Keep the control

April 06

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One of the things I have always liked about property investment is that, compared to some other classes of investment, there it leaves a lot under my control.

In the stock market, you have no operational control of the company (unless you are at the level where you can buy into a position of power, which either means having a LOT of money, or sticking with very small companies.) It is worth noting that the most famous stock-market investor in the world - Warren Buffet - has a long track record of not just buying stocks, but buying CONTROL of companies, so that he can leave in place good management aimed at meeting his long-term objectives.

In pensions, one of the traditional problems has been the need to buy annuities.

When I read the article below on the website of my accountant - Mike Lewis - I tore up my notes on annuities and emailed him asking whether I could reproduce his article instead! Fortunately he agreed.

With property, I have control over two critical things:

• When (whether) I buy
• When (whether) I sell

By simply being prepared to walk away from a potential purchase, I have avoided many deals that looked OK, and concentrated on the few that looked outstanding.

What I have discovered over the last 15 years is that I did not actually need a very big portfolio to become financially free. What I did need to do was ensure that everything I bought put a good amount of money into my pocket at the end of each month.

Buying property (on anything else) on the HOPE that it will go up in value is not, in my book, investment. It is speculation. There is nothing wrong with doing a bit of speculation - but please never confuse it with investment.

Anyway - enough from me - over to Mike.

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At the moment you have to buy an annuity with your pension fund by the time you are 75.

I have had the feeling they are poor value for a long time but recently I worked out how I thought the fund would be diminished with age after you bought an annuity and the insurance company had to manage the fund to pay you an income.

So I looked up the life expectancy of a 65 year old male on the Government Actuarial Stastistical Table. It says that a 65 year old male could expect to live another 16 years.

Then I looked up some annuity rates and found that a 65 year old male could get an annuity rate of 7.2%.

Suppose you have a fund of £100,000. This buys you an annuity of £7,200 a year.

The insurance company now has your £100,000 and it can invest that money. It should be able to manage an income of 4.5% by investing in long term gilts.

So in the first year it should be able to earn £4,500 on your money and pay you £7,000. At the end of one year there is £97,300 left.

The question is, how much money is left after 16 years when, on average, all the males who bought a pension at age 65 are dead? OK some will live longer but some will die sooner. 16 years is the average.

The answer I get is nearly £39,000. That's nearly 40% of the original fund! So basically, on average, the insurance company gets to trouser 40% of the pension fund of a man who buys an annuity at age 65.

Well I'm stunned by that. So stunned I wonder if I've made a mistake. How can it be that so much of the fund remains for the insurance company. I know they have costs but it can't cost that much to maintain a pension fund. Once it's set up all they have to do is pay a monthly pension by standing order and bank the interest cheques they get. I bet that is paid electronically as well. The only other thing I can think of is to check up you are still alive so they know when they can trouser your money.

• Mike Lewis, Chartered Accountant
• www.mikelewis.co.uk
• reproduced by permission

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