Life is full of opposing forces that might be balanced, or even harmonised. Good and bad. High and low. Yin and yang. Pleasure and pain. Credit and debt. Overt focus on the negatives can lead to a spiralling nihilism, whereas blissful ignorance of them might promote an unrealistic mania. We’ve reflected on a few of these factors from the past months and thought we’d share them.
All work and no play makes MedFI a dull boy?
During the two months of April and May, our working pattern was amended to staff a ‘Corona-rota’, a souped-up version of the normal roster. It felt like near-constant work, the usual ebb and flow of shifts lost as we toiled literally day and night against this novel disease. The statistics, however, belie that feeling; for the most part I worked pretty much the exact same amount (in terms of hours and days) as in the antecedent two months.
I suspect this feeling of being stuck in a perennial work/sleep cycle was being driven by a lockdown-induced lack of alternate activity, although the general vibe of the community played a part too. The other contributing factor was a 5% increase in the amount of hours worked overnight. The increased night work and day-night switching massively increased my sleep debt and contributed to a more zombie-like state than usual. A positive corollary was, owing to the way in which doctors’ pay is calculated, a subtle increase in pay during Corona-rota times.
We’re not talking ‘hero pay’; indeed at the risk of sounding insensitive during a time when many have faced furloughing, unemployment and other significant impingement on their finances, the amount wasn’t very much at all. Think Pizza Express for two, sans alcohol. With this small amount of extra capital, and on course to fulfil our ISA allowance thanks to our savings rate, we chose to do something novel. We eschewed our normal investing strategy of using low-cost, global equity indexed funds and bought individual shares in a company. Whether they rise or fall, it felt good to mix things up and enjoy a first attempt at a different type of investing.
When occasions arise that one needs testing for some disease, there exists a period you spend quietly praying that you test negative. Interestingly, now that Covid-19 antibody tests are increasingly available for NHS staff, the opposite seems to be the case. People want to be positive; to have had the disease and not even known about it. The sensitivity of the antibody test (i.e. whether it can actually detect whether you’ve had the virus or not) isn’t 100% – equally it’s not yet known whether having the antibodies confers long-lasting immunity. Still, most of our colleagues have expressed a desire to test positive for the antibodies anyway.
We received a text alert quite soon after having our test: NEGATIVE. So negative, so quickly. No Covid-19 antibodies found flying around our blood stream. We hadn’t unknowingly contracted and cleared Covid-19 without so much as a sniffle. The upshot of this is that PPE seems to work! We’ve been face-to-face with dozens of patients undergoing aerosol-generating procedures and spent many hours in the Covid-19 bay(s). Despite that, despite the flimsy plastic gowns that rip like tissue paper or the now-recalled ‘safety goggles’, we’ve managed to avoid catching the virus so far.
Positivity from negativity
The recent wave of international protests have brought the injustices and inequalities of the world back into sharp focus. The disproportionate number of arrests (27%) and incarcerations (40%) of African-Americans compared to their percentage of the US population (13%) demonstrates significant inequality. The cause for this is undoubtedly multifactorial, although racism within the justice system appears to play a part.
It’s easy to point the finger trans-Atlantically; this is an American problem, no? No. The statistics are just as damning for the UK. People of BAME ethnicity represent under 15% of the UK population, yet are up to three times more likely to be arrested than caucasians and represent nearly 30% of the UK prison population. Again, this disproportional representation probably reflects a medley of factors that affect BAME communities.
In a worryingly similar trend, patients from BAME backgrounds are more likely to die as a result of Covid-19. Those from ethnic minority backgrounds had a two-to-four times higher chance of hospital death. Over 30% of intensive care deaths were in those of BAME background, a disproportionately high number. Similarly, deaths in BAME healthcare professionals were between two and three times higher than expected when compared to their representation within the NHS workforce. There are multiple reasons cited for these statistics, such as workplace factors, higher occupational exposure, higher levels of deprivation, pre-existing comorbidities, economic vulnerability and, sadly, racism/discrimination.
It seems hard to fathom any positivity in the face of such inequality. Awareness, education, and bringing about true systematic change are perhaps the positives to come out of this. In FI(RE) it’s often about being passive, from portfolios of passively managed funds through to passive income. Much like our new foray into buying shares, the evidence of the on-going inequality in our society means that, when it comes to promoting equality and justice, we should all be taking an active approach instead.
As many readers will already know, inflation is “the change in prices for goods and services over time” or “a general increase in prices and fall in the purchasing value of money” 1,2. As often with dictionary definitions, the words don’t necessarily convey the true meaning of the term. So we’ll borrow our own example:
Inflation Do you remember eating Freddo bars when you were younger? When we were still young whippersnappers they cost 10p each. Imagine our dismay when we learned they now cost 25p. In 20-odd years, the price of a Freddo bar has risen by 150%. This is an example of inflation: the price of objects rises over time. Put another way, the purchasing power of your money falls over time. At the turn of the century £1 could buy ten Freddos, but now £1 will only buy you four.
Author’s note: we appreciate that inflation is a complex topic and a broad term with multiple different measures. We want this to be a widely appealing and informative article, rather than a slog through the economic principles and terms. For the sake of simplicity, we’ll be using the CPI(H) when we talk about inflation.
Inflation has a few relatives too: its diametrically opposed twin brother deflation, its boastful older sister hyperinflation (responsible for the $100 trillion banknote), its nefarious first cousin shrinkflation and its awkward second cousin stagflation☨.
In order to maintain our money’s purchasing power, we have to augment the value of our savings by earning interest. At minimum, we want the interest earned to match inflation. If inflation is 2% in a year, we want our money to grow by 2% over that year in order to retain our Freddo acquisition ability. Simple. If we can’t get the interest rate to match the inflation rate, something (e.g. 1% interest) is better than nothing. We can buy fewer Freddos than the year before, but perhaps more than the guy who had his cash stuffed in a shoebox.
Ideally, we want to outstrip inflation. We want inflation to be coughing on the dust thrown up by our runaway interest-generating wagon. If inflation is 2%, we want our money to be growing by three percent, five percent, ten percent; the more the better. You could pick any number here but ~5% is not a preposterous proposition. We want to be drowning in anthropomorphic frog chocolate bars come the end of the year.
Hopefully the above is not news to many of you. The more interest you can earn on your money, the better. Matching inflation should be the bare minimum goal; where should we set this low bar?
Requiem for a Savings Account
The rate of inflation varies geographically. With some exceptions, most people will only need to worry about the rate of inflation in the country in which they reside. If you did want to be more global in your approach, the average global inflation in 2018 was 2.75% 3.
Let’s, however, set our minimum desired interest at the rate of UK inflation. The Office of National Statistics (ONS) is fairly consistent at publishing the most up-to-date rate. Though it does change month-to-month, for the last 12 months the highest inflation has been is 2% 4. Going back a bit further it’s been under 3% since 2012, but let’s use 2% as a current target.
A savings account, you’d imagine, would be a reasonable place to start the search for an inflation-matching interest rate. Yet a quick look tells us that, at the time of writing, the best available instant-access savings account provides 1.05% interest. You could eke slightly more interest by locking your money in a notice (1.25%) or 5yr fixed-rate (1.8%) account, or gamble on the expected returns from Premium Bonds being greater than the advertised 1.16%. Other savings vehicles are not much better. The ‘regular savers’ offer a rate of up to 2.75%, though only on small sums. The realm of cash ISA’s (1.3%) and cash LISA’s (1.25%) isn’t much better. In desperation you turn to a current account and find that the best available offers 2%…on up to £1,500 for one year only 5.
It’s clear that the available interest rates from bank accounts aren’t up to scratch. Agreeably it may be appropriate to tolerate a degree of depreciation on small sums and/or over short time periods. Bank accounts do have other benefits, such as security and ease of access/transfer, but their utility as a medium-to-long-term savings vehicle is poor.
Our best laid plan to match inflation with interest has crumbled all too quickly. You might say that the interest offered is nearly there? Close enough to inflation? We’re not so sure….
What if the true, bona fide rate of inflation is higher than that published by the government? That is, what if our money is losing its purchasing power quicker than we suspect? Since first reading about the prospect in Andrew Craig’s ‘How To Own The World‘, this idea has gnawed at my brain 6.
According to Craig, there are “…ways in which governments ensure that inflation numbers end up always being lower than the true increase in your cost of living (so you think you are wealthier than you actually are…”. He goes on to describe these methods: substitution, geometric weighting and hedonic regression. It’s easy to scoff initially, the ‘tin foil hat’ radar pinging relentlessly. Yet a dig through the ONS site turfs up these terms.
Substitution does occur and, if the new item is sufficiently different from the old item, its cost is ‘imputed’ (*checks thesaurus*: estimated). Re-weighting happens as well; between 2019 and Feb 2020 there was a 9% increase in the weighting of Recreation and Culture and a 6% increase in Education. Conversely, the weightings of the Food, Clothing and Transport sections were decreased 3% each. Hedonic regression is in the mix too, sitting alongside ‘option costing’ and ‘quantity adjustment’ as part of the package of tools used to make ‘direct quality adjustments’ 7.
We’re not suggesting that the whole thing is a sham, although the broad spectrum of uses for, and users of, inflation does provide a strong incentive to keep things neatly in check8. There have been examples of governments overtly manipulating inflation data (looking at you, Argentina9) but we’ve not seen any evidence that’s the case here.
Overall there is an element of subjectivity and estimation involved in the methods used. With enough slightly fudged numbers, be it deliberately or not, the end product could look rosier than it actually is. Even the ONS states that “The methodology for estimating the accuracy of the CPIH, CPI and RPI [measures of inflation] has not yet been fully developed…”10.
The Freddo Index
We didn’t find an abundance of robust data reinforcing the claim that the true rate of inflation is higher than the published one. One report used its self-styled ‘essentials index’ to demonstrate that the cost of essential items was rising faster than inflation11. It found that the cost of essentials rose 7.8% in 2011 and 3.7% in 2012, even though the inflation rates for those years were 4.5% and 2.8% respectively. One US-based article implied that the rate of inflation must be higher than published because of the rising cost of a burrito over time, the so-called burrito index12.
Let’s return to our old friend the Freddo bar. The ‘Freddo Index’, tracking the price of the snack over time, demonstrates how the cost of the wee chocolate bars has drastically outstripped inflation (see graph, above). The price grew 150% between 2005 and 2019, though inflation says it should have only risen ~40%. There was shrinkflation☨ afoot too, as the weight of a Freddo was reduced from 20g to 18g between 2010 and 2011. Even if the price remained the same, you got 10% less chocolate bar in 2011 compared to 2010 and therefore had suffered from 10% inflation. It’s not just chocolate bars either, as you can see below.
These graphs all demonstrate that the cost of goods, from milk to beer to petrol, has often risen faster than inflation alone would dictate. Appreciably the determinants of the price of a good or service are much more complex than merely rising with inflation. The pattern, however, is concerning. It lends some soft weight to the idea that our money is devaluing faster than we realise. This begs the question: how accurate a marker is the published rate of inflation?
Investing: No Longer Optional?
We can’t keep up with inflation through traditional bank accounts and, adding insult to this injury, the actual rate of inflation might be higher than we think. Equally, the future rate of inflation is unclear, an unknown unknown13. There are arguments for both rising inflation and disinflation/deflation14. Whatever the rate, we need to be matching it to avoid our savings depreciating.
Investing, with its concomitant risks, is typically seen as a vehicle for the growth of savings. Now, it might be one of the few remaining bastions for those simply wishing to avoid the inexorable erosion of their purchasing power. Is the choice now between the risk of losing money by investing (but perhaps keep up with/outgrow inflation) or the guarantee of losing money by tolerating sub-inflation interest rates? It seems a damning state of affairs. Especially so for those with delicate financial positions who cannot tolerate the risk of investments losing their value; they are hemmed into a losing position.
☨Deflation: at the end of the year my £1 coin buys 10 Freddos, not 4. Hyperinflation: at the end of the year my £1 coin buys 0.0001 of a Freddo, not 4. Shrinkflation: at the end of the year my £1 coin still buys 4 Freddos, but each bar is only half the size it was at the start of the year. Stagflation, we realise, cannot be simply explained using our Freddo analogy and for this we apologise.
References 1 – Inflation and Price Indices. Office for National Statistics. Available here. 2 – Lexico Dictionary. Available here. 3 – Inflation, World Bank Open Data. Available here. 4 – Percentage change year-on-year of the consumer price index (CPI) in the United Kingdom (UK) from 1989 to 2019. Available here. 5 – Money Saving Expert: Banking & Savings. Available here. 6 – Craig, A. (2019). How to Own The World: A Plain English Guide to Thinking Globally and Investing Wisely (3rd ed.). John Murray Learning. Available here. 7 – Consumer Prices Indices Technical Manual (2019), 9: Special issues, principles and procedures. Office for National Statistics. Available here. 8 – Users and uses of consumer price inflation statistics. Office for National Statistics. Available here. 9 – Citizens Not Fooled by Fake Statistics. UCLA Anderson Review. Available here. 10 – Consumer Price Inflation QMI, 7: Validation and Quality Assurance. Office for National Statistics. Available here. 11 – Measuring the Real Cost of Living (2013). Tullett Prebon. Available here. 12 – If people knew the actual inflation rate, it would implode the entire system. Available here. 13 – The economic outlook, 1.2: The MPC’s projections; CPI inflation. Bank of England. Available here. 14 – Inflation post Covid-19: to be or not to be? Available here.
There’s a common question we come across again, and again, and again. You’ve probably seen it before, or at least a variation of it. It goes like this:
“I have extra money left at the end of the month, should I overpay my mortgage or…”
There are many options for the second part of the question, although “…invest the money” or “…contribute more to a pension” are the two most frequently occurring ones. The topic has been covered roundly, including articles by Monevator (not once, but twice), a more recent variation on the theme by Gentleman’s Family Finances and various other sites including Money Saving Expert. We found ourself lapsing into a state of relative apathy towards the question. Not that we find it in and of itself uninteresting, but reading the same old, carbon-copy responses became wearisome.
Part of the issue is that, although the cut and thrust of the underpinning economic argument remains fairly consistent, the different personal factors involved are too numerous to create a suitable one-size-fits-all answer. Undoubtedly being in such a situation is fantastic; you literally have so much money you’re unsure what to do with it! Whilst mulling it over, we decided to use a different framework to address the question. We thought we’d share it with you; perhaps it will help you in your search for a solution as well.
Johari and Rumsfeld
The Johari window is a tool originally designed for understanding oneself and your relationship with other people, using a 2×2 matrix of what is known and unknown to both you and to others. It’s primarily a learning exercise, as you seek to find that which fills your ‘blind spot’ or is ‘unknown’. As this information becomes known, i.e. migrates into the ‘arena’, your knowledge of yourself improves. Similarly, sharing items that populate your ‘façade’ box will improve inter-personal ties.
The window can be adapted in a system based on the famous words of former US Secretary of Defense Donald Rumsfeld. Both the Johari window and the so-called Rumsfeld box can be used in a broader fashion than just self-awareness, and using them as a framework is exactly how we chose to tackle the ‘overpay mortgage vs. other’ question. Populating the matrix with factors that influence an answer to the question creates, in our opinion, a clearer picture of the balance of risks/benefits. With this more robust understanding in place, answering the question becomes that bit easier.
The ‘Known Knowns’
These are factors that lie in an open forum, of which both you and everyone else is aware. Examples might include: current Bank of England base interest rate, current mortgage interest rates, inflation, interest from savings accounts, and historic stock market performance. Items in this box can help build the foundation of an answer. We know that if mortgage interest rates were lower than real investment returns, the maths alone would dictate that you’d have made more money by investing than overpaying the mortgage.
Factors in this box are relatively ‘low risk’. That isn’t to say the risk of losing money is less, but that these items are more certain in their nature. As such the impacts they’ll have are more predictable and consequently they’re less risky.
The ‘Unknown Knowns’
The ‘unknown knowns’ are perhaps the most difficult to define. These are components that are known by others but unknown to you. One example might be a deeper insight into some of the economic phenomena that will affect the answer to the question. A good proportion of the FI community won’t have a significant grasp of economics beyond the extent of their own research, which may have ignored, misunderstood or otherwise left out pertinent information.
The other collection of factors in this box are things that we do not care to know; facts we wilfully ignore as they do not fit our existing schema of understanding, facts we dismiss out of confirmation bias. There’s a wide spectrum of elements this could cover; personal, professional or purely financial. An example could be that, despite having never experienced a market crash before, you’re certain you’ll be immune to the urge to (panic) sell as the market crumbles – yet what we know about human and investor psychology says most people won’t be. Another might be that, instead of over-paying the mortgage, you’re dead-set on investing in Cryptocurrency because you feel it’s a guaranteed path to El Dorado – yet the data shows Cryptocurrency has proven to be a highly volatile (and therefore unreliable) investment.
These elements carry higher risk; they are unknown to you and the impact they may have is less predictable. As such the goal is to move them into the ‘known knowns’ box. That might be through broader or deeper learning, or acknowledgement of when you’re succumbing to your own biases. Being mindful of the presence of these factors is possibly enough, even if you’re unable to shift them all into the ‘known knowns’ box.
The ‘Known Unknown’s‘
Constituents of this quadrant of the matrix tend to be of a more intrinsically personal nature. Within this domain lie several considerations, such as: • your relationship with money, savings and salary • your psychological approach to debt; does the mental weight of owing money override other factors? • personal facets including your age, family situation, expected longevity • more detailed financial factors e.g. your exact mortgage details (term, rate, overpayment facilities, proximity to LTV brackets etc.)
It is sometimes difficult to decipher your own feelings on these matters and a healthy dose of introspection is sometimes required to get a grip on them. One way of better understanding these personal factors is to plan scenarios and try to anticipate your response. That might be any combination of: outrageously good/bad investment returns, significant rise or fall in mortgage interest rates, loss of or bountiful increase in income, or changes in other personal circumstances.
The ‘known unknowns’ are likely to impact on various other facets of your financial and personal success, so understanding them is important beyond the scope of the ‘overpay mortgage vs. other’ question. Fortunately, the elements in this box will tend to be of lower risk as you can, with enough aforethought, somewhat predict the impacts they’ll have.
The ‘Unknown Unknowns’
The unknown unknowns are items and events masked by the haze of the future, clouded in the fog of war, refracted by the crystal ball. Tucked in just below the dividing line of the two right-hand boxes is the actual, future return for any given investment. Nobody can know for sure how it will perform. Some may have the resources to try and predict returns, which translates into the cost of investing in an actively managed fund. The reality is that, certainly for the vast majority of us, future investment performance is a relative unknown unknown.
We’re in the midst of an unknown unknown now – who could have accurately predicted the advent of the Covid-19 pandemic, or known the timing of its subsequent socio-economic impacts? The 2008 global financial crisis was similarly sprung upon the vast majority of people who were none the wiser. Sudden, life-changing events also fall into this category, e.g. changes in the health of you or your family, changes in employment or relationship status.
As a result of being largely unforeseeable, these elements carry a relatively higher risk. Agreeably the unpredictable nature of factors in this box make them difficult to plan for – is there any value in considering them? Disregarding factors in this box might compound the effects they have. As they’re the type of events that might necessitate a reasonable amount of financial liquidity, tying up all your money in relatively illiquid vehicles (e.g. mortgages, pensions, investments) leaves you at their mercy. Conversely, the problem with overweighting importance to this domain is the trend to nihilistic thinking. “If nuclear armageddon might strike tomorrow then I might as well spend the money rather than invest or pay off the mortgage”. If unpredictable, calamitous events are the only rationale behind spending your money then you might never save! That’s not to say, however, that spending money instead of investing or paying off your mortgage is a bad option.
Example – the outcome of the thought process: “I know that if future investment returns mirror historic returns I would make more money investing instead of paying off my mortgage. However I prefer to have no debt at all and even having a mortgage grates on me. I’m also near an LTV bracket so could remortgage for a better rate if I reached it. My job security is low and I may end up changing careers, so I don’t want all my money tied up in an inaccessible way. I think that the chance of future economic downturn is guaranteed, although I don’t know when, but want to keep some money liquid. As such I’ll split my spare money into 50% mortgage overpayment, 30% investments and the rest as cash.”
Strike the Balance
Ultimately, the answer to your own personal ‘mortgage vs other’ question needn’t be binary, nor absolute. You might decide that the net outcome of the ‘mortgage matrix’ is a split of your spare money between your mortgage and other vehicles. Similarly, you could rehash the problem on a recurring basis to check the balance of factors, assess how they’ve changed and modify your approach as needed. In any case, we hope you find the matrix useful – let us know how you get on with it.
This post builds on our existing NHS Pension series. Throughout the post we’ve put links, where relevant, to the appropriate prior material. We do, however, suggest refreshing your understanding of the NHS Pension prior to reading on.
The term allowance reminds me of pocket money, that highly prized one or two pound coin slipped to us for guilt-free spending on sweets or other frivolities. Once it was spent, there was no more. All that remained were jealous glances at the sibling who saved theirs for later, or bought something longer-lasting. Sadly, the adult world doesn’t stop you from spending more than your allowance. It just taxes you for it.
All pensions, NHS included, are subject to two limitations on contributions. Stay within them and your pension money is all yours (until it’s subject to income tax). Breach the allowances, however, and HMRC will come runnin’ to give you even more of a tax bill. These caps are known as the Annual Allowance (AA) and Lifetime Allowance (LTA).
The Annual Allowance
The AA is the total amount you can contribute to pensions in a tax year, not including the State Pension.
It currently stands at £40,000 (or 100% of your earnings, whichever is less). If you put more than this into a pension in a tax year, you’ll breach the AA and the excess is taxed at 40%. And you don’t even get windshield or breakdown cover…
How do you know whether you’re breaching the AA or not? This is less obvious than it would seem. To be clear, the cost of your NHS Pension (e.g. 9.3% of salary) is not contributory towards the AA. You can work out how much of your £40k allowance you’ve used by calculating your ‘pension input amount’. This is best explained with examples, though in essence is the gain in pension from one tax year to the next, multiplied by 16.
Example 1 Dr. David has been working for the NHS for six years. At the start of the tax year, his pension has accumulated to £5,000. The ‘opening value’ of his pension for the tax year is £5,000 multiplied by 16, then increased by inflation. Assuming inflation is 2%, this is £81,600.
He works another year, earning £54,000. At the end of the tax year, his pensionable amount is now £6,210. The ‘closing value’ of his pension is £6,210, multiplied by 16. This is £99,360.
The difference between the opening and closing values is the pension input amount. I.e. £99,360 minus £81,600. This is £17,760. Dr. David has not breached his AA for the tax year as this is under £40,000.
In the example above, not only has Dr. David avoided any charges for breaching the AA but he also has leftover allowance to use. In theory, he could contribute another £22,240 to a pension and still not be in breach of the AA. That might be through buying more NHS Pension (see here) or paying into a SIPP.
Example 2 Dr. Denise is a consultant. At the start of the tax year, her pension had accumulated to £48,000. This makes her opening value £783,360. After another year of work, her pension has now accumulated to £52,000. This makes her closing value £832,000. Her pension input amount, the difference between these two, is £48,640. Dr Denise has breached her AA and will be subject to a charge.
There are other facets that muddy the waters somewhat. For example, you can carry unused AA over from the previous three tax years, which may increase your available amount in a given year. Similarly, the inflation number used to modify your opening value is taken from a different year as that used to revalue your pension – this may push you closer to or further from the AA in any given year. The Tapered Annual Allowance, whereby your AA was reduced incrementally if you earned over a certain amount, is less of an issue than previously due to recent changes, though remains worth keeping in mind. As usual there’s a handy NHSBSA factsheet and also information from the Pensions Advisory Service about the AA.
The Lifetime Allowance
The LTA is the total value your pension(s) can have at the time you start to draw money from them, not including the State Pension.
It currently stands at £1,073,100. It is due to rise with inflation, so will be slightly bigger each year. However as your NHS Pension is revalued by inflation + 1.5%, you will eventually hit the LTA if you work long enough. The charge for breaching the LTA is fairly steep: 55% on lump sums and 25% on pension income (in addition to whatever income tax you’d pay on that money).
How can you know whether you’ll breach the LTA or not? The NHS Pension doesn’t have a ‘pot’ to compare against the £1.07m figure. Instead you’ll need to work out the capital value of your NHS Pension. You can calculate your pension’s capital value by multiplying the pension income in retirement you’ll receive by twenty. For example:
Example 3 Dr. Damian works for the NHS for 40yrs, retiring at 66yrs old. The LTA has risen over those 40yrs (in line with inflation) and is now £2m. His NHS Pension will pay him an annual (pre-tax) income of £110,000. The capital value of his pension is £110,000 x 20 = £2.2m. As such, he has breached the LTA by £200,000. This amount is subject to the charges for exceeding the LTA.
The LTA applies to all your pensions together, not to each individual pension. This is relevant if you contribute to (or have previously contributed to) a pension outside your NHS one:
Example 4 Dr. Dominique is retiring at 59yrs old. The LTA has risen in line with inflation to £1.2m. Her NHS Pension, after the reduction for early retirement, will give her £50,000/yr in income. She’s also been contributing to a SIPP, which is worth £250,000. The capital value of her NHS Pension is (£50,000 x 20 =) £1m, i.e. under the LTA. However the total value of her pensions includes the SIPP, so is £1.25m. As such, she has breached the LTA and is subject to the charges for exceeding it.
The relationship between your NHS Pension and the LTA is easier to understand conceptually, and to calculate, than the AA. There’s more detail from the NHSBSA for those who want to read deeper into the LTA. Whether you’ll breach the LTA or not is predominantly a product of your pensionable salary and duration of employment. FI(RE) should certainly help in limiting the latter!
What does it all mean Basil?
Those whose salaries climb high enough or work for long enough will almost certainly breach the LTA, and possibly the AA too. Keep these numbers in mind in order to plan a strategy that will minimise tax charges but eke the most value from your pension. Similarly you’ll need to be wary of incurring chargers if you’re planning on also contributing to a SIPP or other pension scheme alongside your NHS Pension. If you can afford it, a reduction in working hours later in your career might be the most rational step forward if you wish to avoid hefty pension bills, even if FI(RE) isn’t part of your plans. Less work? Less tax? Sounds good to us.
The term savings rate brings about agreement and argument in equal vigour. A higher savings rate is almost universally deemed to be a good thing, although there’s likely to be a sweet spot between putting aside a suitable quantity of money and sacrificing too much quality of life. What really brings about disagreement, however, is talking about how to calculate your savings rate.
Which formula to use? The FIREstarter’s formula, which has the backing of blogging heavyweights Monevator? Or the Savings Ninja’s similar version? Why not use ChooseFI’s calculator to save battling Excel’s formulas? Big ERN can surely cut through the indecision – but he describes four different rates! Are savings rates meaningless? Should we bin them entirely and use the FI Fox’s proposed ‘investing rate’ instead ? Do we include pension savings? Or dividends? What about that fiver the neighbour palmed me for mowing their lawn? The debate about savings rates will surely go on forever – there’s unlikely to be a universally accepted measure or one that’s applicable to all.
We’re not going to try and dazzle you with ‘MedFI’s earth-shattering new way to calculate your savings rate’ or ‘how this formula will get you to your FI Number three years quicker’. Instead, we’ll revisit our first thoughts about the savings rate and how that’s panned out since instigation.
One for me, one for you
We read many numbers in our early consumption of FI material, though the one we kept coming back to was from this post by inimitable American FI blogger Mr. Money Moustache. The idea that a fifty percent savings rate could lead to FI in seventeen years was, literally, life-changing. In addition to the allure of feasible retirement before reaching fifty years old, the ’50%’ number felt…symmetrical? As if we were dividing our money into ‘one for present-day us and one for future us’. It created this notion that a month where we spent only half of our income led to a future month that was liveable without income. We know that the maths is actually slightly different, but we couldn’t escape the attraction of this fifty-fifty harmony. It was settled; a fifty percent savings rate was our goal.
At this juncture we reached that tricky question: how to calculate our savings rate? Searching the plethora of financial and FI material did not yield clear cut answers. In the end we decided on a few principles for our savings rate:
1. Simple. This was at the forefront of our mind and links in with the Pareto principle (‘the 80/20 rule’). We felt most of the benefit was to be derived from having a savings goal at all, regardless of how we calculated the rate. We wanted something clean, crisply calculated and clear. 2. Relevant. However we worked the maths, it didn’t need to appease the baying masses on internet forums. It had to be relevant to us, to how we understood our own finances, cashflows and savings. 3. Sensible. It’s easy to jig the numbers to make your savings rate higher or lower with a few additions here or subtractions there. Recalling the advice of a maths teacher from the past, we wanted the number generated to be sensible. If we spent three-quarters of a month’s income there’s no way our savings rate for that month should be 80%. The numbers had to make sense. (Thanks Mr. Barker.)
Using the principles outlined above, we settled on the optimum formula for us. Retroactively applying this to two previous years’ worth of financial tracking yielded savings rates of 34% and 24% respectively. Interestingly, though we hadn’t felt it at the time, we had succumbed to lifestyle creep. A 10% year-to-year reduction in savings rate despite a 3% rise in income. This was both promising and daunting. Even in the ‘creep’ year our savings rate was ~25%. Yet we’d have to double it to reach our target.
He shoots! He…misses?
It’s now been one full tax year since implementing our savings rate goal, although we have continuous data going back fourteen months. You can see the fluctuation in savings rate over that time above, oscillating tantalisingly around that fifty percent mark. Our savings rate for the last tax year (2019/20) ended up being 48.6%. Excluding the two outlying months (i.e. the one with the highest and the lowest savings rate) it was 49.3%. In short, we failed to hit our target.
Some might say that we basically achieved our goal. 48.6% rounds to 49% and 49% is near enough 50%. We’re going to shy away from this thinking, because we didn’t reach our savings rate target. The clear aim was fifty-percent, not ±2%, or ‘close to 50%’. Failure is acceptable and will serve as a motivator for the next tax year. This isn’t pedantry, it’s detail. The phrase that springs to mind is ’look after pennies and the pounds will look after themselves’. Though the ’80/20 rule’ is a useful broad brush, sometimes a more finessed approach is required – choosing when to apply which one is going to be key in achieving our goal next year. The first step will be to look at our expenditure (see above) and find where we can eke out 1.4% worth of marginal gains!
Eradication of existing ‘bad’ debt is one of the pillars of living in a financially stable fashion. This is surely not news to many of you. In addition to loans, credit cards or mortgages, there’s another debt that most of us owe: sleep debt. Again, it’s probably not an earth-shattering revelation that sleep is vitally important for you. Building up sleep debt makes us feel terrible, yet we persistently ignore this other arrears. What are the knock on effects of allowing this somnolescent liability to accrue?
Putting a shift in
In the vernacular, ‘putting a shift in’ is seen as an almost noble effort. It conjures up images of hard graft, perseverance through abhorrent conditions or toiling until exhaustion. Despite this exalted idiom, the existing evidence would suggest that shift work is rather bad for you. At the coalface of the NHS, there’s shift work aplenty. Amongst many other sequelae, shift work leads to a reduction in sleep, which is unsurprisingly more pronounced after working night shifts1.
Shift workers lose up to two hours of sleep per day1. In a year that’s nearly five hundred hours of sleep debt! It may not sound like a great loss, but performance is already impaired after missing out on two hours of sleep2. The effect snowballs too; performance declines progressively as sleep debt accumulates2.
Around 50% of ‘normal’ day time workers will cut back on sleep in favour of other activities. For shift workers the number rises to between 60-70%3. The majority of those who are already behind on sleep are more likely to cut it back even further. It’s not something one ‘gets used to’ either; very few adapt to shift work due to the way our intrinsic circadian systems function4.
It’s not just that the quantity of sleep is reduced in shift workers, their quality of sleep is also poorer1. There are reductions in both deep sleep (refreshing/recharging) and REM sleep (learning and emotional regulation). Shift work is comparable to working in the UK and having your rest days in San Francisco1. Night shifts seem more akin to having rest days Down Under. Unsurprisingly, the fatigue associated with (night) shift work affects the psychological and physical wellbeing of the majority who undertake it2.
We’ve all experienced the effect of tiredness on our ability to work. The hazy, foggy nature of incoming signals, the sluggish processing speed, the delayed, malfunctioning output. It’s certainly not enjoyable, though has even broader consequences.
In terms of functioning, those doing shift work have a greater incidence of poor memory and poor performance compared to day workers. Worse still, they over-estimate their own capability4. Not only are you performing badly but you don’t even recognise it either! With worsening alertness and vigilance comes a four-fold increase in errors4. Reaction time is slowed: after sixteen hours awake it’s equivalent to a blood alcohol level at the legal drink/drive limit5.
This unsurprisingly manifests as an increased risk of road traffic collisions driving home – 57% of surveyed doctors described an accident or near-miss travelling home from nights shifts2, 5. If this litany of fatigue-induced cognitive deficits isn’t enough, shift workers suffer from increased rates of mood disorders, depression and anxiety too4.
It’s not only your mind that takes a bashing from a build-up of sleep debt, your physical health is also in the firing line. Various body systems are affected, though perhaps none more so than your heart.
An increased activation of the body’s natural stress systems puts more strain on the heart, leading to a rise in blood pressure. The long-term effect of this is a 40% increase in cardiovascular disease risk1. This predominantly comes in the form of increased risk of heart attacks (23%), other coronary events (24-41%) and strokes (5%)6. Interestingly these risks remained when other factors such as socio-economic status, itself a risk factor for cardiovascular disease, were taken into account.
The very nature of being tired induces an increased appetite for energy-dense foods, which are typically high in sugar (or other tasty-but-detrimental ingredients)4. Weight gain and obesity tends to follow. There are also suggestions, but not conclusive data, of associations between night shifts and type two diabetes, metabolic syndrome, ulcers and other gastrointestinal disorders7, 8. For those starting a family, there is an increased risk of spontaneous abortion, premature birth and low birth weight1.
There may be some association between shift work, sleep debt and cancer. The strongest link appears to be between night shifts and an increased risk of breast cancer9. The relationship with other specific cancers, and indeed cancer as an over-arching disease, is less clear.
Unsurprisingly the plethora of detrimental effects listed above have added social consequences. Shift workers demonstrate increased rates of divorce and their children tend to underperform in school4. One study showed that other people are less inclined to socialise with individuals who had gotten insufficient sleep10. Furthermore, when sleep-restricted, participants were perceived as less attractive and less healthy.
Financial debt is rarely something that can be paid of in one fell swoop. We chip away at it each month, reducing it little-and-often until it’s gone. Similarly, those days, weeks, months or even years of sub-optimal sleep are unlikely to be corrected with one epic snooze. It’s time to make changes in order to repay this debt.
A number of you probably know what to do to improve your sleep quality. ‘Sleep hygiene’ is a relatively popular topic. There are a whole host of resources on how to improve sleep, including those from the NHS, Sleep Foundation and Sleep Council. For those engaged in (night) shift work the best resource we found was this one. As you can see, there are a plethora of changes you can make to improve your sleep. We’re not suggesting that you make all the changes in one go. It’s not sustainable. You might manage a few days or even a week, but long-term you’ll slip back into the same old routine. Instead, pick one or two and start with those.
The MedFI challenge for you then, dear reader, is to start paying off your sleep debt. Let us know how it goes!
1 – JM Harrington. Health effects of shift work and extended hours of work. J Occup Environ Med. 2001; 58(1). Available here. 2 – H McKenna and M Wilkes. Optimising sleep for nights. BMJ 2018; 360. Available here. 3 – C Williams. Work-life balance of shift workers. Statistics Canada, Perspectives. 2008; 75(1): 5-16. Available here. 4 – C Harvey. Working nights: side effects and coping mechanisms. AQNB Productions. 2017. Available here. 5 – M Farquhar. Night shifts. Don’t Forget the Bubbles. 2017. Available here. 6 – MV Vyas et al. Shift work and vascular events: systematic review and meta-analysis. BMJ. 2012; 345. Available here. 7 – M Farquhar. Fifteen-minute consultation: problems in the healthy paediatrician – managing the effects of shift work on your health. Arch Dis Child Educ Pract Ed. 2017; 102: 127–132. Available here. 8 – Sleep Foundation. Living & coping with shift work disorder. Available here. 9 – X-S Wang et al. Shift work and chronic disease: the epidemiological evidence. Occup Med (Lond). 2011 Mar; 61(2): 78–89. Available here. 10 – T Sundelin et al. Negative effects of restricted sleep on facial appearance and social appeal. R Soc Open Sci. 2017 May; 4(5): 160918. Available here.
Gaining financial independence and retiring early is ostensibly an exercise is quantity. Markers of it are dotted throughout the FI language. FI number. Safe withdrawal rate. Savings rate. Not to mention the emphasis on investments, budgets, net worth and the gamut of other financial tools used to run one’s own personal treasury. This is partly through necessity – FI undoubtedly has a large quantitative component. The comparability of these factors also helps the community converse, share ideas and grow.
The numbers we generate seem tangible and the changes to them visceral; we follow their rise and fall with eager anticipation. Who can deny the exhilaration of seeing your investments rise in value? Who hasn’t felt the dismay of seeing them fall?
Time for one more?
There is another quantitative measure that humans are almost universally obsessed with. Time is invariably sought after, as we try to grasp its frail tendrils in our clutches. An extra moment in bed. Relaxing with that loved one just a bit longer. Wishing the sun would stay up a little while more.
We have a tendency to view our lives in terms of duration and will go to some lengths to prolong it. Everyone from a Pope to mad scientists have sought ways to prolong life. Indeed, our legends are studded with the stories of those who were said to be immortal.
It’s likely that many have found themselves with more time on their hands than usual in the recent days and weeks. Some will be using their newfound temporal freedom to finally take up painting, learn that language, fix their bike or start that novella. The weekly cycle of sleep-work-eat-repeat is being broken for a whole host of people across the country. An insight into the journey after FIRE, perhaps.
Whether it’s our lifespan or FI number, we often focus on quantity. Now more than ever, we mustn’t forget that it’s the quality of our lives that we’re also trying to change, to better, to embellish. You probably know your risk tolerance, or appetite, or how far you’re willing to let your investments drop before you sell them. What about your quality of life? What reductions in that are you willing to accept if needs be? In a period where all of our vitality is under threat, it is time for introspection: examine what brings quality to your life.
Unlike quantity, the language of quality is less easy to communicate in. It’s less clear-cut, more subjective. It makes discussing it that bit more difficult and yet discuss it we must. Reflection is not enough. Talk to your partner, your parents, your friends, your children. Learn what enriches their lives and share what enhances the quality of yours.
Covid-19 has spread to nearly the whole of the UK; it will affect all of us in some way. Many of the population are likely to get coronavirus; sadly many are going to die. There may soon be a time where you’re forced to consider what constitutes an acceptable reduction in quality of life, be it for yourself or for your loved ones. If that time comes, it’s imperative that you’ve already spoken about ‘the other q’.
The fear is real, the hysteria more so. Covid-19 has stepped up to join H1N1 as a 21st century global pandemic. It leaves those other paltry epidemics in its wake, though remains firmly in the shadow of the hundred-year-long HIV/AIDS pandemic. The impact of the whole affair on peoples’ lives seems as if it will be felt for many weeks, if not longer.
C U l8r
Do you remember when shorthand textspeak was all the rage? During the times when typing an ’S’ required four presses of a button, a new language evolved. The advent of phones with full QWERTY keypads saw the language mostly go extinct, though we still get texts from our aunt using terms such as ‘gr8’, ‘l8r’ and ‘thx’.
Coronavirus measures have spawned a new kid on the textspeak block: ‘wfh’. Perhaps it’s already in common use amongst professionals who have the option to work from home? Being in a career that lacks that option, it certainly seems novel. Perhaps we’re just showing our dated-ness, much as our aunt continues to do.
Along with ‘wfh’, words such as ’quarantine’ are enjoying a surge in use, as is the term ‘self-isolation’. As long as ‘self-immolation’ doesn’t join them, things will be alright. Others have written eloquently on the longer-term impact of realising that most jobs can always be done from home, pandemic or not. For many wfh-ing isn’t an option; there’ll likely be a significant financial hit to a large number of households. Those sitting on Emergency Funds can bask in the warmth radiating from their cash reserves.
For many NHS workers there may be a bizarre reverse-‘wfh’ effect. Some of our colleagues have already spoken of the blow-up mattress in their office and plans to stay away from their children. If events in the UK reach a similar scale to those in Italy then it’s a real probability that a high number of clinicians will be infected. In such a case, staying away from home to avoid infecting the nearest and dearest may be people’s chosen option.
Baked beans and shotgun cartridges
The markets remain tempestuous. An approximate 28% dip in the FTSE-250 in the past few months is fairly impressive. Perhaps a better investment decision would have been to buy shares in companies that make sanitary products, though unfortunately Johnson & Johnson (-5%), Procter & Gamble (-10%) and KMB (-16%) are all down. As an aside, there’s just shy of three weeks until the new tax year; time to fill whatever ISA allowance remains before it resets on April 6th.
The message from much of the FI and investing community is… exactly the same as it’s always been. Don’t panic, don’t sell. Play the long game. It draws parallels to the ‘boring prophet’ from Monty Python’s The Life of Brian. Whilst other prophets predict cataclysmic events, the boring prophet preaches the mundane.
Rightly so; history suggests that things will cycle on through as they’ve always done. (Although, have you heard that past performance is not a predictor of future results?) For many, ourselves included, this represents the first test of our investing mettle, of our mental fortitude. Advice is often given and seldom taken. We would be wise to heed that of those who’ve been through it all before.
Gold continues to hold its value, for the time being at least. After our last post, in which we outline the arguments for and against owning gold, Lars Kroijer has weighed in with his own views on gold as an investment in an armageddon-type scenario. We highly doubt that 2020 will herald a post-apocalyptic era. If it does, then there’ll be no jobs, no salaries and the GBP may no longer be the common currency. In fact, we’ll have reached a sort of financial independence nearly 20 years ahead of schedule.
Kroijer quips about not forgetting the can opener in the event of having hoarded baked beans. Based on the evidence from the local supermarkets, the tin opener will primarily be needed for canned tomatoes. As the mass purchase of toilet paper has replaced the weather as Britain’s favourite topic of conversation, we inevitably found ourselves in lunchtime chit-chat regarding the recent bulk-buying fanaticism. “Bog roll!”, exclaimed one of our colleagues, a wry smile touching the corner of his mouth, “No I’m buying shotgun cartridges, to keep thieving bastards out of my pantry”.
There may be a hurricane
We’re not going to go full Michael Fish and suggest that the weeks ahead won’t be stormy, be it literally or metaphorically. The already creaking NHS is being subjected to a new pressure, one that’ll surely expose its already chronically understaffed hospitals and downtrodden employees to a new realm of psychological and physical strain. It’s a system that already relies on the goodwill of many and it will do so now more heavily than ever. There is, however, evidence in the form of the waning caseload of Chinese coronavirus patients to suggest that the storm will pass eventually. There’ll be a blip for sure, but the markets will inexorably grow as ever. Yes, some will discover new gluten intolerance, rendering their carefully sheltered pasta stores worthless. Some may end up working from home on a more permanent basis. And some will have cleaner hands and rear-ends than ever before.
Of the many asset classes available, commodities was one of the least popular amongst FI bloggers. Investing in gold, the archetypal commodity, divides opinion and there are staunch supporters on both sides. We’ve had trouble deciding on the optimum strategy for investing in gold, especially with a plethora of (often contradictory) information flying around. To cut through the noise, and also to crystallise our own thoughts, we’ve distilled out a few key considerations from our research on investing in gold.
Of the arguments for investing in gold, the one made most frequently is its ability to act as a counterbalance in a portfolio. Holding gold seems to be a panacea for failures elsewhere. It’s lauded variably as a “unique” hedge against inflation/paper currency/the government and as the “ultimate insurance policy“. These claims stem from both the ability of gold to hold its value over the long run and a historically poor correlation between gold and equities1. In theory equities and gold might act as two children on either end of a see-saw: as one goes up, the other comes down. Some studies show gold is poorly1 or negatively2 correlated with equities. In one analysis it counterbalanced falling equities 83% of the time; in another holding gold improved portfolio return during UK equity market drawdown in two-thirds of cases. Gold features in three-quarters of Portfolio Chart’s ‘recession-proof’ portfolios.
Adding to the allure of gold is its track record. Having been used as some sort of currency for over 2,500 years, gold’s history, familiarity and ‘safety’ is attractive for many investors. Some see it as the holding in the event of a financial system meltdown or other cataclysmic event. If the collapse of the government or even global society doesn’t get the ‘aluminium foil hat’ juices flowing, physical gold can act as an anti-microbial – it may come in handy in a post-antibiotics bacterial apocalypse!
What about the returns on an investment in gold? Gold went up in value every year from 2000 until 20113. One 10 year retrospective analysis of a physical gold ETF demonstrated a cumulative 96% increase in value (2009-19), though we note this pales in comparison to the 214% increase in global equities. Gold’s annualised nominal return was 7% from 1972 to 2018 and 12% over a shorter, more recent time period (2011-17). Others have found that the price of gold, which increased 591% between 1999 and 2009, outstripped both returns on the S&P 500 (229%) and the stock price of Berkshire Hathaway (536%).
Though the numbers above are enticing, it doesn’t help us understand how much gold to own. As ever, the make-up of a portfolio will depend on a whole host of personal factors and there’s no ‘one size fits all approach’. Varioussources recommend ~10% of your personal wealth is held in gold3, though you can find advocates of it being up to a quarter of your portfolio.
Those who doubt the gilt-edged nature of gold investments can count investment heavyweight Warren Buffett amongst their number. Buffet has had some choice words to say about gold over the years, articulating some of the main points against investing in gold.
There’s a body of evidence that gold is not quite the hedge it’s made out to be. It was found to only be a hedge against equity market downturns in the very short run (i.e. days, not months or years) and that this depended on owning gold prior to the crash. Indeed in the midst of the global financial crisis both the S&P 500 index (40%) and gold (30%) were down in value at the same time. Gold’s strength as an inflation hedge also wilts under close scrutiny.
In modelling our experimental average investing portfolios, gold correlated positively with global bonds, global equities (ex-US), REIT’s, inflation and US equities in decreasing amounts. It was only (extremely weakly) negatively correlated with cash. Indeed, it seems the data contradicts the claims that gold acts as a good hedge against inflation and/or currency. The price of gold is also highly volatile, which belies its purported role as a steady holding in a portfolio.
Gold doesn’t garner interest; its returns often lag behind those of global index trackers as it cannot generate income to be re-invested. This is well known, but there are also thoughts that gold is unlikely to provide strong investment returns in future. Indeed one analysis suggested that the real annualised return on gold in the next decade, regardless of inflation, is -4.4%4 (if gold declines to a calculated ‘fair’ value). Unlike other assets establishing what this fair value is, and whether the price of gold is ‘high’ or not, is complex 4,5. This is in part due to gold’s value relying heavily on secondary market sentiment. This often leads to the ‘gold is only valuable because people think it is’ argument, though we don’t find it the most compelling one.
A consequence of gold’s lack of income provision is that it has a negative carry cost; it costs you to own it. To borrow Warren Buffet’s analogy, gold is a “goose that just sits there and eats insurance and storage”. In other words, gold is an expensive insurance policy.
Coronavirus:A Case in Point
December 31st 2019 marked the first reported cases of COVID-19, the ‘Wuhan Coronavirus’. It has now joined SARS, MERS, H1N1 influenza and Ebola on the list of 21st century viral epidemics. We’ll skip over the medical and other socio-political impacts of the disease; they fall beyond the scope of this post. Instead, let’s look at the price of gold.
Since the outbreak began, gold has risen in price by ~7% ($1515/oz. to $1626/oz.). Increasingly, anxious investors have flocked to gold once again during a time of (economic) uncertainty. Comparing the S&P500 to the price of gold demonstrates this perfectly:
As the angst (read: hysteria) rises so does the appetite for and price of gold. In comparison, the S&P500 lost nearly 13% of its value between the 19th and 28th of February 2020. That’s a lot of fear! The rationale of those in Camp Pyrite is still sound, but we couldn’t pass up this highly contemporary example of the arguments made by those in Camp Auric. With the whole affair set to drag on, we’ll be watching that space for sure!
The inferiority of gold as an investment compared to others means it’s unlikely to make up a significant chunk of our portfolio anytime soon. The start of the accumulation phase of FI is the hardest – partly because your invested wealth is at its lowest – why hamstring it further? Having said that, we do want a diversified portfolio. Gold is definitely a bit different and (dare we say it) exciting.
There are a number of ways of owning gold beyond the small exposure we have through global equity funds. We’d probably opt for physical gold or maybe a physical ETF, but shy away from synthetic ETFs and mining equity. As a satellite investment, we think up to 1 or 2% is an appropriate allocation for now.
As always our post is designed to inform your own FI journey, rather than push one point of view or another. We hope this summary will help you cut through the reams of information on gold out there, whilst providing suitable resources if you wanted to wade through yourself. In the end we all want to have the Midas touch when it comes to our investments, but that doesn’t mean they all have to be golden.
1 – Erb, CB. and Harvey, CR., The Golden Dilemma (2013). Financial Analysts Journal, 69(4): 10-42. Available at SSRN: https://ssrn.com/abstract=2078535 2 – Baur, DG. and Lucey BM., Is Gold a Hedge or a Safe Haven? an Analysis of Stocks, Bonds and Gold (2009). Available at SSRN: https://ssrn.com/abstract=952289. 3 – Craig, A. (2019). How to Own The World: A Plain English Guide to Thinking Globally and Investing Wisely (3rd ed.).John Murray Learning. 4 – Erb, CB. and Harvey, CR., The Golden Constant (2016). Duke I&E Research Paper No. 2016-35. Available at SSRN: https://ssrn.com/abstract=2639284 5- Erb, CB. and Harvey, CR., An Impressionistic View of the ‘Real’ Price of Gold Around the World (2012). Available at SSRN: https://ssrn.com/abstract=2148691
In our last post we looked at the results of our survey of asset allocation amongst FI bloggers. The results demonstrated the average portfolio favoured allocations to equities (68%), bonds (9%) and money in property (15%). The remainder comprised of cash, P2P lending, commodities and other investments. We know that the power of the many can outperform that of the individual in quantitative tasks. Let’s say you were stuck trying to figure out your asset allocation. Instead of copying the investing strategies of one person, why not use an approach aggregated from the ideas of many different people? What would happen if you invested using the ‘Average FI Blogger’ Portfolio?
Let’s look at some issues before we crack on with the number-crunching. Firstly, our data represents only about a third of the community we wanted it to – it’s far from a perfect average of all FI portfolios. Secondly, assessing the performance of some of the asset classes is tricky. We suspect the ~15% allocation to property is predominantly people’s home equity rather than property investing per se, which makes it difficult to model. Similarly, the performance of cash (decreasing value from inflation), P2P (variable) and un-qualifiable ‘other’ assets can’t be easily represented. Lastly, the performance of equities, bonds, property investments and even cash will be highly variable depending on the vehicle in which they are invested. This further muddies the waters. But let’s give it a shot and see what happens.
The PC portfolio comprises of 67.6% total stock market equities, 8.9% long-term bonds, 0.6% commodities and 15.3% property [real-estate investment trust; REIT] investments. The missing wedge (8%) represents the holdings of cash, P2P and other investments in our PC portfolio. We did also model a portfolio without REIT’s just to see if that made a major difference to the results (see below).
The TN Portfolio comprises of investments as show above, though P2P (1.4%) was included with cash and the 1.5% of ‘other’ investments was spread amongst all the classes. We chose a selection of assets that might reasonably be chosen by an investor (see below).
The PV portfolio is similar in make-up to the other two. The equities portion is split into 55% US (VTSMX) and 45% ex-US (VGTSX) equities as there’s not a ‘global stock market’ option. We chose unhedged global bonds (PIGLX) for the bond allocation. Cash (CASHX) is weighted at 6.2%, while the tiny grey sliver labelled ‘other’ represents the commodities (GSG) allocation for the portfolio (0.6%). As with the PC portfolio, we did the modelling both with and without the REIT (VGSIX) portion.
If you’d invested using a strategy akin to the PC portfolio from 1970 until 2020, you’d have averaged annual real returns of 5.8%. Your portfolio would have made money nearly 70% of the time and provided >10% real returns in over 45% of those fifty years. On occasion, however, it lost 20-40% of its value. For 1 in 10 years it’s annual real return was between -10% and -20%! If we removed the REIT component of the portfolio, the portfolio became more volatile (SD 15.9% vs. 14.4%). The portfolio still made money most of the time, though returns were marginally greater at 6.3%. Indeed, real returns were over 20% in a quarter of years!
Losses were a tad harsher in a REIT-less portfolio, however, as it lost 20-40% of value more often. The higher equity allocation in a PC Portfolio without REIT’s would account for both the greater returns and higher volatility. The Portfolio Charts site allows you to do some FI calculations too. With a 25% savings rate, to fund a PC portfolio that could provide a 3.5% SWR for 40yrs you’d need to work for 23-33yrs. If your savings rate was 50%, if would be 12-20yrs. These broad time ranges make the numbers slightly unhelpful, but we’ve included them for demonstration.
The TN portfolio provided annualised returns of 10% (from 2011-present). The cumulative gain was 139%! The ride was mostly smooth – overall volatility was only 8%. There were dips though, losing 20-30% of value in 2015/16 and 2018/19 due to a fall in equities and/or property. Unsurprisingly, you can see that equities do the heavy lifting in terms of portfolio performance.
In terms of annualised returns in the past five years, the TN portfolio (10.1%) outperformed both the FTSE All-Share index (7.6%) and the ‘aggressive’ advisor fund index (8.6%). It lagged behind the FTSE World index (12.5%), however.
Simulating the PV portfolio led to an average return of 7.3% (2007-present). The standard deviation of returns was 13.9%, which is similar to the PC portfolio. Taking out the REIT portion had minimal effect on both returns (7.1%) and volatility (13.1%). Once again equities did the heavy lifting. The cheeky 8.8% annual returns from REIT’s came with a hefty 23% volatility, while it’s fortunate that commodities (annualised -4.3% returns and 22% volatility) are such a small wedge of the portfolio pie.
On average, the most value your portfolio would have lost at any one time was was about 40%. The portfolio commonly (i.e. more than 50% probability) lost up to 10% of its value, though the chance of it having lost value by the end of the 40 year period was <2%. If you started off with £1,000 and contributed £100/month your portfolio would, on average, be worth over £20,000 by the end of 10 years – much more than the £12,000 if you’d just stuck the money in a bank account. By 20 years the gap has widened as your £60,000 portfolio is worth more than double the ‘stick it in the bank approach’!
Overall it seems an investment strategy based on the ‘Average FI Blogger Portfolio’ netted you real returns in the region of ~7%. Whether REITs were a part of the portfolio or not seemed to have little effect on the overall outcome. Commodities/gold seemed a bit of a liability although their impact was minimal as they made up <1% of the portfolio.
We came up with this idea for interest, but in reality you shouldn’t use an averaged approach. We said at the beginning that asset allocation is important because it will tailor your portfolio to your individual needs. An averaged portfolio is tending to everyone’s needs and yet nobody’s at the same time. You suffer from all the compromise and idiosyncrasies of others’ portfolios. Instead, it’d be better to sit down and outline your own plans, your own goals and your own strategy for investing.