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.
Appropriate asset allocation is a key component of investing. It tailors a portfolio to an individual’s investment goals, timeframe, risk appetite and risk tolerance. There are a plethora of asset classes available to the individual investor and choosing a pertinent allocation can be difficult. Investing dogma would dictate a diversified portfolio, with a higher proportion of ‘riskier’ investments initially that tapers to a more cautious allocation as retirement looms. The expanding number of financial independence blogs represent an increasing repository of investing information for those with similar aims. Some readers might follow the investment advice of those blogging about their progress towards FI; what if they chose to use an asset allocation that represented an average of all the portfolios? And what would that look like: an all-out, total stock market equity-fest? A mind Bogle-ing three-fund portfolio? A set in stone permanent portfolio? We wanted to find out.
Finding the numbers
We generated a list of FI blogs from various resources, including Fire Hub and the FIRE-UK subreddit. We didn’t include blogs based outside the UK or portfolios that used a currency other than GBP (£). We asked the author(s) of each blog to provide their age and a breakdown of their asset allocation. If there was no reply or no means of contacting the author directly (via blog, email or social media) we searched their site for a description of their asset allocation. If this was not available, we excluded the blog.
What did we find?
Though we contacted forty-seven different bloggers, we were only able to collect data from seventeen of them (36%). The average age of those surveyed was 38yrs old (range 26yrs – 55yrs). Average (mean) asset allocation can be seen below.
Every blogger had at least some equities in their portfolio (mean 67.6%, range 7 – 100%), making it the most commonly held asset class. This was followed by property (15.3%, 0 – 68%), bonds (8.9%, 0 – 25%) and cash (4.7%, 0 – 40%). P2P (1.4%, 0 – 10%) and commodities (0.6%, 0 – 10%) were the least popular asset classes. Indeed, only two of those surveyed held any commodities whatsoever. Other asset classes (1.5%, 0 – 10%) made up the remaining allocations and varied in their description from ‘exotic investments’ through to endowment policies.
One to rule them all
Equities are the popular choice in many portfolios for their high return, although that comes with a higher volatility too. The ‘100-age’, or even ‘120-age’, rules are ways of choosing an appropriate equity allocation for your portfolio. Our results show that equity allocation was (weakly) negatively correlated with age (r = -0.12). I.e. the older the blogger, the lower their equity allocation. The trend approximately matched a ‘105-age’ strategy*.
Bar one outlier, no portfolio held less than 25% equities. Arguably one might have expected an overall higher equity allocation in an FI ‘accumulation’ portfolio: the better returns on equity could allow you to reach your FI number more quickly.
Bonds. The corollary to reducing equity holdings as you age is a rising bond allocation. The lower-volatility nature of bonds is thought to make them better holdings closer to retirement, though there was no correlation between bonds and age (r = 0.001) in our data. The ratio of equities-to-bonds in portfolios did downtrend with age, although this was a very weak correlation (r = 0.06). Overall we had expected a lower bond allocation, certainly in the portfolios of younger bloggers. The predilection for bonds may represent those nearing FI who wanted to shield their capital from market dips (and hence delay the time to FI).
The UK is often said to be a nation obsessed with buying houses. Although some might plan to rent long-term, the majority are likely to end up purchasing property. We hypothesised that those with no property allocation would have a high cash allocation, as they save towards a house deposit (e.g. H2B ISA, LISA, cash savings) and keep liquidity high. As being mortgage-free will be a part of many peoples’ FI plans, we also thought that property allocation would increase with age.
The ‘liquidity factor’ failed to materialise; there was no correlation between cash and property allocation (r = 0). The highest cash holding (40%) was, however, in a portfolio that held no property. Our other housing hypothesis was borne out slightly better – no blogger under 30yrs held property but everyone over 40yrs owned some. Property allocation weakly correlated with age (r = 0.18).
A pinch of salt
Generating data for only 36% of blogs was disappointing. The lack of responses probably stems from a combination of unchecked email accounts, unchecked junk/spam folders and an unwillingness to share personal financial information with a stranger (fair). Those who did respond represented some of the most popular names in UK FI blogging. Most wanted to remain anonymous, though there was a strong representation amongst our animal-based peers with data coming from both the Foxy Monkey and the FI Fox himself.
There are idiosyncrasies in the data we were provided that might also skew the results. The data is likely to represent a blend of actual and idealised asset allocation, though this may not have had a measurable impact on the results. Some will count their property as part of their portfolio as it makes up part of their net worth; others will have excluded it as it’s not part of an investment portfolio. This may partly explain the large range of property allocation (between 0% and 68%). Those who’ve just bought a first house are likely to have a higher proportion of their net worth allocated to property. Conversely those who don’t own property or have done so for a while may have more invested in other assets.
Similarly, some may have felt cash holdings (inc. emergency funds) didn’t count towards their investment portfolio and excluded this from their asset allocation. We tried to provide a broad range of asset class options, though excluded things such as cryptocurrency – this could have been part of the ‘other’ category though. Overall there’s enough small variations in the way bloggers perceive their asset allocation that this might have impacted the results.
The average FI blogger we amalgamated was 38yrs old, with an equity allocation approximating to a ‘105-age’ rule and a diversified portfolio that included holdings in all major (and some alternative) asset classes. Not exactly mind-blowing stuff. If we were to run our small experiment again we would definitely want to generate a larger data set, so that it’s more representative. We’d perhaps provide clearer instructions as to what we’d like, whether that’s asset allocation as a percentage of net worth, or of perceived ‘investment portfolio’, or some other framing of the question. This experiment is not meant to be a methodologically robust, highly scientific analysis of the FI blogging community. Rather, we thought it’d be interesting to see how much FI bloggers stick to some of the classic investing tropes and have some fun with the numbers.
If you have a question that you’d like our data set to try to answer, comment it below or get in touch. In the near future we’ll play around with the ‘average FI portfolio’ and see how it would have fared as an investment strategy!
* Trendline: y = 110-1.14x. The ‘110-age rule’ would have the trendline y = 110-x.
Welcome to the final part of our series of posts on the NHS Pension! We thought that for the finale we’d touch on some of the other circumstances that many of you will face as you journey from fledgling employee through to battle-hardened NHS veteran.
Maternity (and paternity) leave
44% of NHS employees are female and a number of them might take maternity leave at one point or another. Similarly, a proportion of the gents employed by the NHS will become new fathers and take paternity leave. Pay during maternity leave can be a bit complex as it depends whether you qualify for statutory maternity pay, NHS occupational maternity pay or both.
The NHS pension refers to both maternity and paternity leave as ‘special leave’, and the rules are the same for both. In short, your pension contributions will be as described in Part I (i.e. a percentage of your salary) for the times you are on full pay, half pay or statutory maternity pay.
When you’re on unpaid special leave you can still opt to make pension contributions (i.e. pay for scheme membership). If you do so, you contribute as if you were continuing to be paid the same salary as immediately before your unpaid leave. We contacted the NHSBSA to find out how that works in practice, i.e. how you can make contributions when you’re not actually being paid. Their answer is that:
“the employer would need to make an arrangement with [you]. Contributions can be paid up when you return to work as long as there is an agreement in place beforehand and the contributions are re-paid within a short time of returning to work.”
Furthermore, even though you are contributing during this unpaid period “the pension accrual will suffer because there is no actual pay.” So the positive if you contribute is that you’ll keep your pension benefits e.g. death in service, the negative is you’ll be paying contributions without any additional pension come retirement. It will be up to you to decide whether it’s is worth it!
Time out of NHS work
An increasing number of clinicians are taking time away from the NHS; the Foundation Programme’s destination survey reveals fewer and fewer F2’s are staying in the UK to work. The number of more advanced trainees taking time out is more difficult to quantify, though some will cease NHS work temporarily through either ‘time out of training’ or ‘out-of-programme experiences’. Leaving NHS employment, even if only temporarily, can impact on your NHS Pension.
If you are on an authorised career break, there is published guidance on your pension contributions. You have the choice of continuing or discontinuing contributions. For the former, you can choose to remain pensionable for 6 months. After this, you can still remain pensionable for a further 18 months but will have to pay both employee and employer pension contributions (see Part I).
If your time out doesn’t fall into one of the above categories (special leave or authorised breaks) then we’ll point you in the direction of the guide on leaving the scheme early. This might be if you take ‘F3/4’ years after F2, or similar breaks during your training. As long as your break is less than five years, your pension will continue to be revalued (see Part II) and will ‘link up’ with your new pension once you re-start NHS work. N.B. you won’t get any ‘death in service’ benefits during these five years (see below). The guide also provides information about the various options that exist if your break will be a more permanent one, or if you wish to transfer your pension to another provider.
When you’re gone
There’ll come a time for us all when we die and it’s natural to want to know how this will leave your nearest and dearest financially. As with many facets of the NHS Pension, there are a number of permutations that exist and the outcome will vary hugely between individuals. The brusquely named Survivors Guide is the home to these different combinations, along with other resources that contain the information you need. Your relatives or nominated beneficiary will likely receive something from your NHS Pension when you die, though if you’ve been claiming your pension for >5years that may not be the case.
That’s all folks
We hope that having followed this series you have a much firmer understanding of your NHS Pension and what’ll happen when you retire. Whether you intend to retire early or not, arming yourself with information now so you can make decisions about your financial future is, in our opinion, one of the best investments you can make. As ever the path you choose will be intensely personal, so please read our disclaimer and seek professional financial advice about your NHS Pension. If you have comments or feedback on the series then please get in touch.
Welcome back for the fourth and penultimate part in our series on the NHS Pension! Having already seen how your pension begins, grows and ends, this segment is aimed at how you can get more money from your NHS pension. There are a few ways of “boosting your pension position” and they each come with an unhelpful business-y name and associated acronym. Some options aren’t available to 2015 Scheme members. For those that are, we’ve provided a single-sentence summary of what the option means followed by a more fleshed-out explanation below.
‘I pay the NHS Pension scheme a set amount of extra money now in exchange for a set amount of extra pension in retirement’
In this option, you choose how much additional pension you want up to a maximum of £6,500/year (and in £250 steps i.e. you can’t pay for £3,497.12, you’d have to pay for either £3,250 or £3,500). You can buy this option by either making a single payment or staggering your payments over a period of up to 20 years. How much this will cost you is incredibly variable, so we recommend checking out the additional pension calculator. Have a play with the numbers to see how much extra pension costs.
Of significant note, the additional pension you purchase does not undergo revaluation at the same rate as the rest of your pension – it is only increased by the rate of inflation each year. The additional pension you buy is also subject to reduction if you retire early. For more info. there’s advice from the NHSBSA and the BMA.
Example 1 Dr. Dave wants to have an extra £5,000/year annuity in retirement. He therefore decides to buy additional pension. This will cost him £37,200 as a one-off payment, Or £8,304/year for 5 years, Or £4,608/year for 10 years, Or £2,808/year for 20 years.
2 – Making Money Purchase Additional Voluntary Contributions (MPAVC’s)
‘I pay a company extra money now that is invested, and I’ll get an unknown amount of extra money later’
AVC’s are not quite as easy as 1, 2, 3. In exercising this option, you’ll first choose which provider you’d like to give your money: Standard Life or Prudential. Next you decide how much you’d like to contribute on a monthly basis (£20 minimum with Standard Life, £1 minimum with Prudential). Finally you decide which of the company’s funds you’d like the money invested in. This method of garnering extra pension is very similar to the ‘classical pension’ we touched on in Part I. Come retirement, you can take 25% of the pot you’ve generated through MPAVC’s as a tax-free lump sum. The rest is used to generate extra annuity.
The major benefit to this option is the tax savings you gain, though you still have to wary of the annual and lifetime allowances. One downside is that, as your money is being invested, you can in theory lose money over time. Furthermore, the fees charged by both Standard Life (0.95% – 3%) and Prudential (0.6% – 1.2%) for their funds are exorbitant when compared to some of the popular all-in-one fund choices.
3 – Entering an Early Retirement Reduction Buy Out (ERRBO)
‘I pay the NHS Pension scheme a set amount of money now in exchange for more pension than I would have otherwise received when I retire early’
This is only useful if you plan on retiring early which, by virtue of reading this blog, you might very well be. As you’ll recall from Part III, claiming your pension early brings with it a percentage reduction in annuity. The ERRBO allows you to mitigate this by buying out some of the reduction that would be applied when you retire early.
The way you do this is by paying more in pension contributions. In Part I we discussed how pension contributions are a percentage of your salary. If you enter an ERRBO agreement, you simply increase this percentage. How much it increases depends on how old you are when you enter into your ERRBO and how many years early you plan on retiring. The scale can be found here. You’ll notice that you can only buy out 3 years’ worth of reductions, so if you plan on retiring earlier than that then you’ll still suffer some reduction.
Example 2 Dr. Diane is 38 and plans on retiring at 65, 3 years before her state retirement age. Her annuity would be £50,000/year if she retired at 68, but will be reduced to £42,000/year if she retires at 65. In order to mitigate this reduction she enters into an ERRBO. She therefore pays an additional 4.41% of her pensionable salary each month such that when she retires at 65 her annuity will be £50,000/year.
Options, options, options
It’s perhaps a bit difficult to pick which, if any, of the options for garnering more pension is right for you. They’re also not mutually exclusive – you can purchase additional pension and an ERRBO if you like. Part of the problem with any of them is their restrictiveness; you’ll tie up your money in a savings vehicle that you can’t access until 55 at the earliest. Our thought at MedFI is that if we want extra money in retirement there are alternative ways of saving that provide slightly better flexibility, if not the tax benefits too. As ever, whether you decide to buy more pension or not will be a personal decision and our aim is to simply make you aware of the options – now you know! Next time we’ll be releasing the final part of our series, which will cover the NHS Pension in differing circumstances.
Welcome back to the third instalment of our series on the NHS Pension! In Part I we detailed how our pension is built up over our years of work, before learning how that sum is revalued to keep its purchasing power in Part II. In this section we’ll be touching on some considerations for FI(RE), in particular claiming your NHS Pension early and keeping a watchful eye on your pension allowances.
At the end of part II we stated that you could claim your NHS Pension once you’d reached state retirement age (SRA). What if you’re keen to clock our early, sail to the Bahamas and sip piña coladas? Well you can get there by claiming your pension before the state retirement age – as young as 55yrs old. Let’s see what the impact an early retirement will have on your annual pension (and therefore your coconut cocktail purchasing power).
If you’ve decided to take your pension early, a few factors come into play: 1. Your annuity will be smaller because (compared to someone retiring at SRA) you’ll have generated pension for fewer years. 2. Your annuity will be smaller because you’ve spent proportionally fewer years contributing at your highest salary. 3. You’ll be ‘penalised’ for taking your pension early. You’ll have spent fewer years making pension contributions and you’ll be paid your pension for longer, so there’s a percentage reduction to your annuity.
The amount your annuity is reduced by depends on when you take it; the earlier you claim it the greater the reduction. If you claim as early as possible (55yrs) you can expect a hefty 45% reduction in your pension. If you claim with one year left until SRA then the reduction is ‘only’ 6%.
Example 1 Dr. Diane started NHS work at 25 on £27,000/year and [for the sake of simplicity] continues to be on that salary until retirement age. Let’s see how her pension looks with varying amounts of early retirement: a. 68yrs old: ~£41,000/year b. 65yrs old: ~£30,000/year c. 60yrs old: ~£19,000/year d. 55yrs old: ~£13,000/year
You might be thinking that Diane’s pension at 55yrs has more than a 45% reduction compared to at 68yrs; this demonstrates factor one above (and also factor two if her salary had increased throughout her career). It’s also another illustration of compound interest. This is crucial to understand if you plan on retiring early; you’ll have to balance the many benefits of stopping or reducing work against the financial implications of doing so. The NHSBSA has helpfully published an early retirement calculator that can help you further understand the impact of such a step, whilst it’s also possible to go back to work after claiming your pension if you want the financial boost or socio-intellectual stimulation.
At the point of claiming your pension, you can opt to take a chunk of money out in one go. This lump sum will have a subsequent impact on your annuity – for every £12 of lump sum you decide to take, you’ll lose £1 off your annuity. There’s also a limit to how much of a wedge you can take out of your pension pie as a lump sum, which is 4.28 times your annuity. Another consideration with taking a lump sum is that, over a certain amount, you will have to pay tax on it. Whether or not you decide to take a piece of your pension as a lump sum will hinge heavily on your circumstances as you come to the point of retirement. It’s not necessary to decide now, though it is important to understand that this option exists when the time comes.
There’s a capped amount that you can pay into your pension each year: the annualallowance. Breaching this allowance will incur the wrath of HMRC and lead to a tax bill heading your way. This may have crossed your radar as what’s been creating a storm amongst Consultants in recent times, causing them to reduce working hours and consequently their tax bills. Thankfully this has stirred the powers that be into action, with a new consultation (and hopefully changes) on the horizon. This allowance is £40,000/year, though part of the problem is the complexity of the annual allowance and a full explanation goes beyond the scope of this post.
The second limit is on the total value of your pension: the lifetimeallowance (LTA). Your pension’s value exceeding the LTA is another sure-fire way to twist the knickers of HMRC and earn a tax bill. The LTA, which is £1.055m at the time of writing, is set to increase in line with inflation. However as your pension increases by inflation + 1.5% (see Part II), you’re at risk of going over the LTA at some point.
Example 2 i) Dr. Dave’s NHS Pension is such that he’d earn £50,000/year in retirement. The capital value of his pension is 20 x £50,000 = £1m. As this is less than £1.055m he won’t be breaching the LTA. ii) Dr. Diane’s NHS Pension is such that she’d earn £70,000/year in retirement. The capital value of her pension is 20 x £70,000 = £1.4m. As this breaches the LTA she’ll be subject to extra tax when she claims her pension.
For a more detailed look at both the annual and lifetime allowance, see our later dedicated post on the matter!
One for all
This part of our series has a tilt towards early retirement, though the information it contains is pertinent to anyone with an NHS pension. Knowing how early retirement or taking a lump sum will affect your annuity and being mindful of staying within your allowances are all key components of making your pension work as best for you as is possible. You’re hopefully now developing a serious schema of how your NHS pension works from beginning through to the end. There’s still more handy information to come in Part IV, where we’ll look at your options for adding more money to your pension.
Welcome to Part II of our series on the NHS Pension. In Part I we kept things simple, demonstrating how your salary both pays the ‘membership cost’ of belonging to the scheme and dictates how your pension grows. This time, we’ll look at how your money grows in the pension and what you can expect out at the end.
Inflation and revaluation
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 30-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. With £1 in the early 90’s you could buy ten Freddos, but £1 now will only buy you four. In the ‘classical’ pension of Part I, the pension pot was invested to make its value grow over time – this is partly to counteract the effect of inflation. The NHS pension has a different tool to do this: revaluation. Let’s rope in Dr. Diane from Part I again to demonstrate the effect of this:
Example 1 (No revaluation) Dr. Diane earns £54,000 in pensionable pay. In a single year (e.g. 2019) her annual pension grows by 1/54th of her pensionable earnings = £1,000. When Diane retires in the future, the pension amount from 2019 will start to be paid out. This would be £1,000/year. If she had worked for 40 years at the same salary, she would be paid a £40,000/year annuity.
It sounds pretty sweet, right? It is, but we’ve already seen above that money is worth less in the future because of inflation. In fact, you can work out that Diane’s £40,000 annuity in 2059 only has the equivalent purchasing power of between £15,000 and £20,000 [assumes 1.5% annual inflation]. Diane’s annuity would have to be £56,000/year in 2059 to actually have the equivalent purchasing power of £40,000.
To combat this, the annual amount you generate as pension is increased (‘revalued’) according to the revaluation rate. This rate is defined as: inflation(%) + 1.5%. Let’s see what happens when we apply that to Diane…
Example 2 (With revaluation) Dr. Diane earns £54,000 in pensionable pay. In a single year (e.g. 2019) her annual pension grows by 1/54th of her pensionable earnings = £1,000. As the rate of inflation in 2019 is 1.5%, the revaluation rate is 1.5% + 1.5% = 3%. Her £1,000 undergoes revaluation for the year 2019 and is thus worth £1,030. This happens to that money every year such that in 2059 that £1,000 is now £3,260. The revaluation occurs for all 40 years’ worth of pension she generates. In 2059 her annuity is £72,230/year.
You can see the drastic difference this makes and it also beautifully demonstrates the power of compound interest. The good news is that this all happens in the background without you knowing! Don’t forget that you’ll pay tax on your annuity, so you won’t see 100% of it entering your bank account come retirement time. It’s still nice to know that your pension will be growing faster than the rate of inflation so will have maintained, if not improved, its purchasing power come retirement.
Show me the money, Jerry!
You hopefully now have a better grasp on how the annuity you can expect from your NHS pension is generated. The thing you’re probably itching to know is: how much will you get when you retire? Unfortunately, the answer to this is not as clear cut as we’d like it to be. There are so many variables that will affect the annuity for any one person: place of work (England, NI, Scotland or Wales), age at starting, inflation during your career, training programme, retirement age and lump sum value to name a few. It’s impossible to provide a one-size-fits-all answer. Even running the numbers for the predicted MedFI journey, the figure that comes out at the end has a fair variation to it. There are, however, a few things that you can do to find out a bit more.
You can see what your actual, bona fide, up-to-date pension amount is by logging on to your total reward statement. It will show you how much annuity you’ll be paid come retirement, as well as some other helpful figures. It only shows you what you’ve generated so far and, if you’re at the early stages of your career, it might seem pitifully small. It also doesn’t help you predict your future pension, though as you approach your planned retirement age it will become more useful. You can request an estimate of your hypothetical pension benefits, which may give you more of a number to hang your hat on, though it will cost you £75-£120 for the privilege.
Another helpful tool is this NHS Pension calculator. It won’t show you a total annuity for your whole career, but will show you an annual amount generated for a given salary (/stage of training). As an aside, you should check out the entire junior doctor finance website, an excellent resource for improving your financial literacy as an NHS employee. Another thing you could do is to speak to a professional financial advisor, ideally one well versed in the intricacies of the NHS Pension.
When will I get my pension?
You will be able to claim your full NHS pension when you reach State Retirement Age. This is not necessarily a fixed age, and we suggest checking using either Which?’s calculator or the government’s calculator to find out for yourself. For most it will be somewhere between 65-68yrs, although the actual age may change in the course of time. Ill health and redundancy are two circumstances in which you can claim your pension earlier. There are also differences to your pension if you voluntarily decide to claim it early – more on this in Part III!
Starting to come together
That’s a wrap on Part II of our NHS Pension series. You now know how your pension is generated from your salary and how it is revalued to outstrip the inflation rate. We’ve provided some tools to try and gauge how much you might get in retirement and also when you can start claiming your pension. In Part III, we’ll move on to some considerations for FI(RE) with regards to the NHS Pension.
If you are a past, current or even future NHS employee then the chances are that you will have some interaction with the NHS pension. Having some grasp of your pension(s) is crucial to plotting your own financial journey, especially if you have ambitions of financial independence/retiring early. Unfortunately, wrapping your head around the minutiae of the NHS pension can be difficult, especially in the context of ever-changing pension rules. With that in mind, we’ve done our best to provide an overview of the scheme for those wanting to understand their NHS pension.
We find ourselves in a sort of no-man’s land. If you are an NHS employee with enough interest in personal finance to be reading this blog, the chances are you might have done some reading about your pension already. Conversely, those who might benefit most from the information contained in this series are unlikely to be searching for it. When you add in the British taboo for speaking about personal finance, yet alone the less-than-stimulating topic of pensions, chances of disseminating the information to those who want it isn’t great. We only ask that if you find the content of our series useful, please share it with your colleagues so that they may benefit from it too.
The information we’ll provide is up to date at the time of writing, but as always we implore you to do your own research before making financial decisions. As a final caveat before we get started, we’ve chosen to only detail the latest incarnation of the NHS Pension: The 2015 Section. This is because it applies to both us here at MedFI and 75% of NHS staff. If you are a member of the 1995 or 2008 Sections, you can seek more information using the resources dotted throughout our series.
The ‘Classical’ Pension
Any pension is a specific way of saving money during your working years so that you have something akin to a ‘salary’ after you’ve hung up your stethoscope and retired. The goal is to provide income such that you can continue to live your post-retirement life in a way you’ve become accustomed to.
A stereotypical pension involves you diverting a percentage of your (pre-tax) salary into a ‘pension pot’. Typically your employer will also pay into this pot. Often this money is invested in such a way as to grow its value over time. As the years roll by, your pot grows larger and larger. Once you retire that money is taken back out of the pot by you as a fixed amount per year (an annuity) and sometimes also a large chunk at the start of your retirement (a lump sum). You didn’t pay tax on the money that went into the pot so you pay it as it comes back out. The value or your annuity (and lump sum) is entirely dependent on the amount in your pot.
The NHS Pension
The NHS pension differs from the classical pension model we’ve described above. It is known as a ‘defined benefit’ pension; although this is a descriptive term it’s not that helpful as a stand-alone statement. Each year you work for the NHS two processes automatically happen: 1. You pay a percentage of your pre-tax salary in pension contributions. This percentage changes depending on how much you earn (more on this below). 2. Your annual pension grows at a pre-set rate. This rate is fixed at 1/54th of your pensionable earnings.
Let’s look at some examples of how these processes work:
Example 1 Dr. Dave earns £27,000 in pensionable pay. In a single year: 1. He pays 9.3% of his salary in pension contributions = £2,511. 2. His annual pension grows by 1/54th of his pensionable earnings = £500
This will happen for each and every year you work. Both of those numbers will vary with changing salary:
Example 2 Dr. Diane earns £54,000 in pensionable pay. In a single year: 1. She pays 12.5% of her salary in pension contributions = £6,750 2. Her annual pension grows by 1/54th of her pensionable earnings = £1,000
You’ve generated two different numbers and both pertain to pensions – what do they mean? The first amount (process 1) is almost irrelevant. It does not represent the value of yourpension nor is it being paid into a pension pot. Rather, you could consider it the cost of membership of the pension scheme. This ‘cost’ changes depending on how much you earn as you can see below. In reality it is paying for the annuities of those who have already retired.
Your employer also pays towards the cost of your pension. Compared to your rates (see table below), the NHS pays in at a fixed rate of 20.6%, which makes the NHS Pension relatively ‘cheap’ for employees.
The second process is relevant. For each year you work, process two will generate an amount of pension. When you retire, all of these amounts are added up to make your final annual pension (i.e. your annuity). It might seem that Dr. Diane’s getting stiffed by paying £6,750 for ‘membership’ but her annuity only grows by £1,000. She’s not though, as that £1,000 will be paid to her every year from retirement until death. Let’s look at an example of this:
Example 3 Dr. Diane earns £54,000 in pensionable pay for each of the 20 years she works for the NHS. Year 1: her annual pension grows by 1/54th of her earnings = £1,000 Year 2: her annual pension grows by 1/54th of her earnings = £1,000 … etc. for 20 years. At the end of this time, her pension is 20 x £1,000 so is worth £20,000/year*
*More on why this number isn’t quite correct in Part II
Not so menacingafter all
We’ve tried to keep this first part of the series basic to avoid an overload of detail straight away – trust us there’s more to come. Hopefully you now understand a bit more about what the “pension contribution” line on your payslip means (i.e. process 1). You can also see how your annual pension grows in relation to your salary (process 2). In Part II we’ll look at how your pension grows and what you might expect from it come retirement.