FOOL'S EYE VIEW
The Next Financial Scandal

By Stuart Watson (TMFTiger)
November 6, 2001

Great Titchfield Street, London -- We ran a poll on our site a couple of weeks ago asking what was the worst financial scandal of recent years? The winner (if that's the right word) was the misselling of endowment policies. Not that far behind were Equitable Life and Railtrack, perhaps because they have received far more press attention recently.

That got me thinking. With the collective knowledge of its community, the Motley Fool should be in an excellent position to identify what the next scandal might be. That's not to say it will be an easy task. Most of our efforts, and the efforts of those who post on our discussion boards, are focused on identifying good companies and products, not avoiding or highlighting bad ones.

Even when you are actively looking, bad investments are not easy to spot. Although many people claim to have foreseen all of the above crises, the truth is that their voices were notably absent before the event. That's partly due to the fact that less people were prepared to listen. But in the main, it's because everyone is a genius with hindsight. It's easy to see mistakes once the facts are clear. However, at the time (more importantly, at the time that something could have been done to avoid the scandal), it's much more difficult to see the correct course of action.

So where may the next scandal be brewing? Let's look at a few possible candidates.

Equitable Life II – This Time It's Everyone Else

The problem of guaranteed annuities is not confined to Equitable Life, although it appears as though this may be the worst example. Many companies sold these products in previous decades. Despite occasional stories in the press, very little seems to have happened to identify other companies that may be at risk.

In fact, with-profits policies in general seem to falling out of favour. Their basic problem stems from the fact that they promise stability of returns. However, they can only offer stability by reducing what they pay out to you and keeping the rest of your money aside for the proverbial rainy day. But funds that produce low returns for their investors don't attract new money, and so life companies are driven towards making promises they can't keep.

Trackers

Could the humble index tracker be a scandal waiting to happen? Has anyone else noticed that in the last few months, many commentators in the weekend press have said they have been 'converted' to trackers. A classic warning sign, if ever there was one. 

Many trackers have been missold on the back of a 20-year bull market. A period of lower returns seems more likely. However, it is the relative return of trackers that is their attraction. If you believe that shares offer the best long-term investment returns, then trackers are the most cost effective way for the majority to get these returns. There will be periods when stock markets will disappoint, but trackers will still be near the top of the performance tables over any period long enough to be worth looking at.

Other products that were sold on the back of the 20-year bull market look to be more likely candidates, especially those with high charges. Our old enemy, the endowment mortgage, still lurks around. And poorly chosen ISA and pension mortgages will also be at risk, unless they are closely monitored and more money is pumped in when deemed necessary.

Stock Market Bonds

These products claim to offer stock market returns without the risk. But that's just not possible, not on the sort of scale that these products are sold. Some of the products offer to only return your capital if certain stock market conditions are met. In many cases, it looks like the stock market may disappoint and capital may be at risk. To make matters worse, these products are often marketed to those least able to understand them.

Something Else?

In all probability, the next major scandal is something that few people are expecting. By definition it has to be. If everyone expects it, then it is likely to be avoided. Could it be something like defined benefit schemes? Could large numbers of them stop taking contributions and freeze benefits at current levels?

Don't Panic!

It's not our intention to throw you into a state of panic. There are many things you can do to protect your wealth. Firstly, keep things simple. If you don't understand the product you are buying, then there is a much greater risk that it may disappoint. Secondly, be cautious when evaluating new products and bear in mind the old adage that if something seems too good to be true, it usually is. If there is a company promising returns better than anyone else, or there are shouts of 'easy money' or 'buy now or miss the boat', keeping your distance is usually the best policy. 

Thirdly, spread your investments around. For example, if you think trackers are the way to go, then look to build up half-a-dozen different ones over several years. But make sure that you don't overdiversify, so that you're unable to keep track of everything, and that your costs aren't increased as a result.

If you think you know what the next scandal will be, let us know on the Fool's Eye View board.