The pros and cons of switching PEPs

MONEY Q&A

You answered a letter from a reader unsure of whether or not to cash in an investment in a Virgin index-tracking PEP. I was surprised to see that you did not suggest switching the PEP investment to the Virgin Income PEP to keep the PEP benefits while avoiding stock market falls. This would gain more income, which might exceed possible future capital gain. My wife and I have both types of Virgin PEPs and understood we could switch between investments. Is it not appropriate to do so now ?

RS, Hertfordshire

Virgin runs two basic investment products - a Growth PEP tracking the FT-SE All Share index and an Income PEP. You can indeed switch between the two. One argument against switching between any funds is that the switching process can be costly. Typically, you will cash in one fund at the lower "bid" price and reinvest in another at the higher "offer" price. And that bid/offer spread could be incurred again when you think it is safe to switch back to a stock market growth fund.

This argument is less strong with Virgin. There is stamp duty of 0.5 per cent when you switch out of its Growth Fund in the first five years but there is no other charge by way of a bid/offer spread. The Virgin PEPs have one price whether you are buying or selling.

One caveat. As with other fund managers, Virgin reserves the right to change the basis of the pricing from the higher cost of buying the underlying share to the lower cost of selling them. It can move to this lower price if money being withdrawn from the fund exceeds new investment. So you could still cash in at the lower price and then, if you want to reinvest later, reinvest in the fund when it is back at its normal higher price basis. This is a potential but almost hidden cost.

Incidentally, this ability to vary the basis on which the price of the units is worked out is available to all unit trust managers and is often in addition to the potential cost of the bid/offer spread. The combination of the bid/offer spread and a switch in pricing basis could lose the investor the best part of 10 per cent.

But back to Virgin's Income PEP. It is 55 per cent invested in the safest 22 corporate bonds (those with the best credit ratings) and 45 per cent in government gilts, by tracking the five-to-15-year gilts index.

The investment aim is to give a high but secure level of income. You get a quarterly income distribution, currently equivalent to 6.5 per cent annually. The objective is not to provide capital growth, though a small amount of capital growth is possible.

The Income PEP is for investors who want an income, compared with the Growth PEP, which is for those who can take a long-term view (five to 10 years) in order to achieve capital growth. Some might argue that the distinction is meaningless. What matters is total return - income and capital growth. And if the stock market is even now threatening to lose another 10 to 20 per cent in value, why not switch to the Income PEP for six months or so and get a bigger return?

There is (of course) an argument against this. Timing. Perfect investment timing means selling an investment at the peak of its value and buying back into it when it has fallen to its lowest value. Private investors have a reputation for perfectly imperfect timing. They buy after a rise in the stock market when everything looks rosy and you can, apparently, only win. They sell after a fall in the market when everything looks gloomy.

The UK and other stock markets have already fallen. Sell now and you sell after the event (notwithstanding that the market may fall further). Incidentally, professional investors in the City of London may be no better at timing than the private investors. Acknowledge the danger of bad timing and remember that you invest in shares only if you can take a long term view. Consider locking your money away and forgetting about it. That means ignoring the ups and downs of share prices.

Building cover

I have been phoning up direct insurers for a quote for buildings insurance. I have found some potentially worthwhile savings but part of the savings stems from a considerably lower insurance value than my current insurer uses. Should I be tempted ?

LM, Norfolk

Never be tempted to insure for a lower figure than you need. If you do, any payout on legitimate claims could be scaled down in proportion to the level of under-insurance, even though the amount of a claim is within the overall amount insured. One way of getting the correct figure is to hire a surveyor to do the job. Alternatively, you can go down the DIY route. The Association of British Insurers (0171-600 3333) publishes a leaflet on how to work out the rebuilding costs.

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