Location, Location, Asset Location
Your retirement savings (and any other savings) are only ever made up of only five types of asset:
-Cash on deposit
-Property (and other physical assets, like gold)
-Fixed interest stock (and different types of loans)
-Financial instruments and contracts (including guarantees)
We mix the various types of asset types to create portfolios and funds, and then we develop products by choosing different locations to hold them.
Asset location is the mysterious twin of asset allocation. Financial planners and asset managers talk endlessly about the importance of asset allocation but rarely mention asset location.
Asset location, which refers to where we hold our retirement savings, can be just as important as asset allocation, but less formal research and financial journalism is devoted to it.
Perhaps that is because it hasn’t had a catchy name …until recently.
Asset location determines how an investment is taxed, how (or if) your savings are protected, and how easy it is to access your funds.
Where might your retirement savings be located, then?
Your retirement savings will probably be located in the UK, but there has been an increase in the amount of savings being held overseas, as a result of the rise in popularity of Exchange Traded Funds, which tend to be based in Ireland and Luxembourg.
Many investors hold a proportion of their savings in offshore bonds, which are often based on the Isle of Man or Ireland.
There are a variety of different investment products in the UK (think of them as regional asset location):
-(Self-invested) Personal Pension
-Individual Savings Account
-General Investment Account
-Deposit account with a bank or building society
-With an insurance company (in one of their bonds)
And for those of us with share certificates, asset location may be in the safe or filing cabinet!
If we take a deposit account, in asset location terms, it can be described as follows:
-Any interest payable is subject to income tax (with the first £1,000 tax-free for most savers).
-The first £85,000 of capital is protected by the UK government through the Financial Services Compensation Scheme.
-You can access your money in a few days (unless you have chosen a notice or fixed-term account.
A deposit account is a simple example, but could you describe your pension using the same characteristics of taxation, protection and access?
Asset location hasn’t been a popular topic of discussion, and many people skim over it in a rush to talk about asset allocation. However, asset location presents risks which are just as significant as asset allocation, and which can have a significant impact on your financial well-being in retirement.
Unlike asset allocation, governments have the power to change the characteristics of your asset location. We’ve been lulled into a sense of security by many recent changes, such as pension freedoms and the increase in the FSCS protection level for bank deposits. But don’t forget that changes can go the other way too (e.g. the reductions in the Lifetime Allowance for pensions).
Combined with this, it can be more difficult, and occasionally impossible to change asset location. It’s still not possible to remove money from a pension until you are 55, for example.
Governments can make changes to the taxation, protection and accessibility of assets held in a particular location, at very short notice. From an asset location perspective, pensions can carry significant risk, particularly for the young, therefore.
It’s not hard to imagine the minimum age for withdrawals being increased ahead of schedule, in the future, for example (the minimum age is currently set to rise to 57 in 2028)
When saving money for the future, it may be advisable to consider the location of the assets you hold, and the potential risks presented by this location.
Many asset management firms have been keen to recommend ETFs domiciled in Ireland or Luxembourg, without considering the additional risks presented. Could taxation, protection and access change when (if?) leave the EU?
The risks of asset location can be reviewed by considering the frequency of changes in the past to taxation, protection and access, and then assessing the likelihood of change in the future.
Based on this, I would describe the asset location risks of an ISA as low, as changes have been infrequent and there is little expectation of future change; it’s also easy to release money from your ISA.
Pensions pose greater asset location risks, particularly if you are some years before your 55th birthday; the basis of tax could change (it has done frequently in the past) and so too could access to your money. It’s fair to say that UK based assets present less asset location risk than those locations abroad – we have a better understanding of our own cultural norms and what our government might try to get away with than we do for other countries.
Many UK citizens almost learnt the hard way when they chose Iceland as the location of their cash savings.
If you are unsure about the taxation, protection or access to your retirement assets, ask your adviser about asset location; a good adviser should be able to describe the features of the locations of your assets in terms of taxation, protection, and access, and help you to understand the asset location risks you face.