By Gavin Scott
Most of us have worked hard to build up our savings. When contemplating the options for investing and holding their money, most people’s first concern is to look at the level of risk. However, many only really consider market risk, that is, how market volatility could affect their capital.
It is therefore common for retired people to leave all or most of their savings in bank deposits. What they often fail to consider, however, are inflation risk, interest rate risk and institutional risk, all of which could potentially have an impact on your capital.
Inflation could significantly reduce your spending power over the longer term; interest rates can fall, reducing income (albeit they cannot get much lower than they are at the moment), and we cannot rule out the possibility of a bank failure.
You need to consider the risk/return relationship with any investment asset, from property, to shares, to cash in the bank. Risk and return are not always proportionate. You could be exposed to more risk than is justified by the return potential of the asset or your overall portfolio.
If you take advice from a professional wealth manager like Blevins Franks, they will guide you through setting up a portfolio which aims to provide you with the right risk/reward balance for your objectives, personal circumstances, time horizon and risk tolerance.
Usually, with investment assets, as risk goes up so does the potential rewards. So with corporate bonds, for example, those with a credit rating below investment grade (BBB-/Baa3, depending on the rating agency), will offer a higher level of interest than investment grade bonds.
This does not follow on with bank accounts. Banks are currently offering unrewarded risk, particularly here in Portugal where many banks have non-investment grade ratings and are not paying interest rates high enough to compensate for the risk.
Would a major bank be allowed to fail? While Portugal itself would struggle to find the resources to rescue a bank, the EU may step in – but we can never say never. So you need to consider how much peace of mind you want over your savings and then take steps to diversify your assets and/or ring fence them from institutional failure.
Under an EU Directive, Portugal does have the Fundo de Garantia de Depósitos in place to protect bank depositors. It is set up to compensate depositors of a credit insitution which can no longer meet its liabilities, under certain conditions. There is a limit of €100,000 per depositor, per banking group. If you have savings above that amount the excess may be lost.
We hope we never have to find out how reliable this would actually be at refunding depositors in Portugal, or how long it would take for bank customers to receive their money back.
In the UK, the Financial Services Compensation Scheme (FSCS) limit is now £85,000 (to match Europe’s €100,000).
Many expatriates have savings in the Channel Islands or Isle of Man. Banks in these jurisdictions are not covered by the UK FSCS, even if they are divisions of UK banks. You would need to rely on the local guarantee scheme.
The compensation limit in the Isle of Man, Jersey and Guernsey is just £50,000. They also have an overall “cap” on the amount they have to pay out. Jersey and Guernsey will aim to pay compensation within three months, while the Isle of Man has no time limit.
The only certain way for investors to achieve security from institutional failure is through a state controlled investor protection regime.
Luxembourg stands out among EU Member States with its exceptionally strong culture of investor protection. It has a regime which provides maximum security to investors without limit.
The cornerstone of this regime is the legal requirement that all clients’ assets must be held by an independent custodian bank approved by the State regulator, the Commissariat aux Assurances (CAA). This arrangement involving the CAA, custodian bank and insurance company is known as the “Triangle of Security”.
These are the key points:-
• The regime ensures that the legal separation of clients’ assets from the insurance company’s shareholders and creditors, so investors are protected from exposure to the company’s credit risk.
• The insurance company maintains a register of all assets and how they are invested, which is monitored by the CAA.
• All policyholder assets are deposited with a custodian bank.
• The bank is required to ring-fence clients’ securities (eg. investment funds, shares, bonds etc.) – i.e. they are off its balance sheet. If the bank fails, these securities remain in segregated client accounts.
• The bank is bound by the regulator’s legal powers to protect the assets on behalf of investors.
• 100% of the policyholder’s securities are protected. Cash deposits are not securities and so are not segregated, but cash held in monetary funds is treated as securities and so are protected.
The old adage ‘don’t put all your eggs in one basket’, is particularly true for your investments.
The life assurance bonds protected by Luxembourg’s Triangle of Security allow you to hold a wide range of assets, providing your portfolio with as much asset allocation and diversification as you need. They provide you with the ability to determine the level of risk you are prepared to take relative to the perceived reward.
For bespoke advice on asset protection and suitable diversification, consult a wealth manager like Blevins Franks which has decades of experience advising British expatriates here in Portugal.
This article should not be construed as providing any taxation and/or investment advice. You need to seek personalised advice.
Gavin Scott, Senior Partner of Blevins Franks. Gavin has been advising expatriates on all aspects of their financial planning for more than 20 years. He has represented Blevins Franks in the Algarve since 2000. Gavin holds the Diploma for Financial Advisers.
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