By their very nature, expats live transient lives. They may settle somewhere like the UAE for several years, but at some point they will be ready to move on.
Most could not say where they will be in the next five, 10 or 15 years, so why do so many lock themselves into inflexible 25-year savings plans? Frankly, this is the last thing they need to do.
Unfortunately the answer is simple: in most cases they have been badly advised by unregulated, commission-hungry financial advisers.
It is perhaps the most common financial trap set for newbie expats. The pit is costly to fall into, and even more expensive to escape, if escape is possible.
What makes it worse is that committing to spend over a third of your life paying, say, US$1,000 a month into an investment plan is completely unnecessary. Instead, you can set up a low-cost, flexible portfolio of funds that you can change any time, and with no penalties for doing so, either on a do-it-yourself basis or using a reputable adviser. Twenty-five years can feel like a life sentence, so here is the alternative:
Avoid long-term plans
Many sign up to a 25-year savings plan without fully understanding what they are getting into.
Chartered financial planner Stuart Ritchie of AES International, a UK and DFSA-regulated firm based in Dubai, says the schemes are “horribly outdated” and banned in the UK. “The danger is that too few expats understand the rigid nature of the contract they are signing. You are locked into an extremely long-term plan when you have no idea what the future holds for you.”
Worse, these plans are “front-end loaded”, which means the adviser gets a fat chunk of commission straight after selling a plan. “Say you commit to paying in $2,000 a month over 25 years – that’s $600,000 in total,” says Mr Ritchie. “The insurance company [the creators of these financial products] may reward the adviser with commission of up to 4 per cent of that sum, which in this case is a hefty $24,000 on the very first day you make a contribution.”
The insurer needs to recoup this money from your future premiums so imposes heavy penalties for customers who realise their error and start plotting to escape after just a few years.
And most do quickly: analysts claim that savers stick with their plans for just 7.6 years on average.
Mr Ritchie says barely one in 20 run their plan for the full 25-year term, the vast majority falling by the wayside. “Investing, say, $1,000 or $2,000 a month may be affordable when you are living tax-free in the UAE, but it can be a real burden when you move on.”
Worse, he says the penalties for breaking that contract are severe. “Typically, if you dump your plan after one year, you will lose all of your money. Penalties are stiff and even people who run their plan for five, 10 years or longer will get little back if they cash in early.”
For those who do continue to term, investment returns can often be very disappointing. That is because plans also have expensive product charges, of between 4 and 6 per cent a year, plus another 2 or 3 per cent for the underlying funds, Mr Ritchie warns. “This means your money needs to grow by between 6 and 8 per cent a year just to break even.”
This level of return is increasingly hard to secure in today’s low-growth world, so the value of your pot may be shrinking.
Getting out if you are already in
Breaking out is expensive but may be a price worth paying, especially in the early years, Mr Ritchie says. “If you have been running your plan for 15 or 20 years, then you should probably continue to term if you can afford the monthly payments. Others should consider heading for the exit. It can sometimes be more cost-effective to wave goodbye to years of saving and tens of thousands of dollars than to remain locked into an inflexible plan with poor performing funds and sky-high charges.”
Damian Hitchen, director at UAE-based investment platform Swissquote, says most long-term savings plans do have a facility allowing you to exit the plan before its term or policy date. He says a reputable adviser can obtain a plan surrender value and provide a transparent breakdown of options. If you want to go ahead and leave, then you will need to complete an encashment form.
“Ask your adviser or the product provider when exit fees cease, as it may be more sensible to keep the plan for a little longer, to avoid these expensive charges,” he adds.
What’s the alternative?
If you are confident making investment decisions yourself, you can set up your own portfolio of funds far more cheaply using a low-cost online investment platform available to those in the UAE.
These include Luxembourg-based offshore broker TD Direct Investing International, US-based Interactive Brokers and Danish private bank SaxoTraderGO.
For example, TD Direct offers both low-cost passive funds known as exchange traded funds (ETFs), with no initial charges on more than 900 funds, while Saxo focuses more on shares, ETFs, futures, bonds and foreign exchange, although it doesn’t cover mutual funds.
Charging structures vary, but you typically pay an underlying platform charge of between $100 to $150 a year, plus trading charges starting at around $15 on stocks, and fund charges, plus annual charges of as low as 0.5 per cent a year for ETFs.
Another option is the UAE-based online trading platform Swissquote, which offers a local office and relationship managers in the Dubai International Financial Centre.
It allows private investors to open a multifunctional account which includes an offshore online bank account with a multi-asset class trading platform.
“We offer stocks and shares, ETFs, bonds, mutual funds, options, futures and foreign exchange across more than 60 global markets,” says Swissquote’s Mr Hitchen, adding that most platforms work on an “execution-only” model without advice and give you convenient online access and low pricing.
“Typically fees and charges are much lower than from traditional ‘packaged products’ such as the 25-year savings plans. This gives you a head start as your investments are not 3 to 6 per cent down on day one purely due to product charges.”
Those less knowledgeable but still keen to avoid the 25-year plan trap, can choose from a new breed of regulated advisers, which charge upfront fees rather than commission.
Companies such as AES International and Killik & Co offer a range of individual stocks, ETFs, mutual funds and other financial instruments.
They publish their fee structures online, so you know exactly what you will be paying. But it will work out far more expensive than taking the DIY approach.
AES, for example, charges from 1.25 per cent of your portfolio’s value for investment advice; somebody with a $250,000 portfolio would pay $3,125 a year. Annual fees start at 1.75 per cent for full financial planning.
Killik charges 1.25 per cent on the first Â£250,000 held in a managed portfolio of funds, with a minimum charge of Â£250 a quarter. This falls the more you hold, to a minimum of 0.5 per cent on sums over Â£750,000.
However, as Mr Hitchen adds: “In both developed markets and the Gulf, private investors are increasingly making investment decisions for themselves.”
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