begin. Nevertheless, here are my five top reasons to give with-profits a miss every time:

1. High management charges

With-profits funds spread your money across a range of different assets, such as shares, bonds, property and cash. However, this diversification comes at a price, with many funds charging fees of several percentage points a year for their services. Of course, the larger the fee, the lower your return -- all other things being equal. Indeed, in the above example, the fees pocketed by the with-profits provider vastly exceeded the £1,000 profit made by my relative, making the provider the only winner.

2. Transparency is poor

I like cheap, simple, easy to understand products such as index trackers, which track a particular stock-market or other index as it rises and falls. With-profits funds, on the other hand, are extremely opaque. Other than a broad picture of asset allocation (the proportions of the fund held in each asset class), with-profits funds are largely opaque and obscure. This isn't a great help to investors!

3. Smoothing doesn't help

In theory, with-profits funds use `smoothing' to lessen some of the volatility of investing. So, in the good years, they hold back profits to act as a cushion in the bad years. In practice, with-profits funds -- especially that of the now-infamous Equitable Life -- `over bonused' by paying out too much to previous investors. In other words, they splashed out too much cash when the good times rolled. Alas, now that the property and stock markets are crashing, there's not enough left in the pot to smooth out these falls. So much for smoothing!

4. Bonuses can be chopped

Yesterday, Norwich Union, the UK's largest life insurer, announced reduced payouts for all of its 2.3 million with-profits policyholders. In most cases, payouts this year will be 15% lower than they were in 2008. This will leave many customers facing a mortgage shortfall. Norwich Union's biggest with-profits fund lost 11.9% of its value last year. Although this is better than a 31% drop by the FTSE 100, a loss remains a loss. Furthermore, we can expect similar announcements of reduced bonuses at rival firms such as Prudential, Standard Life, and so on.

5. High exit charges

Lastly, if you are unhappy with the ongoing performance of a with-profits investment, then don't expect to escape scot-free. You are forced to pay an exit penalty of between 5% and 20% of the current value of your fund -- which, in effect, locks you into more years of poor performance. This is why many investors sell their with-profits mortgage endowments to firms that buy up such products, rather than cashing them in for a reduced payout.

In summary, my advice would be to steer well clear of with-profits funds of all shapes and varieties. Although they appeared to work in the good times, they are very much `yesterday's products' and have little to offer to today's investors.

More: Find superior savings accounts | Get Real With Your Savings | Get More From Your Endowment

Comments


Be the first to comment

Do you want to comment on this article? You need to be signed in for this feature

Copyright © lovemoney.com All rights reserved.

 

loveMONEY.com Financial Services Limited is authorised and regulated by the Financial Conduct Authority (FCA) with Firm Reference Number (FRN): 479153.

loveMONEY.com is a company registered in England & Wales (Company Number: 7406028) with its registered address at First Floor Ridgeland House, 15 Carfax, Horsham, West Sussex, RH12 1DY, United Kingdom. loveMONEY.com Limited operates under the trading name of loveMONEY.com Financial Services Limited. We operate as a credit broker for consumer credit and do not lend directly. Our company maintains relationships with various affiliates and lenders, which we may promote within our editorial content in emails and on featured partner pages through affiliate links. Please note, that we may receive commission payments from some of the product and service providers featured on our website. In line with Consumer Duty regulations, we assess our partners to ensure they offer fair value, are transparent, and cater to the needs of all customers, including vulnerable groups. We continuously review our practices to ensure compliance with these standards. While we make every effort to ensure the accuracy and currency of our editorial content, users should independently verify information with their chosen product or service provider. This can be done by reviewing the product landing page information and the terms and conditions associated with the product. If you are uncertain whether a product is suitable, we strongly recommend seeking advice from a regulated independent financial advisor before applying for the products.