“Yes, I plan to retire at 55” repeated the evening’s host.
A stunned silence settled over the other diners seated at the table. They wore looks varying from quizzical to aghast.
The tense hush was eventually broken by a series of staccato questions:
“Are you serious?” “How is that possible?” “Will you tell me your secret?”
The host kept their cards close to their chest, offering a non-committal answer about finances and pensions.
If you’re presuming that I bravely announced to a dozen others my intentions for early retirement, you’d be sadly incorrect. My secret identity remains just so.
I was, however, present for the above exchange. During it I chose to focus on my dessert (too cheesy) while everyone else stared, goggle-eyed at the seemingly scandalous claims emanating from the other end of the table.
I actually found myself struggling to suppress a grin. Not that retiring at 55yrs seemed comical. I was tickled instead by the other diners, who appeared to have their heads buried so deep in the financial sand that the very notion seemed outrageous to them.
Yet the fallout from the interlude was brief. Heads returned to their warm, comforting sandpits. Conversation moved on.
How far I’ve come
I suppose that a majority of the diners simply sifted the idea into the discard pile. Perhaps rationalising with denial – surely it’s not possible? Or taking the stance that the early-retiree-to-be is a statistical abnormality. An outlier. An anomaly. Maybe that guy won the lottery? Or struck gold?
I wonder what would have happened at dinner if I had followed suit by declaring similar, albeit earlier, intentions? Indeed there was a brief temptation to start explaining how “it’s relatively simple to do if you practice financial discipline and start investing“. I might as well have announced that I was a rabid Covid denier, and would also be explaining why the moon landing was fake and 9/11 was an inside job.
The latter may have gone down better.
The event demonstrated just how my framing of finance has changed. For most of my life retiring early had seemed something that only multimillionaires could do. Now it’s an eminently tangible prospect.
Moving in FI(RE) circles it’s easy to lose perspective. It’s easy to be blinkered to what lies over the bubble’s event horizon. It’s easy to forget how niche FI(RE) truly remains, or that simply investing (without designs for early retirement) continues to be relatively uncommon. This was a welcome reminder of how far I’ve come.
It’s hard to describe why the whole affair made me feel happy. It wasn’t exactly schadenfreude. It was as if I had a naughty, or guilty, secret. An inside joke that only I was privy to. A kernel of hopeful ambition that brings comfort.
Perhaps I was happy because I felt as if I was ahead of the game. Because for what all these others seemed so farfetched is well within the realms of my possibilities.
Robin Powell (The Evidence-Based Investor) and Ben Carlson (A Wealth of Common Sense) are two personal finance content creators who need no introduction. As such, I eagerly took up the opportunity to review their soon-to-be released literary lovechild “Invest Your Way To Financial Freedom; A Simple Guide To Everything You Need To Know”.
Disclaimer: I receive no financial incentive for this review.
The book is pitched at UK-based twenty- and thirty-year olds hoping to achieve financial independence, a demographic into which I fall. The guide is also entry-level, so I did my best to put aside my existing knowledge, viewpoints and biases in order to read it in the guise of a wide-eyed investing newcomer.
With regards to the subtitle of the work, it is a misnomer.
The book is undoubtedly a simple guide. It’s easy-to-read, largely jargon-free and does well to steer clear of dense examples. I’d argue, however, it doesn’t tell you ‘everything’ you need to know. It lays a solid foundation for sure, touching on core financial concepts. All the personal finance tropes are there:
Pay yourself first. No reward without risk. Diversification is the only free lunch in investing. Time in the market not timing the market. The best portfolio is the one that allows you to sleep at night. The best investment strategy is the one you’ll stick with. Money is a means to an end, not an end in and of itself.
Yet the information rarely leaves the realm of that broad base. This is no bad thing – the unadorned overview should allow the interested novice to pursue the avenues of inquiry they feel most appropriate. No, the book does not tell you everything, but provides an excellent series of pillars on which to build your financial future.
Other than a slightly jarring step-up in financial speak at the beginning of the chapter “WhatToInvestIn“, the rest of the book does well to create a smooth journey through saving and investing principles. It beats the passive investing drum, appropriately so given its evidence-based motif.
Overall it is suitably deplete of investment analysis. Naturally equities are top billing in the worked examples, with bonds cast in a supporting role. There is, however, only passing mention of other asset classes and few specific examples of investing in X or Y. The authors prescribe principles, not portfolios.
What stood out for me was the strong theme of that oft-overlooked aspect of wealth-growing; behaviour. The book features sage advice on investing behaviour, including that of the financial celebrity A-team: Buffet, Munger, Graham, Bogle et al. I particularly enjoyed the notion of mental compounding; stacking up the mental victories to provide positive, psychological momentum.
This is pertinent for those thinking about making their first foray into investing. The ‘capital at risk’ warnings that are found around every corner on the route to investing can be utterly dissuasive. I know, having avoided it for many years due to the fear of certain bankruptcy. Carlson and Powell do well to counteract this with a simple message: start as small as you like, but just get started. Their pithy recommendation to “get out of your own way” encapsulates perfectly the behavioural side of personal finance.
I would therefore suggest that both titular aspects of the book are incorrect. “Behave Your Way To Financial Freedom” would be a more apt title in my opinion, albeit one that mayn’t sell as well.
The best of a good bunch
The use of an evidence base, rather than mere opinion, to inform the reader resonates strongly with my own approach to my blog (and my investment practice). In the chapter “Treat Your Savings Like A Netflix Subscription” the exploration of finding the ‘quality of life’ vs. ‘quantity of money’ balance chimes with my feelings on the matter too.
The authors allude to an unfortunate side-effect of the growing availability of investment products – complexity – and counteract it well with axiomatic financial principles. Indeed, the book served as a good reminder of key concepts which, if you’re exploring the depths of the investing warren, can become obscured or forgotten.
In their list of personal finance commandments, I think there’s one that’s more pertinent than all of the rest: talk about money more often. The lack of financial education at school, combined with the British taboo on discussing monetary matters, can lead to an information vacuum. That space is ripe to be filled with the empty, baseless advice of shills, charlatans and ‘finfluencers’. Everyone beginning to explore their financial self could benefit from filling said void with the truths found in this simple guide instead.
Investing in real estate is a popular wealth-building strategy. As it would take the average first-time buyer nine years to save a deposit, buying even one property may seem like a pipe dream. Real estate investment trusts (REITs) are often billed as a way for the everyday investor to stick a finger in the property pie, to become a ‘lazy landlord‘. Should REITs form part of a diversified investment portfolio?
Returns from REITs
It’s important to avoid conflating the returns of REITs with those of real estate. The latter are difficult to divine and can be manipulated to support one’s argument (1). Although in the long term the returns may be similar, I’ve tried to keep things purely ‘REIT’ for my own research.
Similarly, the time period examined is all-important, and it can also be subtly twisted to fit a narrative. For example, anyone looking at REITs’ performance c. 2008 wouldn’t touch them with a barge pole. I’ve mitigated this by quoting the relevant time period where possible.
UK REITs recently celebrated a fifteenth birthday following their advent in January 2007. How has this fairly nascent market fared in that time?
UK REITs have provided annualised returns of between 3.9% and 5.1% since 2016, depending on which source you use (2,3). It was a bumpy ride too. The FTSE EPRA Nareit UK REIT index has a 5yr volatility of nearly 17%, provided negative returns in four of the past ten years and had a maximum drawdown of -38% during that time.
Over a 2009-2019 timeframe the outlook was a little rosier, with 10yr returns of 9.7%. This was greater than both UK equities (9.1%) and gilts (8.5%). REITs paid out dividends at inflation-beating rates too.
The UK REIT market remains a relative fledgling space, one that “needs to grow” (4). If you do buy UK REITs, be careful about which day of the week you buy them on (5)!
Perhaps you don’t want to invest exclusively in UK REITs though – what about returns from the country with the longest running REIT market?
US REITs have been around since the 1960’s. The Nareit Equity REIT Index (an index of US REITs) had an annualised return of 7.1% for the fifteen years 2006 – 2020. Returns lagged behind those of large-cap & small-cap stocks, and high yield bonds, and with greater volatility to boot (7).
Since 2008 the returns (7% vs. 9%) and volatility (24% vs. <20%) of the Vanguard Real Estate ETF were worse than iShares’ large- and mid-cap US equity ETFs (8). Over a longer timeframe (2001-2020), however, REITs had a greater annualised return (9.7%) than all other asset classes (9). They still had the highest volatility though.
Expanding the timeframe even further (1994 – 2019), the returns from US REITs remain about 9-10% (10), similar to portfolios of entirely US equities or a 50/50 blend of equities/REITs. The catch is in the risk however, with more volatility from a 100% REIT portfolio (19% vs. 15%), and a maximum drawdown of -70%, which was at least 10% greater than the other portfolios.
In the long run, returns between US REITs and the S&P500 are fairly similar. Since 1972 annualised returns of the FTSE Nareit All REIT Index have been 11 – 13% (11, 12). Over the same time period the S&P500 returned 12.2%. In general, US REITs appear to match or outperform US equities over longer periods, typically those of more than 15 years (11, 13 – 15).
2006 – 2020
Nareit Equity REIT Index
9.9% / 16.7%
2008 – 2021
Vanguard Real Estate ETF
9.8% / 17.8%
1994 – 2019
9.3% / 18.0%
1972 – 2019
FTSE Nareit All Equity REITs
12.2% / 17.4%
1972 – 2020
FTSE Nareit All REIT
10.8% / 17.2%
The returns from various US REIT funds/indices over different time periods. Overall the trend is that returns are better over longer timeframes. Over shorter lengths of time the returns from US REITs appeared to lag behind US equities and the REITs had greater volatility. In the long run returns appear to match, if not outstrip, those from equities.
What does the future hold? Blackrock predict 30yr annualised returns from US core real estate of 6.4% (range 2.5% – 10.4%) and 12.3% volatility (16).
If you’re following a globally diversified, passive investing approach then you may prefer to sample REITs from all corners of the Earth rather than those from any one region.
Between 2005 and 2014, global REITs had an annualised average return of 6.7% (17). The FTSE EPRA Nareit Developed REIT index, which comprises a blend of North American, European and Asian real estate markets, has had a reasonably up-and-down time over the past 20yrs (18).
The iShares Global REIT ETF has an average annual return of 4.9% over five years, or 6% over seven years, similar to the FTSE EPRA Nareit Global REITs Index (3) Over ten years the price returns are similar from both the S&P Global REIT Index (4.7%) and MSCI World REIT Index (5.5%). The latter’s volatility was 1% higher than the corresponding global equity fund in that time. Consequently the equity fund had a Sharpe (risk-return) ratio that was nearly twice as high. In general, REIT returns carry more volatility risk than their corresponding equity indices across multiple developed markets (20).
Monevator’s ‘slow and steady passive portfolio’ provides a useful case study of asset class performance (19). Their global property allocation has gained 38% since 2011, which lags significantly behind other sectors such as emerging market equities (59%), global small cap equities (79%) and developed world ex-UK equities (89%). Indeed only their bond and UK equity holdings have performed worse. Their real estate fund, however, doesn’t contain exclusively REITs.
My take home is that, in the short term, the returns on REITs have historically fallen short of those on equities, with the unwelcome addition of greater volatility. Over longer time periods the returns may approximate to (or even surpass) those of equities, though the volatility risk remains.
I wondered whether REITs perhaps offer a diversification benefit for equities, which might merit their inclusion in a portfolio even if their risk-adjusted returns did not.
Unlike returns, the timespan doesn’t appear to greatly affect REITs’ correlation with equities. During a 40 year period (1970-2010), REITs were highly correlated with both equities and bonds (21). Of interest, commodities offered the greatest diversification hedge in that time.
Multiple sources demonstrate high (typically ≥0.7) correlation between US REITs and US equities (7, 8, 13, 22 – 25). Other findings include: • Moderate-to-high correlation with global equities • Variable correlations with bonds, ranging from moderately negative to moderately positive • Low-to-moderate correlation with commodities • Low/no correlation with cash
This relationship isn’t confined to US REITs, with a similar picture across European, Asian and Global REIT markets too (26 – 28).
Ben Carlson hit the nail on the end when he concluded that “investors say they want non-correlated assets but what they really want is non-correlated assets that don’t get crushed when stocks fall” (29). The evidence suggests that REITs aren’t going to offer that sort of benefit, correlating highly with equities during market downturns (30). Indeed Larry Swedroe has called REITs an “equity security with only marginal diversification benefits” (31).
There’s a smorgasbord of different types of REIT, but correlations among them also appears to be high (28, 32). Despite this there’s evidence to suggest that a global REIT portfolio performs better than one that’s country- or region-specific (33, 34).
Real estate is often lauded as an inflation hedge – could REITs provide a similar benefit? One analysis found conflicting results among six studies that assessed the ability of REITs to act as an inflation hedge (35). Dipping into said studies, the theme appeared to be that REITs are a better inflation hedge over the long-term, as are global REITs rather than US-only ones.
Smoke and mirrors
There’s some doubt as to whether REITs even constitute an independent asset class. According to one study (36), the returns of REITs could be achieved by using a portfolio of small cap value stocks (2/3rds) and long-term corporate bonds (1/3rd) – this blend even had better risk-return characteristics than REITs. It does indeed appear that REITs behave like equities in the short-term, only acting as a real estate asset over longer time periods (35, 37 – 38).
I would hazard that the average retail investor is probably uninterested by this. Sure they could gain the same returns from REITs, without the idiosyncratic real estate market risk, by using a blend of small cap equities and corporate bonds. But they’re probably more interested in feeling like they have some real estate exposure. So that if real estate explodes in value then they’ve already put their finger in the pie.
Space for REITs in your portfolio?
Taken in isolation, REITs appear to offer equity-ish returns but with higher volatility. They function as neither a diversifier for equities nor an inflation-hedging asset. Could they still be some use as part of a multi-asset portfolio?
One paper, from 2006, suggests that the difference in returns between REITs and equities should influence portfolio allocation, rather than their price correlation (39). However we know that the time period over which REITs’ performance is assessed can lead to higher or lower return figures, and consequently a different optimal allocation in a portfolio (40).
Adding 10% REITs to a 60/40 portfolio [i.e. making a 52/38/10 portfolio of equities, bonds and REITs] marginally improved annualised returns (+0.1%) and reduced volatility (-0.1%). Looking at ten year rolling periods from the 1990-2014 timeframe, the addition of REITs improved returns 80% of the time and reduced volatility 65% of the time (41).
A different analysis found that before 2006 adding 10% or 20% to a 60/40 portfolio did not significantly impact upon returns. After 2006, doing so only increased the value at risk (42).
One blogger publishes their REIT-containing USD growth portfolio. It consists of 27% REITs, as well as equities (27%), bonds (22%), gold (22%) and cash (1%). It boasts 16.1% annualised returns since 2005 (44). They’ve back-tested it against other portfolios: • A 1/3rd each equity/bond/gold portfolio • A 50/50 equity/bond portfolio • An S&P 500 ETF
The 27% REIT portfolio had a CAGR of 10%, which was comparable to the other three (9.5%, 9.5% and 10.2% respectively). It did so with comparatively middling volatility of 9.9% (vs. 8.9%, 8.3% and 15%) and a lesser maximum drawdown of -15% (vs. -17%, -18% and -50%). This would appear to support the case for REITs as part of a multi-asset portfolio, although this is a USD-denominated portfolio that is unlikely to suit those wanting a global approach.
Conversely, a study found that REIT allocations of 10 – 30%, as part of an equity/REIT portfolio, did not improve risk-return or drawdowns compared to the 100% equity portfolio (27). Delving a bit deeper, REITs were the only strategy in their analysis that would have decreased risk-adjusted returns of an equity portfolio (2010 – 2019). Other strategies, e.g. dividend stocks, high-yield bonds or low-volatility portfolio, provided better risk-adjusted returns than REITs. In fact one paper found that no optimally risk-adjusted portfolio featured a real estate index (45).
In a series of copy-paste papers, Newell and Marzuki examined the portfolio diversification benefits of various country-specific REITs. They found that UK, German, French and Spanish REITs all demonstrate limited diversification benefits (46 – 48), although the same isn’t necessarily true of Irish or Belgian REITs (49, 50). This is supported by a similar finding across the European REIT market (51).
I had a play around with the portfolio-finder tool over at Portfolio Charts. I asked it to find the portfolios with the best historical risk-adjusted returns. Sadly the modelling is constrained by having equal asset class weighting and only up to ten different assets.
Nevertheless, US REITs featured in eight of the ten best risk-adjusted return portfolios. The best portfolio [US all-cap equities, ex-US intermediate bonds, gold and US REITs] had a conservative long-term return of 4.9% and an ‘ulcer index’ (a composite measure of drawdown depth, length, and frequency) of 5.4%.
Tinkering even further, I added 5, 10, 15% or 20% US REITs to a 100% global equity portfolio:
REIT allocation (%)
Average return (%)
Loss Freq. (%)
Ulcer index (%)
Start date sensitivity (%)
SWR (40yr; %)
The addition of REITs to a 100% equity portfolio provided only marginal improvements across a spectrum of performance markers.
It was a similar story when I back-tested various portfolios using Portfolio Visualizer. The addition of REITs provided some benefits, but nothing earth-shattering.
How much is enough?
You can find recommendations for just about any allocation to REITs in your portfolio. They are entirely absent from a number of classically described portfolios, which may be reassuring to the REIT-less investor.
Of the 19 ‘professional’ portfolios on Portfolio Charts, ten contain REITs. At the lower end of the spectrum is a 4% allocation in the global market portfolio, although the original paper features a portfolio of 3.3% real estate and not explicitly as REITs (52). Most of the portfolios contain 5 – 8% REITs. The highest allocation is 20% (Ivy League and Swensen portfolios), although Swensen later revised his suggested REIT allocation to 15% following the global financial crisis.
Among the personal finance bloggers who publicise having REITs in their portfolio, there’s a trend towards a slightly higher allocation – the median value is closer to 10%. Various sources (38, 53, 54) suggest optimal allocations of 15 – 25%, although of note none contain data from the past ten years, which makes their applicability debatable.
Index investing guru Jack Bogle supposedly said of REITs: “I could see an investor owning the Vanguard REIT fund, but I don’t think they should make it more than 10 percent of his or her portfolio. No one should get overexposed to any one sector, and I’d be especially cautious when that sector is hot.”
In my opinion, REITs shouldn’t be seen as the direct surrogate for property investing they are sometimes made out to be. Their relationship to real estate (and equity) returns is nuanced.
Globally the REIT market is still fairly juvenile, especially outside of the US. As more countries adopt the approach both the performance characteristics of REITs and their correlation with other asset classes may change.
I personally found little compelling evidence that REITs are a must-have in a portfolio. To be fair there wasn’t a great deal to suggest including them would be too perilous either. Overall I suspect there could be a strong behavioural element in the decision to invest in a REIT, especially for the investor otherwise devoid of (physical) real estate.
References 1 – How To “Lie” With Personal Finance – Part 2 (Homeownership Edition). Early Retirement Now. 2019. Link 2 – Private real estate versus REITs – which performs best over the long term? T Fong. Schroders. 2020. Link 3 – FTSE EPRA Nareit UK Index Factsheet. FTSE Russell. 2021. Link 4 – How to solve a problem like liquidity: REITs and the UK property sector. FT Adviser. 2019. Link 5 – UK REIT sector needs to ‘grow a lot bigger,’ say top property executives. C McElroy. S&P Global Market Intelligence. 2021. Link 6 – UK REITs don’t like Mondays. A Jadevicius & S Lee. Journal of Property Investment & Finance. 2017. Link 7 – Guide to the Markets. JP Morgan Market Insights. 2021. Link 8 – Asset Class Correlations. Portfolio Visualizer. 2021. Link 9 – Asset Allocation Diversification – 20 Years of the Best and Worst. MFS. 2021. Link 10 – Alternative investments. Mindfully investing. Link 11 – REITs vs. Stocks: What Does the Data Say? M DiLallo. Millionacres. 2020. Link 12 – Annual Returns by Investment Sector: 1972 – 2020. Nareit. Link 13 – Why I’m Lukewarm on Real Estate. A Arnott. Morningstar. 2021. Link 14 – REIT Average & Historical Returns Vs. U.S. Stocks. N Funari. Nareit. 2020. Link 15 – REITWatch: A Monthly Statistical Report on the Real Estate Investment Trust Industry. Nareit. 2021. Link 16 – Capital market assumptions. Blackrock Investment Institute. 2021. Link 17 – What Do Global REITs Add to a Portfolio? G Fisher. Forbes. 2015. Link 18 – The Callan Periodic Table of Investment Returns: Year-End 2020. Callan. Link 19 – The Slow and Steady passive portfolio update: Q2 2021. The Accumulator. Monevator. 2021. Link 20 – Extreme returns and value at risk in international securitized real estate markets. K H Liow. Journal of Property Investment & Finance. 2008. Link 21 – The Effectiveness of Asset Classes in Hedging Risk. L Garcia-Feijoo et al. The Journal of Portfolio Management. 2012, 38 (3) 40-55. Link 22 – Asset Class Correlation Map. Guggenheim Investments. Link 23 – Long-Term Capital Market Assumptions Matrices. JP Morgan. Link 24 – Correlation Matrix for the 14 Asset Classes. Morningstar. Link 25 – Asset Class and Portfolio Risk and Return. AA Research Affiliates. Link 26 – REITs and Correlations with Other Asset Classes: A European Perspective. J Niskanen & H Falkenbach. Journal of Real Estate Portfolio Management. 2010, 16 (3). Link 27 – The Case Against REITs. N Rabener. Factor Research. 2019. Link 28 – Chartbook: SREITs & Property Trusts. SGX Research. 2021. Link 29 – Is Real Estate a Non-Correlated Asset Class? B Carlson. A Wealth of Common Sense. 2018. Link 30 – Extreme Risk Measures for International REIT Markets. J Zhou & RI Anderson. The Journal of Real Estate Finance and Economics. 2012, 45; 152 – 170. Link 31 – The Role of REITs in a Diversified Portfolio. L Swedroe. Advisor Perspectives. 2017. Link 32 – Investing In REITs – Are Real Estate Investment Trusts a Good Investment? Pensioncraft. 2020. Link 33 – Is there convergence between the BRICS and International REIT Markets? Akinsomi et al. 2018. Link 34 – REITs Portfolio Optimization: A Nonlinear Generalized Reduced Gradient Approach. RYM Li & A Chan. International Conference on Modeling, Simulation and Optimization. 2018. Link 35 – What are the inflation beating asset classes? Schroders Investment Perspectives. Link 36 – Are REITs a Distinct Asset Class? J Kizer & S Grover. 2017. Link 37 – The Rate of Return on Everything, 1870–2015. O Jordà et al. Federal Reserve Bank of San Francisco. 2017. Link 38 – The Case for REITs in the Mixed-Asset Portfolio in the Short and Long Run. S Lee & S Stevenson. 2002. Link 39 – The Stock-REIT Relationship and Optimal Asset Allocations. D Waggle & P Agrrawal. Journal of Real EstatePortfolio Management. 2006, 12 (3). Link 40 – Mean‐variance analysis with REITs in mixed asset portfolios: The return interval and the time period used for the estimation of inputs. D Waggle & G Moon. Managerial Finance. 2006. Link 41 – Why We Believe Your Portfolio Needs Global REITs. Gerstein Fisher. 2014. Link 42 – REITs in a Mixed-Asset Portfolio: An Investigation of Extreme Risks. S Stelk et al. The Journal of Alternative Investments. 2017, 20 (1) 81-91. Link 43 – Taking a Global Approach to Investing in Public Real Estate. Gerstein Fisher. 2014. Link 44 – USD Growth Portfolio. The Obvious Investor. Link 45 – Real Estate Betas and the Implications for Asset Allocation. P Mladina. Journal of Investing. 2018. Link 46 – The significance and performance of UK-REITs in a mixed-asset portfolio. G Newell & J Marzuki. Journal of European Real Estate Research. 2016, 9(2):171-182. Link 47 – The emergence and performance of German REITs. G Newell & J Marzuki. Journal of Property Investment & Finance. 2018. Link 48 – The emergence of Spanish REITs. G Newell & J Marzuki. Journal of Property Investment & Finance. 2018. Link 49 – The development and initial performance analysis of REITs in Ireland. G Newell & J Marzuki. Journal of Property Investment & Finance. 2019. Link 50 – The evolution of Belgium REITs. G Newell & J Marzuki. Journal of Property Investment & Finance. 2019. Link 51 – The Return Performance of Real Estate Investment Trusts (REITs) and Portfolio Diversification Benefits: Evidence From the European Market. P Alexis & P Alexakis. Recent Advances and Applications in Alternative Investments. 2020. Link 52 – Historical Returns of the Market Portfolio. R Doeswijk et al. Review of Asset Pricing Studies. 2019. Link 53 – Investing in Mixed-Asset Portfolios: The Ex-Post Performance. C Fugazza et al. Centre for Research on Pensions and Welfare Policies. Link 54 – Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes. N Bekkers et al. The Journal of Wealth Management. 2009, 12(3). Link
All the ‘hacks’, tweaks and resetting proved futile in the face of an overriding hardware failure. My moribund mobile had had a good innings. It excelled for over five years, which my research tells me is pretty good going for a modern smartphone.
Despite having neither case nor screen-protector, and the physical properties of a wet bar of soap, the phone was otherwise in reasonable nick. Still, I would have to buy a new one.
I recall reading an article on the (now dormant) FI Fox blog about buying a new smartphone. The author takes you through their diligent approach to ensuring they receive the best value for money on their purchase. It’s basically frugality porn.
I think the article stuck in my mind because I remember thinking “if FI(RE) involves this much thinking about every purchase, then I’m not sure it’s for me”. To each their own, but it felt like an extraordinary effort to save money on a smartphone.
Six months later I launched MedFI, and continue to explore my own understanding and experience of frugality, saving, investing and financial independence. One of my key takeaways to date is that it’s not all about quantity (i.e. saving money) or quality (i.e. buying the most expensive thing), but rather the intricate balance between the two that you need to strike.
That is, don’t be afraid to spend money on the things that enrich the quality of your life.
As I was deciding which avenue to pursue with regards to a new phone, I listed all the activities that I use my smartphone for. The list quickly came to thirty roles that it plays on a near-daily basis. It’s all fairly productive too – there’s no social media on my phone, nor games, nor other apps that suck time and life into their abyss.
I concluded that having a phone of a high quality, that can do all that I desire of it, that isn’t going to be obsolete tomorrow, that will (hopefully) last another 5+ years, is worth the cost to me. So call me a materialistic, consumerist capitalist pig, but I decided to pursue the ‘upper echelon’ of available smartphones.
Even as I write this I still feel sort of fraudulent. How can Mr. MedFI espouse spending lots of money on a phone? How disingenuous to preach financial independence whilst frittering money away so wantonly when there are cheaper alternatives?
I suppose the crux is that a financially independent state only exists so long as your expenditure remains consistent. If buying the cheapest, tinniest, mobile will fulfil your smartphone-related desires in perpetuity then that’s fine.
If you scrimp, save and thrift your way to FI(RE) by denying yourself the latest iPhone 30X Pro or Samsung s83, then your expenditure is pegged to that level. Once you reach a financially independent state, there’s not magically going to be more money to splurge on the latest technology.
It’s classic ‘cocktails on a beach’ thinking. Are you spending your money on cocktails on a beach whilst employed? If not, what makes you think you’ll suddenly have the money to do so once you’re financially independent? (Granted if the impediment to seaside-based inebriation is time or opportunity rather than money, it’s a slightly different story.)
New habits die hard
I decided that buying an upper-end smartphone was justified. It actually gives me a better understanding of my progression to FI(RE), because if the future Mr. MedFI is also going to want to buy a higher-end smartphone, then that needs to be taken into account vis-a-vis saving enough money.
New habits die hard, however, and once I’d selected a suitable replacement I did dig around for ways to chip away at the cost. I won’t go into the frugally explicit detail, but all-in the cost to me of the new phone is ∽88% of the listed price.
And no, having an emergency fund would not have made this affair any smoother. The outlay was easily absorbed by my emergency fund 2.0, yet another sign that the strategy appears to work well for me.
Although a tiny part of me still feels a bit phoney, I am now the proud owner of a new smartphone. This one has a screen-protector and case to boot…
A question that I see cropping up with relative frequency, and often from new doctors, is whether one should eschew the NHS Pension altogether.
On reflection, the NHS Pension series is predicated on an assumption: that you’re sticking with the NHS Pension. It’s easy to be dismissive of those who would consider leaving the pension scheme, but I think it’s important to discuss the pros (for there may be some) and cons of doing so. Let’s flip the narrative around: why might one opt out of the NHS Pension?
I’ve made a host of assumptions while writing this article. They are unlikely to all apply to your personal situation. I’ll put the base assumptions in a footnote and mention where I’ve deviated from them. As ever, please read the disclaimer and seek professional, independent financial advice for recommendations tailored to your individual circumstances.
A bit dear
You might want to opt out of the NHS Pension because you can’t afford it.
The cost of being a member of the NHS Pension, as a percentage of your pensionable pay, rises during your career: → 9.3% [from F1 up to CT/ST2] → 12.5% [during CT/ST3 – 8] → 13.5%+ [as a Consultant] As both pay increases and contribution percentage rises, the cost of the NHS Pension increases non-linearly. It’s far from a negligible amount:
Perhaps you have a mountain of (non-student) debt that you’re keen to eradicate ASAP. The UKPF flowchart, many people’s go-to algorithm for personal finance, suggests that you’re making the minimum payments on all debts and clearing debt with a >10% interest rate before auto-enrolling in your workplace pension.
Perhaps you’re the solo earner in a household and need the extra income to make ends meet. The list of reasons could be endless. For some people that money may be better placed in their pocket rather than their pension.
You might decide to opt out of the pension but then subscribe to it later on when you’re on a more even financial keel. In support of this you could point to the fact that, in terms of benefit, the early years of the NHS Pension don’t count as much.
You’d be correct; the benefit to you in retirement of your F1 pension year is approximately £2,250/yr each and every year until you die. Income for life! For F2 it’s £2,500/yr. That’s lesser than the value of, say, an ST3 year (£3,400/yr) or the first Consultant year (£4,500/yr).
That’s only half the story, however, for the pension you accrue earlier in your career is the cheapest, i.e. the best value for money. The cost of each £1 of pension accrued in your F1 year is 5p. That’s cheaper than your ST3 year (7p), first consultant year (10p) or any other year for that matter.
Described the other way around, you’ll receive £21 of retirement income from every £1 cost of the NHS Pension in F1. Much better than from your ST3 (£14) or first consultant year (£10). That’s a lot more ‘bang for your buck’, so consider carefully whether you want to miss out on such value.
Anything you can do, I can do better
You might want to opt out of the NHS Pension because you feel you can earn better returns on your money elsewhere. I would say this is the most common argument I see against the NHS Pension.
Your NHS Pension doesn’t grow per se, but your pension benefits are revalued annually to the tune of 1.5% + treasury orders (≈ inflation). You perhaps feel that you might achieve more than this guaranteed, real-terms, 1.5% growth. To make comparisons, I’m going to use three fictional individuals:
Zippy, the pensions naysayer. They believe that they can beat the growth of the NHS Pension and that pension tax benefits are overrated. They use ISA’s to invest their money instead. For completeness, I’ll model Zippy’s portfolio using a) just a Lifetime ISA [LISA] b) just a S&S ISA c) a combined approach using both.
Sippy, who decides they can earn greater returns elsewhere, but recognises the tax benefits of pensions. They take the money they would have been paying to be an NHS Pension member and put in a self-invested private pension (SIPP).
Nippy, who simply opts in to the NHS Pension in its most basic form, i.e. without buying extra pension or any other frills.
Value of pension ‘pot’ at retirement
Zippy’s LISA strategy is a bit of a bust. The limit on contributions (£4,000/yr) and not being able to contribute after 50yrs old provides them a LISA value of £590,000 at state pension age. The S&S ISA strategy is a bit more promising, owing to greater contributions for longer – value of their S&S ISA ends up at £1.2m. The joint strategy is the non-pension winner, however, as the combined effect brings Zippy’s best effort to a pot of £1.4m. (I’ll use this strategy in any calculations going forward.)
Sippy’s strategy benefits from their contributions being tax-free and being able to contribute all the way up until retirement. Their private pension has compounded over time, giving them a £1.5m pot, 14% more than Zippy’s best strategy.
What about Nippy? One of the idiosyncrasies of the NHS Pension is that there’s no ‘pot’ of money. The number you calculate is the annual pension you’d receive in retirement e.g. £60,000/yr. Fortunately there’s a way of calculating the capital value of your NHS Pension i.e. the equivalent ‘pot’ size. After doing so, Nippy’s NHS Pension has a capital value of £3m.
Value of pension income during retirement
You might argue that the size of the stash is irrelevant, it’s what you get from it that counts. How many years could each of the three draw an income equivalent to their basic, final salary?
Well for Nippy, they receive a pension income that’s greater than their basic final salary, each and every year from retirement until death. I think this is an under-appreciated point.
It’s grimmer reading for the other two, who may only be able to draw such an income for less than fifteen years. Even accounting for the fact that Nippy & Sippy will be paying income tax on their pension, whereas Zippy won’t, the non-NHS Pension strategies are exposed to some serious longevity risk.
Ah, you say, but Zippy is keeping their money invested instead of converting it to a big pile of cash they draw income from or an annuity. This naturally carries with it a degree of risk, leaving Zippy at the mercy of a deep, long market downturn (sequence of returns risk). If, however, their investment grows steadily, this would extend their ability to draw such a benefit to about twenty years.
My calculations use a consistent 2% inflation rate. Of course inflation is not static for forty years at a time. In the last forty years (1981-2021), UK inflation has ranged from 0.4% to 12%. If inflation balloons, then it absolutely destroys the non-NHS Pension strategies – their value is eroded by lower real returns. Indeed, if inflation was, say, 4%, then you’d need a nominal return on equities of over 13% to match the NHS Pension. By comparison, the NHS Pension continues to grow above inflation by 1.5% regardless.
If inflation stays low, then it hampers the NHS Pension strategy. If it were 0.5% for the duration of the model, then the SIPP strategy ‘only’ needs a nominal annual return of 6.5% to overtake the NHS Pension’s capital value. It’s a similar story with inflation at 1% (7.9% nominal returns) or 1.5% (8.8% nominal returns). That still doesn’t eradicate longevity risk, because the NHS Pension will pay its benefits indefinitelyuntil you die, whereas the SIPP won’t necessarily.
You may feel that a 7% nominal return on equities is conservative. For the other strategies to match the NHS Pension in terms of capital value, you’d have to achieve 9.7% nominal returns for the duration of the accrual period. The S&P500 index has indeed achieved on average that amount over its ~100yr lifetime. Yet its worst twenty year period delivered ‘only’ 6.4%; what if you experienced one or more of these long periods with lower returns?
It’s also easy to retrospectively pick the best performing index from history and use that as a model. The future is much more opaque. How many SIPP investors would stick all their pension savings in one, foreign, stock market index fund and leave it untouched for 30-40yrs? Chances are you’d tinker, chances are you’d diversify your portfolio into fixed income as you near retirement, chances are you’re unlikely to pick the winner of tomorrow, today.
You could conversely argue that a 7% nominal return is outlandish. Long-term data on the returns from equities vs. fixed income has the former outperforming the latter by approximately 4%. Using that 4% nominal return naturally exacerbates the difference between the NHS Pension and the alternatives.
Comparisons to alternative pension options also often neglect the fact that these vehicles come with fees of their own. Appreciably the total cost of a well-priced SIPP (platform fee + ongoing charge) is likely to be <1%, but that’s another <1% you’ll be having to earn in interest to break even.
In addition to longevity and sequence of returns risks there’s a diversification risk with the SIPP and ISA strategies. If both your pension and other investments are in equities, then all of them will lose value if there’s a large and/or prolonged market downturn. The NHS Pension doesn’t suffer this risk; it will revalue by treasury orders + 1.5% whether the market is up, down or sideways.
You might want to opt out of the NHS Pension because you want to exert more control.
The NHS Pension is, largely, outside of your control. There’s no option as to where your money goes. You simply pay your membership fee and then assume the gears of the great bureaucratic engine are turning. This may be unattractive for those who want to rule over their retirement finances with an iron fist.
There are ways of gaining some control within the NHS Pension (e.g. MPAVC’s), but overall these pale in comparison to that of, say, a SIPP.
I like to be in control as much as the next financier (and have the spreadsheets to prove it). Sometimes simplicity and automaticity can be beneficial, however. The inability to tweak and tinker is probably under-appreciated when it comes to investing. There’s that apocryphal story about the best investments belonging to those who either forgot about them or are dead…
If it weren’t for those meddling politicians
You might want to opt out of the NHS Pension because you feel it will be decimated by future legislative changes.
In my opinion there’s ample historical evidence to justify such a presumption. The nature of any interference is less predictable, though you could bet good money that it won’t make the scheme more generous.
You can eliminate this risk by opting out of the NHS Pension full stop. Naturally the downside is that you’ll miss out on the benefits, especially so if drastic detractions fail to materialise. Furthermore, you merely transfer 100% of the risk to whichever other pension roadmap you follow. What if legislative changes are punitive for SIPPs or ISAs just as much? No point moving all your eggs to another basket if it’s going to be dropped too.
My personal feeling is that it’s wiser to diversify pension strategies, to spread (albeit not eliminate) such interference risk.
Leaving the NHS
You might want to opt out of the NHS Pension because you don’t plan on working in the NHS long-term, which may include leaving to work overseas.
Opting out could make matters simpler by avoiding your pensions being spread out across multiple caches and/or countries. Naturally it may be difficult to predict your future career path with any great certainty.
If you were to opt out but then find yourself staying in the NHS, you may have missed out on some of the early benefits described above.
If you were to leave the NHS having already opted in, and wanted to take your pension with you, what happens then?
NHS Pension transfers
It is possible to transfer any existing NHS Pension, both domestically and internationally. As a rule of thumb it’s much easier to transfer out if you’ve been a member of the NHS Pension scheme for less than two years.
With fewer than two years’ membership, you can: • Transfer into other defined benefit (DB) or defined contribution (DC) pension schemes. [The NHS Pension is a type of DB scheme, a SIPP is a type of DC scheme]. • Ask for a refund of your contributions to date • Ask for a break if you intend to return to the NHS Pension scheme later on and don’t want a refund.
It’s still not a simple matter of clicking a few buttons, however. If the transfer value of your pension is over £30,000, you must provide proof of having received independent financial advice before you can proceed. As a reference point, the transfer value of your F1 contributions alone is likely to be over £30,000 (according to different calculators).
With more than two years of membership, things are even more limited. You’re unable to transfer your NHS Pension to DC pensions, though you can transfer to other DB schemes. These restrictions may seem Orwellian, but they’re borne of the fact that DB schemes such as the NHS Pension are so good. The FCA, ever a cautious bunch, say that “in most cases you are likely to be worse off if you transfer out of a defined benefit scheme“.
These sentiments are echoed by the Pensions Regulator, who “believe it is likely to be in the best financial interests of the majority of members to remain in their DB scheme“. Both comment that the value of a transfer is likely to be less than the benefits you’d otherwise receive.
You can ask for a transfer value if you wanted to do the maths yourself. It’s free and you’re not obligated to proceed with a transfer if you do so.
You’re also able to transfer your NHS Pension benefits to certain, HMRC-registered, overseas pension schemes. Some of the same caveats as domestic transfers apply, such as only being able to transfer into DB pension schemes if you have more than two years’ membership.
There are other niggles that could make an international transfer poor value, including: • A possible 25% overseas transfer tax • Being stung by the lifetime allowance [as your pension benefits are tested against it at the time of transfer] • Higher tax rates in your destination country [depending on its tax relationship with the UK]
Transfers, domestic or overseas, are irreversible, which makes them a bit of a nuclear option. Their convoluted and constrained nature could make opting out from the off seem a more attractive option if you foresee your long-term employment being outwith the NHS.
Caution is due, however. As inimitable personal finance guru Pete Matthew concludes: “one thing’s for sure, there is no more controversial, challenging and potentially life-changing financial decision than the choice to transfer out of a DB pension scheme.”
More tax is bad
You might opt out of the NHS Pension because you’re concerned you’ll incur tax penalties, for breaching the annual (AA) and/or lifetime (LTA) allowances.
According to the models I used for comparisons earlier, both the NHS Pension and SIPP strategies would breach the lifetime allowance. It’s difficult, however, to predict what the LTA will be in the future. It’s previously been as high as £1.8m, is frozen at its current £1.07m for the next five tax years and there have been rumours that it’ll be reduced even further. It’s impossible to estimate the value of the LTA at the time of your retirement, though obtaining independent financial advice closer to the time seems a sensible strategy.
The annual allowance, particularly its tapered form, led to many consultants being stung with huge tax bills over the past few years. It’s seen many of them reduce their NHS working hours or indeed leave the service altogether. The government made changes in 2020 to mitigate this effect, which now means the majority of doctors will be unaffected.
Trying to accrue less pension in order to avoid either of these limits is a classic case of letting the tax tail wag the investment dog, an unwise strategy in most cases.
You might opt out of the NHS Pension because you want access to your retirement funds early.
That could be because you plan on early retirement, or simply prefer the flexibility of not having money tied up until a certain age.
In its raw form, the benefits from the NHS Pension can only be taken at state pension age (SPA), which is likely to be 68yrs for most readers. Some believe, not unreasonably, that SPA may well be 70yrs or more in the future. This is more restrictive than other vehicles, where you can withdraw your money earlier e.g. SIPPs (55-57yrs), LISAs (60yrs) or S&S ISAs (anytime).
You can access your NHS Pension early, although it’ll come with its benefits trimmed accordingly. For example, a member who would’ve expected £50,000/yr upon retirement at 68yrs, would only receive £27,000/yr if they claimed benefits at 55yrs instead.
What happens to our three amigos from earlier if they pull the plug on work at 60yrs? Nippy suffers a 33% pension benefit haircut for retiring early. Yet the capital value of their pension still outstrips all the other strategies. Despite the reduction for Nippy, the others lose out from having less time for compound interest to work its effect. They’re still at the mercy of longevity, sequence of returns and diversification risks too.
The NHS Pension has an optional mechanism for limiting the reduction if you did want to retire early; the ‘Early Retirement Reduction Buy Out (ERRBO)’. This allows you to retire up to three years before SPA without incurring a reduction in your benefits, though you’ll have to pay more throughout your career to do so. Whether or not this is ‘worth it’ is both tricky to model and will be highly variable between individuals. Risks of doing so include more eggs in the NHS Pension basket and greater risk of breaching the allowances.
You might want to opt out of the NHS Pension because you think it too complicated.
Undoubtedly the NHS Pension is more complex than your average pension scheme, hence writing the NHS Pension Series in the first place. Its translucent nature can make building a mental framework for what’s going on seem near-impossible. Many would prefer the simpler idea of paying money into a pot, which grows, from which you then withdraw in retirement.
In the face of NHS pension perplexity, opting out is probably the path of least resistance. However, in my opinion, self-education and obtaining professional advice are more rational behaviours, especially when it comes to the money you’ll live off in retirement.
Opting out of the NHS Pension
The point of this exercise isn’t to exalt the NHS Pension and denigrate other retirement strategies, or vice versa. The NHS Pension isn’t perfect, nor without its idiosyncrasies, though it remains a powerful tool for building wealth for retirement.
It’s not for me to tell you that you should or shouldn’t use an NHS Pension. What’s important is that if you’re making a decision, one way or the other, you’ve availed yourself of all the relevant information.
Your choice should be intentional, not on a whim or hearsay. As such, I would implore anyone to seek independent financial advice before thinking about opting out of the NHS Pension.
Assumptions • You’ve already read through the existing NHS Pension series to build a basic understanding of how the NHS Pension functions • Pensionable pay = basic pay as described in the latest NHS Pay Circular • Start F1 at 24yrs old • State pension age 68yrs old • Enter training programme directly from FY2, train to ST8, then work as a consultant thereafter • Work full time throughout • Annual inflation consistently 2% • Annual, nominal (before inflation) return on equities consistently 7% • 25 years of retirement income (68 – 93yrs old) as is the standard for defined benefit pensions (the type that the NHS Pension is) • For comparisons of strategies I use the same gross input, although money put into ISAs is subject to income tax whereas that put into pensions (NHS/SIPP) is not.
Gambling. Speculating. Trading. Investing. Owning the future world currency. Whatever your thoughts about cryptocurrency, what could happen if you put your money in it?
Many will have reaped the rewards of cryptocurrencies’ meteoric rise to a market cap of approximately two trillion dollars. Indeed, few other asset classes could have matched the returns from cryptocurrency over the past year:
Performance of £1,000 invested in different assets (August 2020 – 2021) → Ethereum: £6,650 → Bitcoin: £3,430 → Apple stock: £1,340 → Vanguard FTSE Global All Cap Index fund: £1,250 → Cash: £999 → UK Government Bond fund: £950 → Gold: £880
The heady returns of cryptoassets are, however, only half the story. If the timing was right then you could’ve indeed profited generously. Conversely, if you bought at the peak only to panic as the price dropped, selling off in the trough, that list looks very different:
Performance of £1,000 invested in different assets, buying at peak and cashing out at trough (August 2020 – 2021) → Cash: £999 → Vanguard FTSE Global All Cap Index fund: £960 → UK Government Bond fund: £900 → Gold: £830 → Apple stock: £810 → Bitcoin: £620 → Ethereum: £440
There’s some suggestion that factors such as income, crypto knowledge and belief in crypto ideology are positively correlated with returns (1). In reality, given their volatility, ROI from cryptocurrencies was linked to the timing of your investment.
Up & down
It is this exquisite volatility that makes cryptocurrencies an uncertain bet. One analysis found that Bitcoin had an annualised volatility of 76% [range 35 – 120%] (2). Bitcoin’s weekly volatility is comparable to equities’ annual volatility. The Crypto-Index 20, an index of the top twenty cryptocurrencies by market cap, was significantly more volatile than major equity indices in the UK, Italy, Spain, France and Germany (3). Bitcoin’s price does appear to be decreasing in volatility as it becomes more mainstream, which may make it more attractive as part of an investment portfolio in future (4, 5).
Perhaps crypto’s most troubling facet for a potential investor isn’t volatility, but manipulability. The influence individuals can have over cryptocurrency prices is concerning, as is the prevalence of ‘pump and dump’ (6) scams for smaller coins. These manipulations can cause large price distortions (7). ‘Wash trading’ is another price manipulation strategy, with one study finding the majority of the trading volume on unregulated crypto exchanges to be artificially fabricated (8). Part of cryptocurrencies’ attraction is their decentralised nature, but falling outside the purview of regulatory bodies leaves them vulnerable to these interferences.
All for one
Another issue for would-be investors is the positively correlated price movements between most cryptocurrencies.
There’s a high correlation (>0.8) between the price of Bitcoin and other major cryptocurrencies such as Ethereum, Litecoin and Ripple (9). Bitcoin also shows positive correlation to the majority of altcoins (10). Although data suggests such price associations are fluctuant over time, in general Bitcoin maintains a significant influence on the price of most other cryptocurrencies (11, 12). Of the top ten coins by market cap, only the US dollar-linked USDC and USDT coins have weak/no correlations with the eight others (13). The aforementioned Crypto-Index 20 was more positively correlated than other major European equity indices (3).
Consequentially, within the cryptoasset class, there is less overall (price) diversity to be had. Indeed, one author concludes that “the idea of a diversified cryptocurrency portfolio [is]… a myth” (9) and another calls the high correlation “dangerous” for diversification (14). Despite this, several sources suggest a diversified cryptocurrency portfolio benefits from improved risk-adjusted returns (15 – 17). Overall this makes it difficult to draw any firm conclusions about the ideal way to diversify one’s cryptoassets.
More at stake?
Returns from cryptocurrency needn’t all come after riding a volatility rollercoaster. Staking is an increasingly popular way of generating ‘steadier’ returns from cryptoassets, without suffering at the hands of market timing. The cut and thrust of staking is that you tie up your cryptocurrency for a length of time in order to earn income/interest on it (18). (You’re rewarded for using your cryptocurrency to maintain the operation of a proof-of-stake blockchain system.)
The amount of cryptocurrency being staked has risen sharply, from just shy of $200bn in January to about $600bn in August (19). It’s a tantalising prospect too, with reported annualised rewards of anything from 2% to 31% (18). One site lists the average reward as 14.95% (19).
Benefits of staking (20): • Generates income on top of potential capital gains • Low technological entry requirements (especially vs. ‘mining’) • Some resources allow you to stake with fractions of cryptocurrencies • Removes the temptation to sell your cryptocurrency i.e. time the market
Downsides of staking (21): • Can only stake certain cryptocurrencies • Minimum amount required to stake some coins e.g. 32 Ethereum (∽£75,000 at the time of writing) • Risks inc. security, illiquidity if price crashes, fines for accessing early/node not functioning • Rewards fluctuate frequently • Opportunity cost of owning the crypto required for staking vs. other cryptocurrencies/assets
In my opinion, comparisons to traditional savings accounts (22, 23) downplay the risks associated with staking. You may well earn better interest than the ∽1% offered by 1-year fixed-rate saving accounts (24), but will certainly be taking on extra risk to do so.
If nothing else, the old adage ‘if it sounds too good to be true, it probably is’ should ring loudly in the ears of any would-be stakers. Indeed, one author sagely concludes that “…staking, despite its FOMO-inducing growth, should be approached with caution, especially the newly-created protocols promising suspiciously high rewards” (18).
If cryptocurrency prices are too volatile, and staking too dicey, there are ways of gaining exposure to cryptoassets without necessarily incurring the same risks.
Dollar cost averaging
Dollar-cost averaging (DCA) is a common technique employed to reduce the risk of price volatility, typically that associated with equities (25). It also has behavioural benefits e.g. reducing the temptation to try timing the market. It’s increasingly popular in the crypto world, allowing individuals to slowly accrue cryptocurrencies over time (26). To backtest DCA, I used a comparison of $100/month for a year vs. a $1,300 lump sum (Aug ’20 – ’21).
If the object is to reduce volatility risk, DCA works. Lump sums in Bitcoin [-49%] and Ethereum [-54%] would have lost more value compared to a DCA technique [-33% and -32% respectively] during the Spring 2021 crash (27, 28). The story is similar if the timeframe is expanded out to a 10yr period, and for other cryptocurrencies too. I suppose overall it’s a smoother ride, but by no means plain sailing!
The cost of reducing volatility is, of course, by giving up some returns. DCA investors in Bitcoin and Ethereum would have been worse off than their lump sum counterparts over most any timeframe. The relatively high fees for buying and selling cryptoassets would also eat into the returns from DCA to a greater degree.
Exposure to the growing number of cryptoasset/blockchain/digital asset companies could provide some of the returns without the risk of owning the underlying cryptocurrencies. Which of these companies should one invest in? A diversified approach is likely to be better than betting it all on one business, although one blogger chalked up a seven figure sum from their exposure to one blockchain company (29).
Free-to-trade investment platform Trading 212* allows investment in user-created portfolios (‘pies’.) Crypto pies contain a variety of different companies with ties to the world of cryptocurrency, though they are not robust financial vehicles. Any average joe can make a pie; they are certainly amateur at best.
If you’re after a more professional instrument to gain crypto exposure, then funds may be a better option. Investors may prefer the convenience, familiarity and comfort of buying an ETF rather than individual equities or cryptocurrencies (30).
The Invesco Elwood Global Blockchain UCITS ETF is one of the largest blockchain funds (31). Its closest competitors are smaller, and with less raw cryptocurrency exposure (32). An investment in the Invesco ETF would leave you lagging on returns compared to pure Bitcoin (158% vs. 259%), though you’d have experienced much less volatility. All the options for cryptoasset ETFs are beset by high fees (≥0.65%), which could be off-putting for some investors.
As mentioned in Crypto III, Goldman Sachs are planning to release their own blockchain ETF. However, a look at the index that the ETF will be tracking reveals a fairly generic list of tech companies (33). None stand out has having particular DeFi, blockchain or crypto exposure. It’s almost as if Goldman want to profit from the name of blockchain (34), a strategy that plagues the world of ESG investing and is likely to creep into the crypto space too. Other companies are also at various stages of launching cryptocurrency ETF’s, including JP Morgan and NYDIG.
The CRIX index (35) is a fluid cryptoasset index that currently consists of five cryptocurrencies, although over 85% of it is comprised of just two (Bitcoin & Ethereum). One analysis shows that an investment in CRIX benefited a portfolio’s volatility and return when compared to Bitcoin alone (36). There are a variety of other cryptoasset indices, although investing in them isn’t always possible in the UK (37).
Indeed a major stumbling block to crypto-fund investing in the UK is the current lack of availability and therefore paucity of choice. It may only prove a temporary issue, however. The assets under management in crypto hedge funds nearly doubled from 2019 to 2020 (37), and there are predictions of the imminent arrival of more cryptoasset funds to the UK (38, 39). I expect that in the future investing in such funds will become easier, cheaper and a more popular way of gaining cryptocurrency exposure.
If you already own a diversified set of equities in your portfolio, one option for gaining increased exposure to cryptoassets is to simply do nothing at all.
More and more big name corporate players are getting in on the crypto act. Existing exposure to these companies may be enough to grab onto the coat-tails of crypto’s rising market cap. Furthermore, non-crypto funds are adding digital asset exposure to their holdings (37, 40). For example Blackrock’s Strategic Income Opportunities Fund, a self-styled ‘flexible bond strategy’, is adding the option to own Bitcoin as part of its holdings (41). Others may follow suit (42).
The rewards will almost certainly be lesser than the pure, unfettered exposure of owning cryptocurrencies directly, but it is also likely to be a less risky option.
No asset is an island
With the exception of ardent purists, investors are unlikely to own cryptocurrency in isolation. What impact could cryptoassets have on a multi-asset portfolio. Booster? Diversifier? Makeweight? Lead weight?
There’s reasonable evidence that Bitcoin could act as a diversifying part of a portfolio. Bitcoin demonstrates negligible [-0.1 to +0.1] or only weak positive correlation with a variety of other traditional assets (43, 44), including equities (2, 45), bonds (5) and commodities (12, 46). This could reduce portfolio risk (12, 47, 48). Ethereum demonstrates similar characteristics (49) and may even be a better diversifier (50).
Caution is due, however, as it seems that cryptocurrencies’ correlation with equity markets increases when they are in a downturn (36, 51). This is presumably due to a run from volatile assets during troubled times. Some suggest that Bitcoin’s correlation to equity markets is increasing over time (5, 45). This means that holding cryptocurrencies mayn’t quite have the same protective effect on your portfolio as other traditional diversifying assets such as bonds, property or gold.
What about returns? Most of the data I found seems to suggest cryptocurrencies improve portfolio returns. Care must be taken with the literature, however, as I think there’s likely to be a fair degree of publication bias.
Cryptocurrencies in general seem to improve portfolio risk-return (52 – 54). Bitcoin, added in various amounts to a mixed portfolio, improved performance (2, 5, 45, 50, 53, 56). This appears to be by increasing returns and risk simultaneously. One study concludes that Bitcoin improved risk-adjusted returns to a greater degree than Ethereum (57). Ethereum still improved returns though and with lesser increases in volatility than Bitcoin. I’m sceptical of the idea that cryptocurrencies could improve performance while simultaneously decreasing volatility (58).
As one might expect, the positive impact of crypto on returns was seen in ‘tangency‘ (optimal risk/return) portfolios rather than minimum-variance portfolios. Cryptocurrencies play little-to-no role in improving (53, 54), and may even worsen (36), the latter’s performance.
How much is enough?
“What percentage of my portfolio should be cryptoassets?” is a question that’s ultimately unanswerable. You can find suggestions for just about any allocation, some of them based on nothing more than gut feeling and many relying on less.
A 0% allocation will suit some, particularly those aiming to minimise their portfolio volatility. Unsurprisingly, the head of Bitcoin-laden company Microstrategy believes “a 0% allocation is the wrong number for every investor” (59). One article suggests starting at an allocation of 0.5% and modifying your asset allocation based on how you predict Bitcoin will perform vs. equities (60). A 2020 survey by Fidelity found that the 91% of respondents planned to have a cryptoasset allocation of at least 0.5% (61).
Many of the analyses of cryptocurrency in a mixed portfolio used a 5% allocation to Bitcoin (2, 5). The oft-quoted Yale study (62) suggested a 6% Bitcoin allocation, though it’s probably an out of date recommendation. A more recent paper suggests the optimal amount of cryptocurrency in a portfolio is 4.6% Bitcoin and nothing else (53). That number is almost plumb in the middle of the findings from the ARK group (63), who suggest an allocation of 2.55% (for minimal volatility) or 6.55% (for maximal risk/return). Others prescribe only ‘small’ doses (15, 45).
FI Scribbles suggests <5% of a portfolio in cryptoassets, at least appropriately calling it a “finger in the air” recommendation (64). Foxy Monkey has a similar 5% holding (65). In a rare venture outside of real estate, The Property Podcast propound that if they were a billionaire, they would “absolutely stick…£50m or £100m in Bitcoin”, giving them a <5-10% allocation (66). Perennial personal finance aficionados Monevator have written a framework for deciding whether you should even own any at all (67).
An alternative strategy would be to own a certain amount of a cryptocurrency itself, rather than a certain value. For example, aiming to own 1 whole Bitcoin (73). Or if you believe Bitcoin will one day hold all the world’s capital value, then you only need ~0.003 of a Bitcoin to own your ‘fair share’ (74).
The putative benefits of cryptocurrency in a portfolio appear to be felt even if it only represents a small percentage of your overall holdings. With little robust evidence about the optimal allocation, the maxim ‘only invest what you can afford to lose’ springs to mind.
Watch the space
Cryptocurrencies are likely to remain an attractive investment option for many, owing to their (historical) propensity for high returns. Alongside these potential rewards come high volatility, manipulability and within-class correlation. Methods for reducing volatility risk are available to varying degrees, including dollar-cost averaging, diversification through funds and exposure via existing equities.
There’s reasonable evidence that cryptocurrencies could be a beneficial part of a multi-asset portfolio, diversifying and improving returns in tandem. The optimum allocation to cryptoassets within a portfolio, however, will depend very much on the individual investor’s situation. Most recommendations are for under 5%, but for many a smaller allocation will seem more appropriate.
Overall, drawing long-term conclusions from the short-term data on cryptoassets’ performance is fraught with risk. Increasing adoption may bring reductions in both volatility and trading fees, as well as confidence that the space won’t implode. Conversely, burgeoning popularity may consign the extreme returns of cryptocurrencies to halcyon days. Overall, an attitude towards cryptoassets that’s neither fanatical evangelism nor unconsidered dismissal seems most reasonable.
All prices correct at the time of writing.
*If you sign up using this link we both get a free share.
Disclaimer – I own the following cryptocurrencies: Bitcoin, Ethereum.
References 1 – Returns from Investing in Cryptocurrency: Evidence from German Individual Investors. Ante et al. BRL Working Paper Series No. 6. 2020. Link 2 – Bitcoin: An Asset Allocation. A Lux. Lightfinance blog. May 2021. Link 3 – Modeling the optimal diversification opportunities: the case of cryp to portfolios and equity portfolios. F Aliu et al. Studies in Economics and Finance. 2020. Link 4 – The Bitcoin Volatility Index. Link 5 – How a Little Bitcoin Can Change Your 60/40 Portfolio a Lot. A Millson. Morningstar. June 2021. Link 6 – Pump and Dump. R Dhir. Investopedia. June 2021. Link 7 – A New Wolf in Town? Pump-and-Dump Manipulation in Cryptocurrency Markets. A Dhawan et al. 2020. Link 8 – Crypto Wash Trading. LW Cong et al. 2019. Link 9 – You Don’t Need a Diversified Crypto Portfolio to Spread Risk: Here’s Why. Kenny L. Towards Data Science. 2018. Link 10 – Bitcoin and Altcoins Price Correlations. Link 11 – Bitcoin-Ethereum price correlation. Coinmetrics. Link 12 – An analysis of cryptocurrencies conditional cross correlations. N Aslanidis et al. Finance Research Letters. 2019, (31):C, 130-137. Link 13 – Cryptowatch Cryptocurrency correlations. Link 14 – Portfolio Optimalization on Digital Currency Market. J Mazanac. Journal of Risk and Financial Management. 2021, (14), 160. Link 15 – Conditional tail-risk in cryptocurrency markets. N Borri. Journal of Empirical Finance. 2019, (50), 1-19. Link 16 – Cryptocurrency-portfolios in a mean-variance framework. A Brauneis & R Mestel. Finance Research Letters. 2019. (28), 259-264. Link 17 – Portfolio diversification across cryptocurrencies. W Liu. Finance Research Letters. 2019. (29), 200-205. Link 18 – Crypto Staking Guide 2021. W Vermaak. Alexandria 2021. Link 19 – Staking Rewards. Link 20 – A Beginner’s Guide to Crypto Staking. A Lielacher. Trust Wallet. 2021. Link 21 – Cryptocurrency Staking | Definitive Guide 2021 | ADA, XTZ, DOT, ALGO, ETH. J Major. Finance in Bold. 2021. Link 22 – Will Crypto Staking Replace Traditional Savings Accounts?. A Lielacher. Trust Wallet. 2020. Link 23 – Ultimate Staking Guide: Overview of Best Crypto-Projects to Stake with PoS and DPoS (Profitability, User Experience, Low-Risk). u/icysx. 2021. Link 24 – Top Savings Accounts. Money Saving Expert. 2021. Link 25 – Dollar Cost Averaging. J Chen. Investopedia. 2021. Link 26 – What is Dollar Cost Averaging? CostAVG. Link 27 – Dollar Cost Averaging Bitcoin Calculator. Link 28 – Dollar Cost Averaging Calculator For Cryptocurrency. Link 29 – Thanks a Million! Bank Compliance Department Causes £1m Crypto Profit. Finimus. 2021. Link 30 – Are Crypto ETFs Coming? Morningstar. 2021. Link 31 – The best Blockchain ETFs. Just ETF.Link 32 – Blockchain ETFs: a way to gain bitcoin exposure? T Bailey. Interactive Investor. 2021. Link 33 – Solactive Blockchain Technology Performance-Index Factsheet. Solactive. August 2021. Link 34 – What’s in a name? A lot if it has “blockchain”. P Sharma et al. Economics Letters. 2020, (186). Link. 35 – The CRIX (CRypto IndeX). Link 36 – Bitcoin is not the New Gold – A comparison of volatility, correlation, and portfolio performance. T Klein et al. International Review of Financial Analysis. 2018, (59): 105-116. Link 37 – The Ultimate Guide on Cryptocurrency Index Funds. Hodlbot. 2019. Link 37 – 3rd Annual Global Crypto Hedge Fund Report 2021. PWC. Link 38 – Bitcoin ETP takes Swiss route to UK after cautious London response. P Stafford and L Fletcher. Financial Times. 2021. Link 39 – Coinbase expects Bitcoin ETF approval by end of 2021. Diana. Blockchain Today. 2021. Link 40 – Are Cryptocurrencies Lurking in Your Funds? Morningstar. 2021. Link 41 – BlackRock Strategic Income Opportunities Portfolio. Statement of additional information. SEC Filing. January 2021. Link 42 – Bitcoin Could Spread to More Fixed-Income Funds. K Anderson & B Joseph. Morningstar. 2021. Link 43 – Live Correlation Matrix (All Assets). Long short signal. August 2021. Link 44 – Risks and returns of cryptocurrency. Y Liu and A Tsyvinski. National Bureau of Economic Research. 2018. Link 45 – Does Your Portfolio Need Bitcoin? A Arnott. Morningstar. 2021. Link 46 – The economic value of Bitcoin: A portfolio analysis of currencies, gold, oil and stocks. E Smitsyi et al. Research in International Business and Finance. 2019, (48): 97-110. Link 47 – Portfolio diversification with virtual currency: Evidence from bitcoin. K Guesmi et al. International Review of Financial Analysis. 2019, (63): 431-437. Link 48 – Diversification benefits in the cryptocurrency market under mild explosivity. S Anyfantaki et al. European Journal of Operational Research. 2021, (295):1, 378-393. Link 49 – Ethereum as a Hedge: The intraday analysis. A Meshcheryakov and S Ivanov. Economics Bulletin. 2020, (40):1. Link 50 – Portfolio optimization in the era of digital financialization using cryptocurrencies. Y Ma et al. Technol Forecast Soc Change. 2020; (161). Link 51 – Should stock investors include cryptocurrencies in their portfolios after all? Evidence from a conditional diversification benefits measure. S Demiralay & S Bayraci. International Journal of Finance and Economics. 2020. Link 52 – Management of investment hybrid portfolio. P Hrytsiuk et al. International Journal of Business Performance Management. 2021. Link 53 – Are Cryptocurrencies Suitable for Portfolio Diversification? Cross-Country Evidence. JA Colombo et al. 2021 Link 54 – Investing with Cryptocurrencies – evaluating their potential for portfolio allocation strategies. A Petukhina et al. 2020 Link 55 – Virtual currency, tangible return: Portfolio diversification with bitcoin. M Briere et al. Journal of Asset Management. 2015; (16): 365-373. Link 56 – The role of bitcoin in well diversified portfolios: A comparative global study. A Kajtazi & A Moro. International Review of Financial Analysis. 2019, (61): 143-157. Link 57 – The Role of Cryptocurrencies in Optimal Portfolio Diversification: A Case for Ethereum. OE Walter et al. 2020. Link 58 – Investing with cryptocurrencies. S Trimborn et al. 2017. Link 59 – Stone Ridge Shareholder Letter. 2020. Link 60 – How Much Bitcoin Should I Own? A Mathematical Answer. A Grealish. Kiplinger. 2021. Link 61 – Fidelity Institutional Investor Study. 2020. Link 62 – Every Portfolio Should Have 6% Bitcoin: Yale Study. N Reiff. Investopedia. 2019. Link 63 – Big Ideas 2021. ARK Investment Management. Link 64 – 7 Tips On Dealing With The Ups And Downs Of Crypto. FI Scribbles. 2021. Link 65 – How much crypto should I own? Foxy Monkey. 2021. Link 66 – Bitcoin v Property. Property Hub Podcast. 2021. Link. 67 – Should you own Bitcoin in your portfolio? The Investor. Monevator. 2021. Link 68 – How Much to Invest in Cryptocurrency, According to 5 Experts. R Haar. Time. 2021. Link 69 – How to Dip a Toe Into Bitcoin. A Tergesen. Wall Street Journal. 2021. Link 70 – How Much Crypto Should Be In Your Investment Portfolio? N Pongratz. Yahoo Finance. 2021. Link 71 – What Percentage of Your Portfolio Should Be in Cryptocurrencies? The Motley Fool. 2021. Link 72 – Current Crypto Asset Allocation and Return: April 2021. Fifth Wheel Physical Therapist. Link 73 – Weekend reading: Enough Bitcoin. The Investor. Monevator. 2020. Link 74 – Crypto commentary I. MedFI. 2020. Link
The future is promising yet unclear; a watchful eye on cryptoassets and their underlying technology is certainly reasonable for the time being.
It’s been over a year since I first looked into the world of cryptocurrencies with a two-part extravaganza (1,2). In a sector that’s ever-growing, you could probably write an update every week, day or even hour. I think, however, that a year is a natural enough timeframe over which to look back at cryptoassets and, perhaps more importantly, look forward.
For all that’s changed in the space, there are many factors that remain unaltered. For example, ongoing concerns about cryptocurrencies’ use in nefarious activities. Nearly £300m of cryptocurrency has been confiscated by UK police in the last two months alone (3). Losses to illegal deeds are also not uncommon, be it through scams (4) or theft. A reported $1.9bn of cryptocurrency was stolen via hacking in 2020 (5,6).
Yet the dark side of Bitcoin has been labelled by some as a ‘false narrative’ (7). One report suggests that only 0.34% of cryptocurrency transactions were associated with illegal activity in 2020 (8) – a falling percentage that’s eclipsed by the amount of illicit funds involved in conventional finance. Another report found “little evidence” that the secrecy offered by ‘privacy coins’ such as Zcash was being exploited by those with malicious intent (9). Other common arguments against cryptocurrencies have been countered too (10). Overall, a “fact-based discussion of the issue” would probably be more beneficial than mere mud-slinging (11).
The negative ecological impact of cryptoassets is also a hot topic. The energy used for mining Bitcoin contributed to Tesla’s infamous volte-face on the archetypal cryptocurrency. There are, however, an ever-growing number of cryptocurrencies to choose from, many with green(er) credentials (12). One can ‘do good’ with crypto too as more charities accept cryptocurrency donations, including the RNLI (13).
As an investment choice, cryptocurrencies remain beset by their nature of having no underlying asset. The sheer spectrum of choice can be confusing. They continue to be highly volatile and are plagued by other issues such as high fees for buying/selling, risk of loss (through user error or malicious intent) and potential tax uncertainty.
Misgivings about cryptoassets haven’t stopped the space growing significantly. Widening adoption has played a part in the rise of crypto’s market cap, from $10.7bn to over $1.5T in the past five years (14).
In addition to Las Vegas strip clubs (15), a growing number of distinguished companies are facilitating use of digital currencies. Visa processed over $1bn of transactions on crypto-linked cards in the first half of 2021 and plans to support Central Bank Digital Currencies (CBDC) (16). Their arch-nemesis Mastercard is following close behind (17), collaborating with Island Pay to provide a card that can be used with the Sand Dollar, the world’s first CBDC (18). A whole host of other household names are increasing their accommodation of cryptoassets.
Other financial establishments are also getting in on the act. JP Morgan will now allow its advisors to perform crypto trades on behalf of its clients (19), while Goldman Sachs has a blockchain ETF in the pipeline – the ‘Goldman Sachs Innovate DeFi and Blockchain Equity ETF‘ (20). There are whispers on the wind of integrated Bitcoin payments at Amazon (21) and Twitter (22), while historic auction house Sotheby’s will allow purchases to be paid in Bitcoin for the first time (23).
These institutional changes appear to be in line with consumer desire, rather than mere ‘pump and dump’ schemes by the companies concerned.
Endorsement of cryptoassets isn’t just at the corporate level either. El Salvador made headlines in June as it announced Bitcoin would become legal currency (24). Other Latin American countries are following suit (25), with varying degrees of acceptance in Argentina (26), Paraguay, Mexico, Panama and hyperinflation-maligned Venezuela (27). Not everyone is on board, however, with Ecuador banning Bitcoin back in 2014.
There are signs of future adoption on other continents too. Tanzania’s treasury has been told to ‘prepare for cryptocurrency’ (28); it is one of the top five African nations with regards to crypto trading volumes. Kazhakhstan is planning crypto bank accounts (29) and The Bank of Israel are using Ethereum technology as part of their digital Shekel programme (30).
Conversely, Middle Eastern neighbours Iran have called for greater regulation (31). Other countries such as Egypt, Nigeria, Ghana and Turkey have restricted cryptocurrency transactions to try and keep them within their regulatory control. There’s an outright Bitcoin ban in China and legislation facilitating confiscation of crypto pending in Russia, so some of Asia’s biggest players are yet to enter the fray. Adoption in Europe is slower, although Hungary is halving tax on Bitcoin (32) and Germany recently announced certain funds will be allowed to consist of up to 20% cryptocurrencies (33).
Nearly two thirds of surveyed central banks are analysing the potential impact of stablecoins on monetary and financial stability (34) and many countries have launched their own cryptocurrencies, including Japanese J-Coin, Emirati Emcash, Estonian Estcoin and sanction-swerving coins such as the Venezuelan Petro and Russia Cryptoruble. The global trend is definitely towards greater adoption of Bitcoin and its brethren, although the IMF are pessimistic about long-term use of crypto as national currencies (35).
The trend of adoption doesn’t stop at use of existing cryptoassets, however, as there’s also been a sharp rise in interest in CBDC (36). Only the Bahamian Sand Dollar and the (pilot) East Caribbean Dcash are live, however, and the remaining countries’ CBDC are in various stages of development (37). For example, The Bank of Japan say they have “no plan” to issue a CBDC (38) and the USA is still exploring CBDC’s as a way of “improving payment efficiency and robustness, facilitating financial inclusion, and maintaining financial stability” (39).
The UK launched its own CBDC task force in April this year, although “The Government and the Bank of England have not yet made a decision on whether to introduce a CBDC” (40). The BoE have said that future digital money could take the form of either stablecoins or a CBDC (41).
UK public perceptions of cryptoassets are evolving as well. Compared to years gone by, there’s greater awareness [78%] and the majority had a positive experience of crypto [53%], with fewer regretting their investment [11%] (42). Fewer people see cryptocurrency as a gamble, although more consumers are using it as a speculative investment [47%] than as part of a balanced portfolio [25%] (43).
Perhaps worryingly there is lower understanding of cryptocurrencies than before. 1 in 7 of those buying cryptocurrency has borrowed money in order to do so (42). Yet only 10% are aware of FCA consumer warnings on the subject and 12% thought crypto investments were protected, which they are not (45)!
Cryptocurrencies remain a polarising topic, a no-mans land of reasoned discourse between trenches filled with “grumpy grandpa[s]” and “laser-eyed cultist[s]” (46). Yet whether it’s individuals, companies or countries, the trend in sentiment is clear. Curiosity. Investigation. Awareness. Acceptance. Adoption. Normalisation. Progression.
Cryptoassets aren’t going away anytime soon, so it’s only prudent to inform yourself as best possible. Although researching and citing these posts is time-consuming, I do so in the hope of providing balanced and clearly-sourced information. Having access to impartial material can only help increase understanding and improve dialogue in a space that may be of increasing importance in years to come.
In that vein, the potential role of cryptocurrencies in an investment portfolio is something I will look at in a future post.
References 1 – Crypto commentary 1. MedFI. August 2020. Link 2 – Crypto commentary 2. MedFI. August 2020. Link 3 – Met Police seize record £180m of cryptocurrency in London. BBC News. July 2021. Link 4 – Beware of These Five Bitcoin Scams. Investopedia. September 2020. Link 5 – 3 Key Takeaways From Last Year’s Biggest Crypto Hacks. L Lamesh. Nasdaq. January 2021. Link 6 – Cryptocurrency Crime and Anti-Money Laundering Report. Ciphertrace. February 2021. Link 7 – The False Narrative Of Bitcoin’s Role In Illicit Activity. Forbes. January 2021. Link 8 – The 2021 Crypto Crime Report. Chainalysis. February 2021. Link 9 – Exploring the use of Zcash cryptocurrency for illicit or criminal purposes. Silfversten et al. Rand. 2020. Link 10 – Crypto is increasingly being used for criminal activity and is a haven for illicit finance. Coinbase. May 2021. Link 11 – An Analysis of Bitcoin’s Use in Illicit Finance. Morell et al. Crypto for Innovation. April 2021. Link 12 – The 16 Most Sustainable Cryptocurrencies for 2021. L Matthews. Leafscore. June 2021. Link 13 – RNLI Bitcoin Donations. Link 14 – Coin Market Cap. July 2021. Link 15 – Las Vegas Strip Club Now Accepts Bitcoin Payments Over the Lightning Network. S Sinclair. Coindesk. July 2021. Link 16 – Visa says spending on crypto-linked cards topped $1 bln in first half this year. Reuters. July 2021. Link. 17 – Why Mastercard is bringing crypto onto its network. R Dhamodharan. Mastercard. February 2021. Link 18 – Mastercard and Island Pay Launch World’s First Central Bank Digital Currency-Linked Card. Mastercard. February 2021. Link 19 – JP Morgan ready to jump into cryptocurrency trading. J Encila. Mickey.com. July 2021. Link 20 – Goldman Sachs ETF Trust. SEC Listing. July 2021. Link 21 – Amazon To Integrate Bitcoin Payments And Launch Its Own Token By 2022, Insider Confirms. R Marquez. Bitcoinist. July 2021. Link 22 – Jack Dorsey wants Bitcoin as the “native currency” of Twitter. Tech HQ. July 2021. Link 23 – Sotheby’s diamond auction marks another bitcoin milestone. Reuters. June 2021. Link 24 – El Salvador announces Bitcoin will be legal tender. Twitter. June 2021. Link 25 – Support for making Bitcoin legal tender grows in Latin America. M Quiroz-Gutierrez. Fortune. June 2021. Link 26 – Member of Argentina’s National Congress Submits Bill to Allow Workers to Receive Salary in Bitcoin. N Hoffman. Bitcoin Magazine. July 2021. Link 27 – As Venezuela as economy regresses, crypto fills the gaps. B Ellsworth. Reuters. June 2021. Link 28 – President Samia gives cryptocurrency markets a boost, as Bitcoin closes on $40,000. The Citizen Tanzania. June 2021. Link 29 – Bank Accounts for Cryptocurrency Will Be Available in Kazakhstan As Country Expands Its Crypto Mining to Global Market. A Arystanbek. Astana Times. July 2021. Link 30 – Bank of Israel uses Ethereum blockchain for upcoming ‘digital shekels’. O Adejumo. Cryptoslate. June 2021. Link 31 – Iranian President Wants to Regulate Crypto ‘as Soon as Possible’. A Baydakova. Coindesk. June 2021. Link 31 – Hungary Plans to Cut Taxes On Bitcoin In Half. Bitcoin Magazine. May 2021. Link 33 – Germany to Allow Institutional Funds to Hold up to 20% in Crypto. S Kahl. Yahoo Finance. July 2021. Link 34 – Ready, steady, go? – Results of the third BIS survey on central bank digital currency. C Boar & A Wehrli. Bank for International Settlements. January 2021. Link 35 – Cryptoassets as National Currency? A Step Too Far. T Adrian & R Weeks-Brown. IMF Blog. July 2021. Link 36 – III. CBDCs: an opportunity for the monetary system. BIS Annual Economic Report 2021. Bank for International Settlements. June 2021. Link 37 – Central bank digital currencies for cross-border payments; Report to the G20. Bank for International Settlements. July 2021. Link 38 – Establishment of “Liaison and Coordination Committee on Central Bank Digital Currency”. Bank of Japan. March 2021. Link 39 – Building A Stronger Financial System: Opportunities of a Central Bank Digital Currency. N Narula. US Senate Committee on Banking, Housing, and Urban Affairs Subcommittee on Economic Policy. June 2021. Link 40 – Bank of England statement on Central Bank Digital Currency. Bank of England. April 2021. Link 41 – New forms of digital money. Bank of England. June 2021. Link 42 – Research Note: Cryptoasset consumer research 2021. Financial Conduct Authority. June 2021. Link 43 – UK regulatory approach to cryptoassets and stablecoins: Consultation and call for evidence. HM Treasury. January 2021. Link 44 – White paper: cryptocurrency adoption across Europe and America 2021. Triple A. January 2021. Link 45 – FCA research reveals increase in cryptoasset ownership. Financial Conduct Authority. June 2021. Link 46 – In Praise of Bitcoin. B Hunt. Epsilon Theory. April 2021. Link
It’s that grand time of year where we usher in a new cohort of doctors. To my new colleagues – welcome!Let us ignore the recentfurore over financial turbulence in the medical world for the time being. Instead we’ll focus on the fact that you’ll soon enough be enjoying the satisfaction, some of you for the first time, of being paid!
During your two Foundation years you will learn the ropes of hospital life as a doctor with all its idiosyncrasies, ups and downs. In that regard, I think it only prudent that you establish a solid financial foundation too.
When there’s a spare bit of bandwidth not being taken up by learning how to use a fax machine, or which ward clerk’s chair not to sit on, think about working through this financial induction for (new) doctors. You’ll find action points in blue at the end of each section.
Nothing fancy is required here. Chances are you already have a current account into which you’ll be paid. As long as it has a debit card along with it then you’re pretty much set. It may be worth looking to see whether you can upgrade or change your student account for a graduate account. Somebank accounts offer extra perks for a fee, e.g. Barclays Blue Rewards or the Santander 1|2|3 Account. Although worth looking into, in my opinion these are rarely worth it. Unless you’re on the ball it may end up costing you more than you save.
Some people have multiple current accounts to allocate money for different purposes. For example, it’s common to have a separate account for ‘day-to-day spending’ or ‘fun’ money. This physical separation of cash may prevent you from spending all of your money at once! The FinTech banks, e.g. Starling or Monzo, are often used for this and also have other attractive benefits, such as fewer fees when used abroad.
Some people use old accounts they’re not actively using to reap the rewards of switching bonuses, a moderately time-efficient way of generating small (~£100) amounts of cash.
→ Make sure you’re getting the most from your bank account(s)
Budgeting / tracking
Along with ‘moist’, the word budget seems to invoke an involuntary shudder in most people. Budgeting can seem laborious, unsatisfying and unnecessary yet it is a vital pillar of financial wellbeing. I won’t give you a detailed run-down on how to make, follow or curate a budget as there are a plethora of resources available online. Some people find app-based budgeting tools useful.
I will, however, suggest that you can start by simply tracking what’s coming in and out of your account(s) each month. Perhaps a simple spreadsheet with two tabs: money in (your salary, any interest you earn on savings, other income) and money out (perhaps split into categories e.g. rent, entertainment, food etc.). 30 minutes on the final day of each month should suffice to fill this out, and build the habit of keeping an eye on your financial goings on. You can embellish it in time if you so desire.
→ Set up a budgeting and/or tracking system for your finances
Unfortunately you’re probably graduating with debt, the bulk of which will undoubtedly be your student loan. You may have other debts too; overdrafts, credit cards, car repayments or other loans. I’ll leave student loan debt aside as the answer to “should I pay it back early or not?” is a bit more nuanced.
The interest rates on your other debt, if not 0%, are likely to be astronomical; 10%, 20% or even 30%. It is therefore imperative that you rid yourselves of this financial lead weight as soon as possible. The two commonly described methods are the snowball method and avalanche method. Whichever you choose, the key is to eliminate your debt as soon as is feasible so you can start building your wealth.
→ Start clearing any non-student loan debt ASAP
Unless you’re bathing in luxury and going ham at payday parties, it’s probable you’ll be able to save some money each month. The core principle behind saving successfully is ‘paying yourself first‘. It’s universal to have direct debits leaving your account at the start of the month e.g. for rent, utilities or subscription services. It’s therefore wise to set up a similar process for your savings. By setting up a direct debit to a designated savings account you take the process of saving money, and the temptation to spend all of your disposable income, outside of conscious control.
Common practice is to first build up savings equal to ~3 months’ worth of expenditure, to act as an emergency or ‘rainy day’ fund. The question: “where is best to put my saved money?” is difficult to answer. Even the ‘best’ savings accounts and cash ISA’s offer interest that doesn’t match inflation, leaving them poorly-suited for medium- or long-term saving. They are reasonable repositories in the case of emergency funds and for other short-term savings though. For longer-term financial growth think about whether to invest your money instead – I won’t delve further into investing as it falls outside the remit of this basic induction.
→ Start saving money each month; little and often is better than nothing at all → Make sure you’re getting the best interest rate available → Consider investing as a long-term strategy for growing your money
(NB for a full explanation of the different ISA’s available, see here)
A roof over your head
Building a nest egg is all well and good, but it should have a purpose. Amongst other saving goals, it’s possible that you’ll be looking to buy your first property in the not too distant future. Two things to consider are your credit score and the best place to save.
Having a higher credit score is better when it comes to being approved for mortgages, so it’s prudent to start buffing your credit rating early. Experian, one of the UK’s credit agencies, gives examples of how to do so. Part of this can involve getting a credit card. Credit cards can be extremely powerful monetary tools if used correctly, but the ultimate method for financial self-sabotage if not. Get to grips with the basics and use them properly for maximum benefit.
It’s well worth thinking about using a Lifetime ISA (LISA) for the savings earmarked for your house deposit. LISA’s, into which you can put up to £4,000/yr, can be used towards purchasing a property up to £450,000 in value. They come with a free 25% government bonus that is not to be sniffed at. With maximal contributions, your LISA could be worth over £10,000 by the end of FY2.
→ Take steps to optimise your credit score → Consider using a credit card to help do so → Think about using a LISA to save money towards a house
HMRC will be taking income tax (PAYE) from your pay each month. Certainly in F1, and probably F2 too, you’ll be in the lowest rate (20%) tax bracket. It’s still better to pay less tax where possible, so you should claim tax relief on professional expenses. Check the ‘tax’ section of the resources page for a variety of guides on what you can claim for and how to do so. This quick and easy process could save you hundreds of pounds each year.
Other expenses you can claim include money for relocating and travelling to/from work. You claim these directly from your trust, and each will have a different process for doing so, therefore it’s best to contact your HR department about their preferred method. This is money to which you are contractually entitled and can again save you many hundreds of pounds.
→ Claim work-related expenses back each tax year from HMRC → Claim relocation and travel expenses, where applicable, from your trust
The old adage is that you should insure what you can’t afford to replace. Unlike your car, insurance for your life, income protection, home contents, phone etc. is optional. Whether it’s ‘worth it’ is an entirely personal decision and ultimately unpredictable. The best insurance is the one you never have to use.
→ Consider the need to insure facets of your life, in particular income protection insurance
You may have only just started working, but it’s worth having a quick think about retirement planning too. Indeed, you may be tempted to think about financial independence and/or retiring early. I often see questions about whether it’s wiser to opt out of the NHS Pension and use a personal pension (or other investment vehicle) instead.
In my opinion the current NHS Pension (2015), although a shadow of its historic self, is still a reasonable scheme to be a part of as a savings vehicle for retirement. It is also my view that it will be meddled with and devalued in the future, so relying on it for 100% of your retirement income isn’t wise. Don’t just take my word for it though.
Much as you won’t be a Consultant after you finish FY2, you won’t be a personal finance aficionado after having read this induction. One of the best financial steps you can take is to continue educating yourself – it is only then that you’ll be empowered to make reasonably informed decisions about your financial health.
Throughout the post I’ve linked to other articles that explain various facets of personal finance. Where possible I’ve tried to link to impartial, non-affiliated, government or otherwise neutral sites. There are a whole host of financial media available, be they websites, videos, podcasts, books or forums. If, however, you just want a simple and robust place to start then look no further than the UKPersonalFinance flowchart.
Most important advice of all
I have two final pearls for you. Firstly, a cliché. The best time to plant a tree was 20yrs ago; the second best time is now. Time is money, as they say, so start off on the right foot and reap the benefits for years to come.
Secondly, you’ve survived the gauntlet of medical school and are starting an equally tough journey on the career path of a doctor. Therefore the best thing you can do with your first pay-check is to treat yourself – you deserve it!
I hope you’ve found this post useful; do share it with your new colleagues if so. Be it on the ward or in your wallet, I wish you all the best for the year to come.
There’s a whole host of heads buried in the sand when it comes to personal finance. Unexciting topics such as financial planning for your retirement and the intricacies of pension schemes are only likely to push heads, shoulders, knees and even toes further into the silica. Indeed, pensions are about as interesting as watching paint dry. However, whether you’re aiming to reach financial independence or not, they are crucial to financial wellbeing – so jump into the pensions fray we must!
The government has recently crystallised its plans to change/meddle/interfere/tinker (delete as appropriate) with the normal minimal pension age (NMPA). I won’t aim to explore the why*, but rather aim to summate the what and how this influences you.
State of play
Before diving into the future changes, let’s look at the state of play in the pensions domain. There are four main groupings of pensions in my mind:
State Pension. Accessible at (funnily enough) your state pension age (SPA), which is currently most likely to be 68yrs. HMRC inform me I’ll receive £9,371.27/yr from mine. I won’t embroil us in the ‘will the State Pension still be around’ debate; it’s a story for another time.
NHS Pension (2015 scheme). Accessible at your SPA too, which is currently most likely to be 68yrs. If you want, you can claim your NHS Pension early at any age from 55yrs – 67yrs, but suffer a reduction in the money you’ll receive because of it. See Part III of the NHS Pension series.
SIPP (self-invested personal pension). Accessible from NMPA, which is currently 55yrs.
Other DC (defined contribution) pensions e.g. NEST, workplace pensions. Accessible at NMPA, which is currently 55yrs.
Chances are you have at least two of the above pensions. If you’ve worked for the NHS, for another employer and opened a SIPP then you may have all four.
Winds of change
We know how things are. How are they going to change? Time for a, err, timeline…
2010 – The NMPA was increased from 50 to 55yrs.
2014 – It was announced that the NMPA was due to rise from 55yrs to 57yrs from 6th April 2028.
2021 (February) – The government published the results of a consultation regarding this rise in NMPA.
This change has no real bearing on the current state pension, although continues the trend of rising pension/retirement ages. Indeed, NMPA will have risen from 50yrs to 57yrs between 2010 and 2028.
The impact on the NHS Pension 2015 scheme is likely to be fairly niche. It could be that it is no longer possible to claim the NHS Pension at 55yrs, where you would have been stung with actuarial reductions anyway, but at 57yrs instead. It may be that one can still claim the NHS Pension at 55yrs. The NHSBSA replied to my query with a succinct: “Currently we have received no guidance about the increase to the minimum retirement age from 55 to 57. “
The impact on SIPPs and other DC pensions is where the crux of the matter lies. Where previously accessible at 55yrs, it will be 57yrs from April 2028. This is largely going to affect on people who would have been claiming their pension around that time – things will be pushed back a couple of years.
An interesting sub-plot is the potential influence on the lifetime allowance (LTA). Accessing pensions later means (potentially) two years’ more contributions and growth. This may tip one over the edge of the LTA threshold and incur a tax bill, or increase the size of it if it was coming your way anyway.
In the FIRE-ing line
The government’s consultation document notes that “…most people do not now retire at 55.”
Although this implication of this sentence is that people retire later, chances are that if you’re reading this post you may plan on retiring earlier than 55yrs. These changes to the NMPA may well alter your plans.
It might be that your early retirement blueprint was some variation on the theme:
X yrs – stop work and fund yourself by selling investments in a S&S ISA 55yrs – start drawing money from your SIPP and/or workplace pension 60yrs – start using money from your LISA 68yrs – start taking the NHS Pension and state pension
Naturally the changes to the NMPA will impact on this set up. If the plan had been to use investments in an ISA to bridge the gap between ceasing work and starting to draw money from your SIPP, that money will have to last an extra couple of years.
The flip side is that value of your SIPP may not need to be as large, as it’s doing fewer years’ heavy lifting. Contributions that were going to your SIPP could be funnelled to ISA/LISA’s instead, which may also mitigate the LTA issue. There are obvious tax downsides to this, however.
Through the loophole
It all seems fairly cut and dried. NMPA rising to 57yrs in April 2028. Done deal. End of.
Except we’re actually in a window of opportunity to somewhat circumvent this change.
Some people will automatically enjoy ‘protected pension age’ i.e. they will still have the ability to start claiming their pension at 55yrs. Namely, individuals who are members of the pension schemes of the ‘uniformed services’ (a group to which the NHS does not belong despite many of its employees wearing outfits that looks suspiciously like uniforms) will enjoy this benefit.
If you’re not a fireman, police officer or Ghurka, it seems you can still maintain a 55yr NMPA if:
You’re a member of an HMRC-registered pension scheme
Whose pension scheme rules on 11 February 2021 conferred an unqualified right for you to take your pension benefits earlier than 57yrs
And you joined the scheme before 5th April 2023
(NB this is specific to an individual as a member of a particular scheme, it would not apply to all the pension schemes of which you are a member.)
What’s an “unqualified right”? It appears to be where the rules of the pension expressly state that benefits can be drawn from 55yrs. Rules that reference ‘the NMPA’ or the legislation that underpins it don’t seem to count.
Ergo all you have to do to circumvent the planned changes is find a pension provider whose rules, prior to February 2021, stated explicitly that you had the right to take your pension benefits at 55yrs of age. Then either set-up a new pension with that provider, or transfer your existing SIPP/workplace pension into it, before April 2023. Easy, right?
To the key question – which pension providers have worded their T&C’s in such a way as to give you an ‘unqualified right’ to take that pension at 55yrs?
The jury is out at the moment. Some big name SIPP providers seem as if they are off the cards in this regard; Vanguard, AJ Bell, Hargreaves Lansdown and Interactive Investor all reference the increase in NMPA to 57yrs in either their T&C’s or FAQ’s. Fidelity may have worded things so as to fulfil the ‘unqualified right’ criteria (credit to MSE Forum user MDMD), but that’s still unclear.
With things so hazy it would be pertinent to wait for the dust to settle a bit instead of immediately transferring your pension(s) to a different provider. A case of masterful inactivity, cat-like observation – you have until April 2023 to execute any changes.
If your retirement plans revolve exclusively around the NHS Pension (+/- state pension), this news may be fairly inconsequential for you. A word of caution, however. Changes to pensions are happening all the time – for example some DB pensions will be revalued by a lesser amount from 2030. It would be asinine to assume anything other than the NHS pension undergoing future changes (read: devaluation). A more diverse or multifaceted retirement approach will provide greater shelter from the winds of change.
If your retirement plans involve a DC pension or a SIPP, it seems pertinent to try and have that money in a scheme that will confer on you the ability to take it at 55yrs. It’s a flexibility thing – it makes your money accessible earlier, which could be beneficial. It may be of no material consequence down the line, though in general it’s better to live with ones hands untied rather than bound behind ones back.
* Depending on which parts of the Government’s rhetoric you read, the change might occur to: …”support the government’s agenda around fuller working lives and has indirect benefits to the economy through increased labour market participation, while also helping to make sure pension savings provide for later life.“ …”encourage individuals to save for longer for their retirement, and so help ensure people have financial security in later life.” …”reflect long-term increases in longevity and changing expectations of how long people will remain in work and in retirement.”
I recently experienced a personal novelty; an emergency. Though my working life is (sadly) rather replete with the emergent, outside of the four hospital walls I’d never before become unstuck by the vicissitudes of bad luck.
One of my very first posts was about the financial pitfalls of cars, so it was perhaps fitting that the culprit in this affair was my own automotive wallet-drainer. Cars are a modern Janus; dichotomous beasts that both augment your life (freedom to travel, convenience, comfort, status symbols) yet simultaneously detract from it with their polluting ways and by acting as a monetary black hole.
When it became apparent there was a problem with my own mirth-mobile I did what any modern man would do and Googled a home-brewed solution. Low and behold the hacks and quick fixes fell flat on their faces. With little mechanical know-how of my own, and at serious risk of inducing damage rather than repairing it, I conceded defeat and called a mechanic.
As I watched my vehicular Hector being dragged away by the recovery truck it was not the impending financial blow that was most frustrating. Rather it was the faff factor, the annoyance, the inconvenience of a whole chapter of tasks, dates, timings and organisation that would require my attention. The bill did come eventually though…
To the emergency fund!
Most followers of mainstream personal finance strategy would perhaps scoff at this stage. An emergency? What’s the big deal? That’s what the emergency fund is for! They’d be correct. Except, being the obstinate trailblazer that I am, I did not have a classical emergency fund. I had an Emergency Fund 2.0. My own ‘it’s hitting the fan’ strategy resembling a credit shield wall approach. In short, the spongy debt of a credit card covers most emergencies.
The overall fiscal assault of my car troubles, including a painfully long taxi ride to work, broke harmlessly against those credit ramparts. That’s a four- or five-figure sum, X months’ worth of expenses, I have invested instead of languishing in an easy-access account ICE. Indeed, the more I reflect on events the more I’m convinced that, at this juncture, a traditional emergency fund is a sledgehammer that I don’t require. I have a nutcracker that does the job.
I’m not so wrapped up in my own comforting confirmation bias that I didn’t recognise a warning sign. My approach to emergency funding is, if not playing with fire, certainly frolicking close to some hot embers.
If I suffer high-cost or back-to-back emergencies I may not have the credit required to cover them. If the emergency cannot be dealt with by credit card, I’m sort of stumped. If there is any aberrancy in being paid that month (as happened in October 2020) then I’m poised to suffer some outrageous credit card interest rates.
The strategy is absolutely fallible. It’s a calculated risk that I feel is worth taking. As my own FI(RE) journey / investing adventure is still in its relative nascency, each little boost to keep the compounding snowball a-rollin’ is invaluable.
Emergency Fund 2.1
Although I didn’t feel financially vulnerable during the aforementioned emergency, I did want to shore up the defences some more.
I concluded that the only way to be absolutely safe from every eventual emergent possibility was to have an unwieldy store of cash, a strategy I’m still reticent to engage with. I thought about restructuring things à la Shrink, with his multi-layered emergency fund that is varied along both temporal and geographical axes.
In the end I decided to double down, a phrase perhaps fittingly taken from the gambling world. Where I had one ‘credit shield wall’ before, I now have two. Two lines of credit, from different providers might I add. The total available credit equates to approximately 10 months’ expenditure. The timing of the repayments is staggered so that they occur as far apart as possible.
Thus Emergency Fund 2.1 was born. It’s not impervious; a castle with a wall twice as thick is still vulnerable to sappers, supply chain issues and other structural faults. The strategy should, however, shield me from emergencies that are either high-cost in nature or occur in quick succession.
1 – 0
I think it likely that there’ll be future iterations of my emergency fund 2.1. Nothing much stays static in the rolling waves of life. I may end up being hoisted by my own emergency fund petard at some point in the future. Until then I’m saving on a rather large opportunity cost. Those savings may well eclipse any potential future costs associated with my alternative emergency strategy so, in the great game of cosmic financial karma, for the time being I’ll chalk this one up as a victory for myself.