Two Lessons From Big Financial Companies

One big financial company is selling alternatives to shares, and another wants those of us with above-average earnings to do a tax-saving deal with our employers.

Big financial companies can teach us some lessons, but not always the lessons that they wanted to teach. I've been reading company propaganda (i.e. press releases) this week. Two caught my eye. One is a good idea that could save people money on taxes and boost their retirement pots. The other is an unintended, reading-between-the-lines lesson about investing in shares.

1. Sacrifice salary to reduce National Insurance contributions

I'm going to hit you with some figures, but I'll keep it simple.

Next tax year (April 2009 to April 2010) the tax-free personal allowance will rise from £6,035 to £6,475 and the threshold for paying 40% tax will go up from £34,800 to £37,400.

However, most of you earning these sorts of figures will end up paying more in National Insurance (NI) contributions. This year (2008/9) you pay 11% NI on earnings up to £40,040. (Above that, you pay 1%.) In 2009/10, you'll pay 11% on up to £43,888. This increase of £3,848 will mean you'll pay around £400 more NI next year, if you earn £43,888 or more.

Tax changes in April 2009 for earners close to the higher-tax threshold

The point is: what you'll save on income tax, you lose in National Insurance contributions.

But Standard Life has a crafty suggestion to reduce or eliminate the extra NI cost.

It suggests that people earning these amounts should talk with your employers, ask for a salary sacrifice, and ask the employer to increase contributions to your pension scheme by the same amount.

You could save up to 11% NI, and your employer - which also pays NI on your earnings - could save 13%. What's more, your employer could save on corporation tax. You could negotiate for some or all of the savings your employer makes to be added to your pension pot as well.

I'm going to trust that Standard Life wouldn't suggest something illegal, so it would seem to be a good idea.

2. Should we be seeking alternatives to shares?

It's a rule of thumb only, but when investment-fund providers start frantically peddling a new fund, it's usually already past the time to be investing in it. The most obvious example in recent history is commercial property. After years of great gains in the area, funds flooded the market in 2006 and 2007 to say `You can do it, too!' But by then the big gains had already been made. Indeed, commercial property investments suffered an inevitable fallback shortly afterwards.

Now, Norwich Union hasn't yet started frantically peddling new funds, but it's taken the first step, and I expect others to follow suit. It has added 23 new investment funds to many of its different investing schemes. One of the few funds that it singles out in its latest press release is the Schroder Diversified Growth Fund. It aims for 'an equity level of return but with a much smoother path over the medium to long-term'. (`Equities' are `shares'.)

`An equity level of return'

This fund has a reduced direct exposure to shares and it invests in currency, commodities, private equity, and other areas. Thus, it will now seem very attractive to people who've lost loads of money in shares in a market that's collapsed. So that's most of us, making it an easy sell for Norwich Union.

The problem is with the funds mission. Promising anything more than `an equity-level of return' would beggar belief (although that doesn't stop some funds from doing so). Therefore, it aims merely to do as well as equities.

It's not necessarily wrong to invest in currency, commodities or private equity. Nor is it necessarily wrong to invest in the Schroder Diversified Growth Fund itself. However, to invest in anything you must firstly understand what you're doing. What's more, to invest in a fund you must know the fund manager's (or management team's) performance over a long period of time. (I'd say ten years, minimum.) Finally, if you're looking for `equity-like returns', there's one way to get returns that are even more like equities: invest in equities.

Equities are relatively cheap to buy and sell and you can find equity-based funds with very low management fees, but funds such as this one from Schroder invite high fees and high costs. This will make it much, much harder to get an equity-like return.

`A much smoother path over the medium to long-term'

I can't ignore these words from Schroders, either. The more funds and advisers mention `smoothing' the more hunched and lumpy my neck and spine gets. Smoothing is an unrealistic and unnecessary concept. It doesn't matter that your fund's performance goes up and down. That is normal. What's important is that you make money in the long run, which is also normal (although obviously not guaranteed).

Fighting the lumps is a costly affair. The smoothing process justifies higher management fees, and the effort to smooth usually involves more, unnecessary, trades. The more trading, the more costs.

Turn my rule of thumb on its head. Fund providers are now starting to push alternatives to shares. Not only should we be wary of using the alternatives, but we could also consider it yet one more sign that now is a great time to be buying shares. Investing now should be cheap, and very rewarding in the long run. Don't expect it to be smooth, and I can't make promises, but investments held for the next ten-plus years are looking very promising.

*Sacrificing salary can affect entitlement to other tax benefits both positively and negatively. For example, by reducing salary, those with children may be able to claim higher Child Tax Credits but this reduction may also reduce entitlement to State Second Pension.

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