sharesave schemes and hedging losses and house price deposits using spread betting

This one comes with an extreme wealth warning. Hedging anything is counterintuitive, sometimes hard to understand and subject to margin calls. It is easy to screw up bigtime. Do you own research, and then cross-check it. The first time I tried this I lost £500 before bottling out. Under some conditions your losses are theoretically unlimited. There be dragons in this swamp. You get my drift 🙂

Hedging an investment basically means purchasing a financial instrument that moves in the opposite direction to another. People have all sorts of reasons for wanting to do this. The first time I came across it was with my company sharesave schemes. Another potential opportunity is for people saving for a house deposit to track the deposit with house prices. I will deal with that further down, though to do that you need balls of steel…

In this I talk about using financial spread betting. Some companies offer contracts for difference which are another hedging tool, I have no experience of CFDs but you ought to at least be aware of their existence and consider them as well if you have a need to hedge shares, where they are more transparent. There are differences in capital gains tax liability, and the way margin charges appear – it is in the spread and rollover for spread betting, as an explicit daily charge for CFD

hedging sharesave

With sharesave you take out an option to buy shares in your employer at an agreed and known price, usually at a discount to the current market price. You then save an amount, up to £250 a month, with a bank. After three or five years, you can exercise the option, ie buy the shares with the proceeds of the bank investment, or get your money back. Obviously if you have any brains you don’t buy the shares if they are below the option price, though I’ve seen people do it…!

Taking one of these out is a no-brainer, it is a classic one-way bet and it’s rude not to take part.  The simplistic way to look at this is that if at the end of the 3 year period, the share price is higher than the option price, then buy the shares and sell immediately, instant profit. If the share price is lower, take the money and let the option lapse. I’ve been doing these for years, and sometimes I end up taking the money, sometimes I’ve done okay on the shares. As a general rule if you are an ordinary grunt not paid in stock options it’s probably unwise to have long-term shareholdings in your employer for any other reasons. You’re already highly exposed to your employer’s financial health – redundancy is more likely if the employer is squeezed. You don’t want to have a load of your financial wealth tied up in them too. The only exception is if you work for Berkshire Hathaway…

In the past you could drop a sharesave contract and use the allocation on the next year’s options, but HM Revenue has closed that. My company had a few years where the share price basically went down the toilet for years on end, so I was glad to have this possibility to just drop and sign up for new options. I am now maxed in a three and five-year scheme taken at a very good share price – it’s risen 100% on the option price now.

One wrinkle that it took me far too long to spot was that I should always aim to put the same amount of total money into a 3-year and 5-year scheme. Though diversity has no meaning in a single company share, the performance of a 3 year option may be different from a 5-year option, so temporal diversity is worth having.

Because this is a one-way bet, I improve my odds by exposing myself to both time frames – if one bombs the other may make good. I used to always go for the 5 year option because the option price was lowest until I jumped to the value of diversification. With the new HMRC rules that you can’t drop previous allocations, sharesave investors should aim to have equal exposure to all options.

Hence in the first year put in £50 pcm, split £31.25pcm in the three year scheme and £18.75 pcm in the five year scheme. That buys you £1125 of each share option if taken to maturity, ie 60 lots of 5 year contributions and 36 lots of 3-year contributions. Do the same the next year and the one after that, in the following year 4 your three year option will come out leaving you £81.25 option space to allocate rather than £50. And so on – a spreadsheet will help you track the strategy. Fortunately I avoided all this complication, and this doesn’t apply to me any more as I won’t be buying any new sharesaves after my current one comes out in two years time because I don’t expect to be working there any more.

So what’s all this got to do with spread betting? What that does is allow me to lock in a particular price at any point in the three-year term of a sharesave contract, though because of rollover costs it is best for the last year or two. Say I have an option to buy 1000 shares at £1 each in MegaCorp, and the share price rises to £1.50 after two years. I decide that this is good for me, but obviously I can’t count my chickens yet, as the share price may tank.

So I go to IGIndex, and place a spread bet on MegaCorp as a sell option. Things to watch for here is that IG sell options on a pound per point basis, ie lumps of 100 shares. So I only want to sell 10 IG options on MegaCorp, not 1000! The way to test this is to ask what happens if the share price move up a point. For my shareholding it will move £10 (1000 shares time 1p). To redeem my IG option I need an extra 10*£1, neatly cancelling out the rise. What this does is it clamps my overall return – if the price rises my options on exercising do better, but my spreadbets cost more, if the price falls then spreadbets compensates for what I lose.

The added bonus is that my downside is limited on the shares themsleves. Say the price tanks to 50p. I liquidate my IG options on the three year term end day, banking (150-50) points * 10 IG options * £1 = £1000 and also collect my £1000 sharesave stake, letting the option lapse, rather than exercising it and losing £500.

If MegaCorp does well, and soars to £2, then I take a bath on my IG options, having to pay them (200-150) points times 10 (IG options) times £1, kissing goodbye to £500. On the other hand, I exercise and sell the share options, finding that for my stake of £1000 I now have £2000, out of which I must pay £500 to IG. So I have made an overall profit of £500, which is what it was when I decided to lock in the £1.50 share price of MegaCorp.

What can go wrong? Well, if I lose my job in the first three years the options die, which is a bummer if I am sitting on IG options that have risen. A takeover of MegaCorp is one of the circumstances which makes redundancy and a share price rise likely. A more subtle hazard is if the share price skyrockets, say to £10. Now the cost of closing the IG option would be 900points * 10 options * £1 = £9000. It isn’t a problem to carry that obligation, remember the shares on option exercise can underwrite the obligation, or the price will fall and the obligation goes away, but IG tend to like you to have a reasonable cover for liabilities, so they may demand you fund your account with some proportion of £9000 or they will close you out. That proportion is typically 10-20%, ie up to about £2000 cash you have to keep with them until closeout at the end, so you may end up having a lot of working capital sterilised, or have to close the position, exposing you to losses on a precipitous share price drop. The moral of the story is be careful out there.

Another application is for employee share incentive schemes. These are a means of purchasing shares in your employer with pre-tax money. Now when HMRC are saying they won’t steal 41% of your money before you get a hold of it then it pays to listen up – I was able to buy £125 worth of shares a month for the price of £74 difference in take-home . The downside is you buy the shares but they are embargoed for 5 years, though you do get the dividends. As it is my company’s shares tanked, though overall I’ve still come up as the dividends have been good and so the composite loss is < 40%.

Hedging works just as well for those and if I’d known about it I could have saved myself from the losses as the shares tanked. Ain’t hindsight a wonderful thing. Unlike the sharesave options there are actually bought, so losing your job doesn’t clobber you if the shares have risen so the IG index options are in the red, as you actually have the shares even if you can’t get your mitts on them until the 5 year embargo has expired.

For all this talk about using spreadbetting to hedge shares, this is an application where CFDs are probably the more correct tool for the job, and I will investigate that approach before doing this.

How to use hedging with house prices

For God’s sake don’t even think about doing this until you have understood the options, have convinced yourself I’m not talking bollocks, and you have explained the plan to someone else and they agree it makes sense 🙂 I feel a little bit odd describing this because my personal belief is that house prices will tank because mortgage lending requirements are tightening, and there are requirements that people actually pay back some of the capital rather than taking an interest-only mortgage. Doing this in a falling market is a nutty thing to do.

But I also remember what it felt like as a first time buyer watching house prices race away from me. So who am I to impose my forecast expecations on you, make your own mind up, though you might want to read the cautionary tale first, buying a house at the 1988/9 peak was the most monumental personal finance cock-up of my whole life 🙂

The problem first time buyers have is that house prices are at high income multiples. If the average salary in the UK is £22k and a two-up-two down in my area is £130k then the income multiple is 6x. That’s obviously dear, but it also makes saving a deposit in a rising market almost impossible. If you need a deposit of £13k and you’re paying rent of say £6k you need several years to get there even if you eat ramen every day. The gripe was that house prices race away, so where you need 13k in the first year you need 15k the next year because thet two-up-two-down is now £150k, so it is an endlessly moving target racing away from you.

Now if you do believe house prices are still going to go up, you could hedge the deposit, buying house price call options to protect your deposit percentages. If your target is £13000, then if house prices go up 10% you need another £1300 to still have a 10% deposit. Once you’ve got your mortgage and house you’re on the ladder, and presumably want prices to race up to 10x earnings multiple so you can laugh at all the upturned faces below you.

At the time of writing, IGIndex are currently citing UK house price indexes for September 2011 at 153p, so if house rices go up by 10% this will rise by 15 points. At £1 a point, I need to buy 87 points to make up my £1300 (ie 15*87)

buying IG Index house price futures

I need to deposit £666 to be able to do that, but if prices go up I am protected. You can reduce that stake by using stop-losses, at the expense of risking getting bounced out on spikes and crystallising losses. You can see how much this insurance is costing me – there’s a three-point difference, so if I buy and sell on the turn I pay £261. This is how IG make their money. A more subtle way they make money is you’ll observe this bet lasts a year, so next year I’ll have to roll it over for another year (assuming it takes two years to save my deposit). As I understand it rollover bets only incur half the spread, so Mr First Time buyer will be rushed another £130 every year. This game isn’t cost-free, but it’s cheaper than finding the extra £1300. Conversely, he takes a stiffing if prices fall, but there again he needs less deposit anyway so no great harm done.

There are other wrinkles, too. For a start, what is a house price index? How do you test IGIndex’s value? TFS offer some guidelines, but is IG’s product a derivative of that? It is easy enough to qualify the spread betting price for a ordinary share – look it up in the FT, and the spreadbet future price ought to bear some resemblance to the current price with an influence from the history, but housing is hard to gauge.

This is for a average UK house. You’re not buying one of those. The London market is totally anomalous, for instance, due to the distorting effect of the City and foreign wealth not grounded in the UK. Sometimes the market for flats is different from that of detached houses. Sometimes the South goes in a different direction to the North.

Bear in mind that IGindex’s house price future is a futures index. They are not a guarantee of future property returns but rather are dynamic forward prices that are subject to change, this isn’t the same as even shorting the Halifax house price index, although the value should converge towards the maturity date.

I am toying with using this in the other way. To short the housing market a bit, along the same rationale as the sharesave scheme, to protect the gain I have made on the house since I bought it. But it needs thinking about, and I will first use spreadbetting or CFDs to hedge my employer share schemes. I have quite a lot of these, and my employer is on a roll at the moment.

Oh, and why did I lose £500? I had the general theory right but failed to account for the scaling factor of the £1/point. Be careful out there, there are a lot of subtle ways to screw up royally in this spread betting lark.Although he was talking about the music business, I think Hunter S Thompson could have been talking about spread betting

“The business is a cruel and shallow money trench, a long plastic hallway where thieves and pimps run free, and good men die like dogs. There’s also a negative side.”

I’ve never had enough skin in the game for it to matter for me, but for those with more courage/foolhardiness than me the proceeeds of spread-betting are apparently free of capital gains tax. IGIndex just happens to be the spread betting firm I used, there are others out there. Particularly in house price futures, you would do well to find a more narrowly drawn index that matched your locality, indeed if it is London I’d say this is essential.

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Nick Clegg is confusing believing in what you are doing with doing what you believe in

He socked it to the IFS, who party pooped by saying that the CSR hits the poorest hardest.

Now anybody with a numb skull will jump to it that if the poorest have been the greatest beneficiaries of Labour’s largesse, then if you roll that back they will be hit the hardest. D’oh. Obviously this is a bit tough for Nasty Nick’s self image of bluebirds tweeting and everything being great, but it’s what happened. And the IFS called it out

So Nick throws his toys outta the pram and charges the IFS with being partial. Sorry Nick, me old mucker

ifs the poor got hit for six in the CSR

just what part of this do you not understand? There’s crow to get eaten here, and it’s your turn, along with all that university fees and graduate tax jazz too. Suck it up, bud, and salute your heart of darkness. It’s a harsh introduction to the realities of what can actually be done compared with what it would be nice to do.

It’s disturbing to be on the same page as the Dirty Digger, but I think Rupert Murdoch summed up Labour’s failure to get traction on the problem pretty well.

It wasn’t a matter of furnishing the underprivileged with privilege, but of providing them with opportunity.

When we had loads of pretend money sloshing around, spreading privilege around a bit was easy, but it didn’t address many of the issues. The Digger hasn’t addressed the other side of the coin, which has been the concentration of power and abuse of it at the CEO level either, where there are excessive short-term rewards for long-term failure. But the insufficiency doesn’t detract from his sharp observation of the problems of Labour’s approach to the poor.

Winter of Discontent battle lines being drawn

Well, Gideon’s had his say yesterday. I figured I’d wait around for the churnalists to go through the fine print before taking the opportunity to shoot my mouth off, or perhaps to bleat that it’s unfair, because middle class me is taking the bullet in some way akin to our army of fragrant Guardian-reading SAHMs.

Well, they’ve failed me dismally, or perhaps as a homeowner in the sense of being the party on the deeds without sharing it with a bank and part of a child-free couple, there is compensation for ten years of not getting any free gravy from Labour. Not getting any in the first place means Gideon doesn’t get to take it away. Obviously there are the macroeconomic hazards in future rang out by distant bells tolling but I didn’t take it straight between the eyes yesterday. That I’m aware of so far, anyway.

That’s not to say that I’m unaffected. If I were to want to go somewhere by train, the original small mortgage I’d need to raise for the ticket is likely to go up to a mid-sized mortgage as a result of the subsidy change. Obviously VAT is going to go up. But the place I am going to take it is in the back, in a mightly subtle way.

Gideon’s taken out an awful lot of money from the British economy. If he were flying a plane he’s kicked the throttle back from Gordon Brown’s full bore to about half. He has to avoid a stall.

What he will probably do is get the Bank of England to hit the old QE button and create money. That’s the nice thing about being the government, you can make money. If you or I did that in our garages we’d get nicked for it, because it creates inflation. But when Mervyn King does it, it’s a good thing, and it compensates for all that wedge the government isn’t spending, and gives us something to pay unemployment benefit to the half-a-million people who will lose their jobs.

Merv doesn’t have to make money in his garage, he has a computer to do it, and if he has to get physical then he has those nice chaps at the Royal Mint to do it. Lately even they have been complaining about inflation, as it is costing too much money to make money, particularly those danged 5p and 10p coins.

Last time that happened we made the buggers smaller, but there a limit to how far that can go before we can’t see them any more. The problem is the copper price has gone up so much the copper in the cupro-nickel now costs more than the coin it’s made of. Maybe I should stockpile some of these, and heat them up in a metal bucket over the fire in the desperate times to come, so I can release them onto the London Metal Exchange when Peak Copper has happened. Anyway, for some reason Merv doesn’t think this is a problem, he’ll simply get them to make the 5 and 10ps out of pressed steel, like they did with the coppers a while ago. So your silver coins will become magnetic for the first time. The need to continually debase the coins of the realm is not usually an indication of fastidious economic management.

Inflation will destroy chunks of my wealth held in financial instruments of all sorts, though this will particularly affect cash holdings like my cash ISA which is worth about 2% less this year than last.

Wealth held in non-financial instruments like Real Stuff will probably weather the storm better, though I’d draw the line at claiming that my house will be a hedge against inflation (the inflation hedge rationale behind that article applies equally to a property bought at home).

So the places I will take the bullet aren’t as explicit as the places many people will be taking it. But take it I will. I will concentrate my energy on adjusting my risk profile and asset class spread to minimize the damage, but I won’t bother writing into the Guardian about how dreadful it all is. I don’t think Patrick Colllinson will be as nice about people like me as he was about hard-done-by SAHMs that everybody was so mean about.

If they have got any brains, the Argies are likely to have another bash at taking over the Falklands in the next ten years as we launch our shiny new aircraft carriers, without any aircraft on ’em. I guess that indirectly affects me as there is oil there which will be kind of handy in a post-peak world and so the punch-up is more likely, and actually about something real rather than the need to get Thatcher re-elected. I don’t normally have much time for the old goat Norman Tebbit but I can’t help agreeing with him that you need planes on an aircraft carrier in the same way as beer is rather useful in a pub. Part of the problem here is there is no sense of competence or personal responsibility in people who draft the byzantine contracts in these things.There’s apparently some wizard wheeze about using giant rubber bands to launch paper aircraft later on.

Before someone takes me to task for being a warmongering SOB I really ought to say that it is way beyond my competence to know whether or not Britain needs aircraft carriers and a blue water navy in the 21st century. That’s why we have guys with gold braid on their shoulder pads and handlebar moustaches to think about stuff like that. But this much I do know – if we do need aircraft carriers then we need aircraft on the darned things and not just a few choppers to break up the stark expanse of the landing deck a little bit. It’s not like we’re going to use the pointy bit as a battering ram are we 😉

It seems to be part of a general disease, this casual approach to dotting the Is and crossing the Ts. I suppose I didn’t specify that I’d like to have the wheels and the engine when I bought my last car, but I’d have been mighty pissed off if they hadn’t come with it, as well as looking a bit silly when I got in the thing to drive it away. It isn’t the sort of minor detail that escapes you in buying something.

It’s not just the MOD, it appears that our fine friends over the pond have been getting a bit slap-happy with the paperwork in issuing mortgages, and as a result they can’t really work out who a house belongs to, which at least is giving some people a break by freezing foreclosures for a while. Sometimes I wonder about our American friends. The rule of law and secure property rights are meant to be axiomatic to human freedom, and I am suprised at the casual approach to this in the US, this will cause endless pain in future if the property registration system ends up subject to undisclosed future claims and liabilities.

It was not until researching this observation about the rule of law, which I had been taught at school, that I realised that it was quite so right-wing in its derivation 🙂 Anything which needs references from the Adam Smith Institute and where the wikipedia article cites Hayek and the Austrian School is usually the signature of a community that considers Genghis Khan as a bleeding-heart liberal, but in this area I’m with them.

The half-million souls hammering the public sector is due to take is asking for a fight, we only have to look over the Channel to see some of the brouhaha we could be in for. As a gratuitious aside, I love the comment that after years of continual man-eating, Carla Bruni supposedly said that she graduated to marrying Sarkozy because she wanted a “man with nuclear power“. There’s no way up for her afterwards, so Sarko has gotta smash the unions. I don’t know if SamCam feels the same. And no, I have no explanation for Thatcher’s behaviour on that line of reasoning at all 😉

Some events mark generations, and one of those was the Winter of Discontent, a punch-up between the unions and the Labour administration of James Callaghan. Well, it looks like the brothers are getting ready for another rumble, along similar battle lines.

Some things are different, of course, gone are the days of Scargill’s flying thugs pickets, and the time may yet come again when taxi drivers have to look nervously at motorway bridges for the descendants of Art’s enforcers innocent hot-headed boys with concrete blocks that just happened to be in their hands when they accidentally let go of them into the traffic.

Part of the problem is that many people just don’t get it. We have been living beyond our means. Michael Lewis put his finger on it in his Vanity Fair article about the astonishing carry-on in Greece.

The tsunami of cheap credit that rolled across the planet between 2002 and 2007 has just now created a new opportunity for travel: financial-disaster tourism. The credit wasn’t just money, it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge. Entire countries were told, “The lights are out, you can do whatever you want to do and no one will ever know.”

What did we Brits want to do when the lights were out, I wonder? We wanted to inflate the price of our houses, and feel rich that way. Oh and we preferred not to get round to the tedious business of paying down the mortgages that went with them, preferring to stick with paying the interest only.

Of course, our inflated house prices made us feel rich, so we liked to take that money out and fritter it away on holidays and trinkets for the kids. All the while telling ourselves that our houses were making us more money than our jobs were, and never asking ourselves where did all this money come from?

Then some bugger turned on the lights, somewhere in late 2007, and we’re now spitting bricks, because they also seem to have turned off the free money tap. The trouble is, many of us also seem to have got infantilised at the cheap credit teat, and now it is gone we don’t seem to get it.

Living standards are going to fall. If we’re lucky, they will only fall to where they should have been without the sugar rush of almost free credit. If we’re unlucky, we will get to find that they fall further as we share the world’s resources with a burgeoning middle class elsewhere.

We’re also going to find out that we were carrying a lot of passengers. In the good times we had money to spare for all sorts of frippery. There’s nothing wrong with that, if you have the money then why not spend it to make a prettier world.

This save the arts video strikes me as a classic case of self-interested bleating. The trouble with ‘funding’ is it allows people to go right up their own backsides. At least when the King sponsored art the artist had to please him. Mozart, Beethoven and Michaelangelo didn’t get government funding. The very fact that the arts need funding means that they don’t speak to enough people to pay their way.They need to do better now.

Some of those passengers are also an awful lot of these unions’ members. It will be interesting to see how this pans out. Some of the cuts will be way over the top. Some will be cutting stuff that we can’t afford to do any more, like buying aircraft. There’s an awesome special interest pleading that these cuts will hit the poor hardest. It really isn’t that hard to understand. The poor have been the major beneficiaries of the benefits culture. Any attempt to roll that back is gonna hit the poorest hardest. They can’t hit me with benefit cuts because I don’t get any. The only way the poor can not be hit hardest if for taxes to go up. I think some of that was discussed at the election, though I am not sure the Lib Dems are exactly delivering what their voters expected.

send not to know for whom the bell tolls

…it tolls for thee. Hat-tip to Monevator, from whom I’ve  unwholesomely pinched the phrase. There again, he swiped it from Hemingway, who got it from John Donne. We will find out on Wednesday what else is in store from the Comprehensive Spending Review, few will escape unscathed, even if only hit by dint of buying stuff, for VAT will rise to 20% from January. So far that is the only hit I know of, barring the NI hike but I believe it was the last lot who set that up.

In researching some of the previous posts I turned up some breathtaking examples of smart people who seem to take complacency to new levels – let’s hear it from

Sarah (hat tip to Lemondy for turning up that one)
Joseph and his brood of 5
Nicholas with his £500 a month nursery habit
fulltimemum
on the DT – it’s not just a Guardian thang…

Though it’s true that all these individuals have kids, this isn’t their problem. They’re all better off than most UK households, and their primary problem is  an overdeveloped sense of entitlement, a lack of foresight and suboptimal personal finances. Jacob from ERE has a wry analogy of how they got to be that way.

They live according to their means – all the way up to their income limit and in some cases beyond. It means there’s no slack in the system, and in some cases no savings either. Now it’s understandable if you live on a tough council estate and have no savings, but if you’re a higher-rate taxpayer writing for the Guardian you really can do better.

As Monevator intimates, send not to know for who the deficit reduction bell tolls. it tolls for thee. The obvious response to the distant drumbeat of cuts is above all else reduce outgoings. Sun Tzu had words of wisdom:

Invincibility lies in the defence; the possibility of victory in the attack.

Now is about defending your personal finances. The time will come later to try and improve them by increasing your income, for instance going for a better job.

Building up savings is nice, but reducing cash haemorrhages can really improve your financial position short and long-term. On the principle that it’s good to get one’s attack in first, the time to start doing this is now, so you won’t have to mount a response to  something like the loss of child benefit under fire.

That means tackling subscriptions, Sky, mobile phone packages, eating out, drinking, jazz lessons, visits to the cinema. Knowing how much you spend on these items per month is a really good start, particularly the ones which come frequently but at random like eating out.

I’m not going to bore you with the mechanics. Knowledge is power – tracking where your money is going is the key to this. I have used Quicken since 1998, and it gives a rear-view mirror perspective to my spending. Most personal finance guidance advocates setting a budget, ie trying to get a forward view on spending, but it all depends on the quality of your estimation. Mine was pretty ropey, I could only control my spending watching the rear-view. For most of those years I used Quicken to avoid going into debt and paying bank charges, living a reasonably middle-class and hedonistic lifestyle, up to, but never beyond my income. I did save indirectly, as I took the now unusual step of repaying some of the capital on my house at various times.

It was only with seeing the writing on the wall at work with some changes that drew it to my attention that I did not want to carry on doing things this way that I changed. At the time I thought I was going to be finished in a year. That concentrated the mind – I switched to intense pre-tax savings in pension AVCs and post-tax savings in ISAs – first a couple of cash ISAs to achieve an emergency fund that wouldn’t get destroyed on the stock market (it’ll just get destroyed over the next couple of years by the twin horsemen of inflation and QE), then NS&I index-linked certs for the three-year timeframe and shares ISAs for the five-year plus.

At the same time I also allocated about the same amount of resources to non-financial investments because I believe there is a significant likelihood that Britain and the West will never recover from this financial crisis, and that the financial bloodbath that started in 2007 is the harbinger of fundamental changes to geopolitical power and global resource shortages particularly in energy.

I had the advantage(?) of hearing the bell toll for me, and having a year to prepare. For pretty much anybody in the UK, but particularly anybody working in the public sector, well, chum, that bell is tolling for thee. For heaven’s sake, start preparing. Three months ago would have been a good time to start, but now is still good, and better than three months hence.

SAHM Sarah is at least on the right track, though some of her outgoings still beggar belief. F’rinstance, she’s chuffed to be saving £36pm on her car insurance. I couldn’t do that, because mine is about £20 pm fully comp, so either she is driving some fancy wheels or she is a rotten negotiator. She’s younger and a damn sight more attractive than me, but as a lady probably gets a discount for not having testosterone coursing through her veins. I hate to think how much her insurance was before!. If her husband works in Ipswich, then why on earth do they pay Cambridge house prices? For sure, Cambridge is prettier, better connected, more cosmopolitan, but is it really worth the extra costs? Plus faced with

We have no savings – all money spent on moving house six times in 10 years for my husband’s career – but we’ve stopped the £20 a month put in each of the children’s child trust funds.

Ever heard of that archaic practice called renting, dear woman? Yes, you don’t build up (negative) equity in the home, but you lose a shocking amount of money moving house if you are a homebuyer, not to mention the emotional frazzle of the process. The money lost in the home purchase turn isn’t so bad amortised over 7 years which is the average dwell time of UK homeowners, but churning your residence every two years is as nutty as churning your shareholdings every couple of months. Just don’t do it – or at least tot up the total of all those estate agents, surveyors, solicitors, mortgage arrangement and moving fees…

If you’re a banker you’re probably okay, but for anyone else in the UK live as if you’re going to take a 25% pay cut over the next year. Regardless of your risk of job loss, there are some serious economic headwinds coming our way over the next few years –

  • More expensive fuel, heating and electricity as a result of increased world demand and potential supply bottlenecks
  • a loss in the purchasing power of the pound due to quantitative easing, inflation or both
  • potential falls of house prices in real terms due to wage pressures, less money for mortgages and inflation. That is particularly bad for people with a high loan-to-value because interest rates will go up if inflation takes hold
  • Increasing food and clothing costs are a result of fuel and resource pressures

Now is not the time to be spending up to the limit of your income, like I was a few years ago. And it is definitely not the time to be spending beyond your income, no matter what the reason.

It’s time to get a personal finance tin hat – you need to electively choose to start living on less that your income even if it means doing without things, so you have space to deal with this loss of purchasing power. There’s no point in burying your head in the sand – deal with reality, otherwise reality will deal with you in its own way.

As the cited individuals show, filling in a sudden personal finance hole causes worry and grief. A sense of entitlement simply makes you blame the rest of the world for problems. It may well be the fault of the rest ofthe world, but it is easier to change yourself and your actions than it is to get the rest of the world behind your point of view.

Obviously I could be wrong, but anybody with half an ear to the news will observe that the likelihood of being richer in a few years time is less that the expectation of being poorer. Plus, what’s the worst that could happen? You scrimp and save a bit now, Britain starts booming again and you end up sitting on some saved cash? Time for that trip to Australia, pop the bubbly and have a good laugh at your ill-founded pessimism and that fruitcake at SLS.

Whereas take the ostrich mentality to the incoming crapstorm, what’s the worst that could happen? You lose your job, then your home? You start whining on the Guardian and then have lots of people say nasty things about you which brings Patrick Collinson out in hives?

Oh yes, and that bell is tolling for me too, just to show we’re all in it together. I’m not rich enough for the pension changes announced so far to affect me, but known issues I will be hit by –

  • VAT rise
  • fuel costs
  • heat/light/power
  • property/council tax rises
  • increasing costs of food
  • demise of the State pension/introduction of means testing, goodbye to 30 years NI payments for me.
  • inflation due to QE destroying a good part, ~50% if I am lucky, almost total wipeout if I’m not, of my accumulated wealth despite attempts to turn it into real stuff  and shareholdings (tin hat/optimistic portfolio)

and I’m sure George has got something thought up especially for me.

He can’t take any of my benefits away, because I don’t get any that I know of, but he can raise taxes. It is true that since I am close to the end of my working life the cumulative effect of this is less, but those readers who are at an earlier stage in your working lives and therefore more exposed can take some comfort in knowing that the devaluation of the currency will trash a significant amount of my accumulated wealth.

Plus the forthcoming house price crash will trash the nominal value of my house, though that doesn’t upset me that much as I have no mortgage. It might even give me an opportunity to upgrade. Whatever happens, the house will still keep the rain off my head.

child benefit, the law of unintended consequences

You know how it is, sometimes, when you have to let the heart of darkness shine through. This is one of those times…

One of the comments made me think, as they should 🙂 on my careless use of Gore Vidal’s comment

it is not enought to succeed, others must fail

in my post on entering a family-unfriendly economic system

I’m not actually that mean. I don’t take any particular pleasure in seeing others take the shaft here, and I don’t expect to gain from the withdrawal of CB from the better off. It’s not like I suddenly expect to get a non-child benefit, and somehow I don’t expect any tax cuts to happen while I am still working 😉

However, I do wonder if Labour’s approach of trying to eliminate child poverty by slinging cash around didn’t have some pretty ropey results that we are going to have to live with for a long time.

What’s that again – how can any right-thinking person be against an attempt to reduce child poverty?

I can. And before I get hammered for being a mean and nasty child-hating SOB who wants children to be poor, it may be necessary to point out that not being for something doesn’t necessarily mean I am for the converse. If you are not intellectually up to understanding that, please read no further!

There are some things that are assumed to be good regardless. A reduction if poverty is always good, natch? What kind of mean-spirited git must this guy be, does he want to see the workhouse and children sweeping the chimneys?

Well, get this.

the government’s target of halving child poverty by 2010 is defined in terms of relative poverty. [1]

Now that, I do have a problem with. The trouble with relative poverty is this (from the same reference)

The reason that we believe that relative poverty is important is because we believe that no one should live with “resources that are so seriously below those commanded by the average individual or family that they are, in effect, excluded from ordinary living patterns, customs and activities.

I didn’t realise that Labour had changed the definition of poverty to this. (oops, they didn’t change it at all. My bad, see SG’s comment and BBC reference below) and To me child poverty means being cold, not having enough to eat, being deprived of emotional connection. It doesn’t mean not having a mobile phone or a games console.

The problem here is that I believe there is more variation in intellectual talents, drive and capability that can be encompassed by the spread which is inherent in the definition living in a household with less than 60% of the median income.

Don’t get me wrong – if there were an easy way to prevent this happening (ie households spending < £100 a week excluding housing costs) I’d say go for it. It is when it has the result of bankrupting the country

that I start to think it’s gone too far.

There are other things that are wrong with this sort of social engineering. When I was at school, the average number of children per household was 2.4. Most people think it’s the poor that have all the kids, but there is some economic effect on people’s decision of how many children to have. It first struck me when I started at my current company, at the callow age of 28, just how many people there were there with three children, and in some cases four or five. These were people who were reasonably well-off at the time.

For more recent examples,  David and Samantha Cameron have three children. Nick Clegg and his wife have three sons. Ed Miliband has two, the Browns had three kids, the Blairs had three. I’ve chosen politicians because this information is easy to get hold of, but it shows having larger than usual families isn’t just something the poor do. I would say that where there is more money around, people have more kids than the replacement norm of two, just not the crazy numbers we associated with the Victorian poor.

And so finally I reveal my heart of darkness. If poverty is measured relatively, why did we throw money at people who have poor prospects so they could have more children than their economic situation permitted?

Relative poverty isn’t about putting food on people’s plates, or heating their homes. It is so that they can live the typical lifestyle people are accustomed to. Child poverty is about having a mobile phone and being able to go on school trips these days.

Let’s take a moment to think about this for a moment. My parents didn’t have a television set when I was a child. Does than mean they were poor? I don’t have a mobile phone personally. Does that mean I am poor? No. My parents, and I, think for ourselves, and we choose not to spend money on things that other people regard as essential needs…

Benefits are about securing the bottom two of Maslow’s hierarchy of needs. When we drift into the upper reaches we run the risk of distorting behaviour. These children will continue to have poor prospects, all other things being equal. Having children isn’t the sort of thing that improves your economic situation in industrial economies. Once poverty in terms of the lowest parts of Maslow’s needs have been addressed, it becomes devilishly hard to address the others. Everybody has a mobile phone and Playstation? There’ll be a new set of consumer thneeds that the kids will think they need. And so on and so on.

So by sponsoring the poor to have children, we are actually damning more children to poverty. These are children that wouldn’t exist were it not for the distorting effects of well-meaning efforts to reduce child poverty. The reason for this is that social mobility has dropped in Britian from a high-water mark in the late 1960s.

Why has social mobility dropped in Britain? According to Blanden et al this is because of the right cods that we have made of university education because we couldn’t man up to the task of telling some of the little darlings that their classmates were brighter than them. So we make the exams tell everybody they are great, and tell wannabe university students that of course there is equality of opportunity, as long as they can pay about £65k for the fees. Then we wonder why for some reason there are fewer kids from poor backgrounds going to university. D’oh, perhaps the reason is they can’t find the money?

So all that, in a roundabout way, is why I’m asserting that the result of efforts to attack child poverty by paying the poor to have more children than they can afford may result in more child poverty in the future, as the poverty echoes down the generations. Perhaps we should have been smart here and only sponsored the first, or first and second child.

I can relate to addressing child poverty in terms of food, heating etc. But in terms of relative poverty, then what on earth does success look like?Is there a standard kit of consumer goodies children should have not to feel left out? Do we take the rich kids’ toys away and give them to the poor kids? Oh, and shouldn’t we have asked ourselves what success looks like before we embarked on this journey, anyway?

There’s a separate argument about whether we as a society want people to have more kids rather than, say, importing people for the workforce. However, if that is the issue, then we want to sponsor rich people to have kids, because they will push them and help them educationally. We’ve actually been doing that for a while, and have only just recently announced that we want to stop. Perhaps we are going about this all the wrong way.

We really need to have the courage and honesty to ask ourselves what it is that all this social engineering is aiming to do, rather than starting out with a muddle-headed goal like eliminating relative child poverty. If we want bright kids to become the dynamic knowledge workforce that will drive Britain into the 21st century, then we first need to fix the education system so we can distinguish the bright kids, and we probably wouldn’t go about it by sponsoring the people to have children that we’ve been sponsoring for the last 10 years… If their kids are bright we’ve queered the pitch for them educationally so they can’t afford to get ahead anyway.

It doesn’t greatly upset me to be 4% poorer to do this sponsoring. But it does upset me that we don’t seem to know why we are doing it, we have chosen a metric that seems to be unachievable by definition, and that by our actions we might be adding to the sum total of human unhappiness in Britain to come as the extra children of the poor have extra children themselves. The road to hell is paved with good intentions…

Source:

  1. http://www.poverty.org.uk/summary/social exclusion.shtml

we’re entering a family-unfriendly economic system

There’s been a lot of hue and cry about the changes to child benefit and stuff, and Stephanie Flanders of the BBC has spelled it out over a couple of posts.

She gets away with it where it’s probably incendiary for me to tackle this, because

a) she’s an established writer and understands the subject better
b) she’s a woman
c) she has kids

But I’m going to tackle it anyway, because the reason why we are entering a family-unfriendly economic future surprised me, even though I had a gut feel of it. The thrust of her argument is that

Labour tilted the tax and benefit system in the direction of children and families, particularly low income single parent families. For better or worse, that is what their target of eradicating child poverty encouraged them to do. It is going to be hard to raise serious money from the benefit system without tilting it back.

Now I had been aware that I wasn’t personally getting any of the gravy over the last 10 years. That’s a good thing in many ways, having managed to screw down my outgoings there are limited ways the government can manage to shaft me. They can’t take away my benefits because I don’t get any. They can raise taxes and obviously the VAT increase next year will hit me.

But what I hadn’t realised is just how much gravy people with children did get out of Labour. The government can reduce the deficit by either taxing more or spending less, and because the ConDems emphasis is on the latter, it means that people with children will be taking most of the pain, just as they took most of the gain in previous years. Single parents are apparently about 16% better off as a result of Labour’s changes, whereas I am about 4% down. That great sucking force you hear out there in the distance is the sound of much of that about to be rolled back.

Relative to people with children I expect to be 20% better off when Cleggeron have finished. Unfortunately this will be achieved along the lines of the second part of Gore Vidal’s aphorism

it is not enough to succeed, others must fail

I don’t expect to be any better off at all, it is just that families with kids will lose a lot of the extra bungs and sweeteners society has given them to make having children easier/less expensive.

Before people start screaming that it isn’t fair, perhaps you might want to ask yourself whether getting free gravy was fair in the good times. It wasn’t fair to me, for instance. Twice in my life I asked myself the children question, and each time I didn’t really feel I could manage to support a family for 18 years.

Before the aggrieved hordes of the Daily Mail and the Torygraph seize on that as proof positive that as a higher-rate taxpayer it shows I know you can’t raise kids on 44k of course I could have kept the wolf from the door, but to me life is about more than that. Many people get an awful lot out of having children, and if I had that sort of desire I would prioritise this up the stack and manage somehow.

I didn’t do it because I didn’t want to hard enough. It’s called making choices in life, knowing your values and acting accordingly. It’s not the Government’s job to get involved in my lifestyle when if comes to such individual and personal decisions, unlike with services we all need, like healthcare and policing. And yeah, I know it’s different for guys.

It’s going to be a rough ride, people.

Rich Dad Poor Dad’s Increase your Financial IQ

Rich Dad Poor Dad Increase Your Financial IQ

Robert Kiyosaki isn’t everybody’s cup of tea. I was surprised to see this book on the shelves of the County Library and couldn’t resist it. You don’t often see some of the personal finance classics in a UK library, for instance I’d quite like to read the seminal Your Money or Your Life but it isn’t in the library. RDPD polarises opinion – some people find the book inspirational, some find it dire, and some people aren’t quite sure.

People that do that are usually worth listening to. They upset people because they challenge preconcieved ideas and comfort zones. They inspire others because they show them a new way of looking at the world. And they confuse others because they see the inspiration, and they see the awful flaws at the same time.

This book did the same for me, in a smaller way. It didn’t start off good with an intro by Steve Forbes and Donald Trump. The former seems to be somewhere to the right of Genghis Khan in outlook, the second an arrogant S.O.B. to boot.

The book itself was a maddening combination of utter bullshit and compelling and refreshing new thinking at the same time. Let’s start with the utter BS. The author clearly still carries around a large chip on his shoulder, it shows in some of the fictional writing, it shows in the clear fondness for the material trappings of richness. His alleged Rich Dad didn’t need those trappings of wealth, he drove an old car, a regular house, but Kiyosaki is a blowhard. He talks about the size of his…property portfolio. He talks about leverage, and though it is true that using other people’s money can help you get ahead, those other people usually like to charge you for the use of their money, which he doesn’t seem to factor into his hastily calulated ROI.

RDPD shamelessly plugs his other books and a fearsomely expensive board game in this book too. There is a strong sense of the get-rich-quick charlatan to the patter, and the motivational stuff is very similar to Paul McKenna’s book but the American style grates on me in a way McKenna didn’t.

So far so bad. What are the good bits?

He bangs on about passive income,which is correct, but not something I didn’t know. Where he did add genuine insight for me was

Rich Dad on Currency versus Money

Nixon’s abandonment of the gold standard (indirectly expressed in the Bretton Woods system) in 1971 turned the US dollar from money into currency. What he means is that previously it was a store of value, referenced against a finite good, as well as a medium of interchange. What it is now is a medium of interchange, and an unreferenced and depreciating store of value.

Now there are loads of people on the Net spitting bricks about fiat currencies and whatnot so this is hardly new, but it comes without the hyperbole that a lot of people succumb to when talking about fiat currencies. We probably needed fiat currencies to accommodate economic growth sponsored by the gift of oil over the 20th century – if the money supply can’t increase to match the increasing value of the goods and services in the economy then presumably a form of deflation occurs, which rewards old money and historic capital over new, which isn’t conducive to growth. We have experimental proof of that in most of European history, where old money was king, often literally, and growth was measured in the sort of amount per century that we demand per year. The trouble is that this flexibility of fiat has a dark side, which is the temptation for governments to manipulate the currency by creating money for them to spend. This increases the supply, thereby invisibly taxing stored value as more money chases the same goods and services.

The reason the currency is a poor store of value is because it is not synchronised to an independent arbiter of how much of it is in circulation, and indeed it is not referenced to anything which as an inherent value such as gold or silver. Sophists will of course grizzle that value is inherently relative. To a starving man a loaf of bread has far more value than 800g of gold, but I’m going to handwave my way through that. Assuming an inflationary, but still in control monetary system, gold and silver have an inherent value, currency does not, though it has a temporary, and decaying value. The half-life of the decay is longer than that of fresh fish, but historical precedent seems to indicate it is less than two hundred years. It’s still damned useful if you want to buy a newspaper, just less so if you want to give money to your future self, because a significant amount of it will fall off the lorry on its way to your future self.

Now I’ve already had to think about this in the tin hat portfolio, against serious decline due to peak oil etc, but assets that work well there are illiquid, usually indivisible, lumpy and not fungible. For non-apocalyptic situations where I want to store wealth, I could do with a currency that is backed with something real, so that buggers like Mervyn King don’t get to press the ‘make more money’ button and double the amount of money in circulation chasing the same bucket of goods and services, thereby taxing my cash assets at 50%. I don’t like that very much. I could whinge that it isn’t fair, but more constructively I could see if somebody is offering a currency that is backed by something that is real.

Here is an example of a currency backed by something real. Look carefully at the back. Or is it the front? I don’t know. The side with George on it, anyway, rather than the side with the symbol of the illuminati, the freemasons and the symbolism of the new world order. No, I didn’t mean that last stuff, I was just having a laugh with SEO keywords for conspiracy theorists, and showing I’ve read too much Dan Brown. He’s sort of like engine oil flush solution for the mind, but it obviously left some traces. I dragged out a genuine greenback from a trip to the States and the side that says ONE on it looks pretty much identical to the non-George side of this apart from the lizard.

A silver certificate

What Kiyosaki opened my eyes to is that, for the above example, a unit of a silver physically backed ETF is the same thing in many ways.

Of course, a non-physically backed ETF is a derivative product. Derivatives are basically smoke and mirrors used to sell something you don’t own, and I’d prefer not to to be a buyer of such given recent experiences.

Even a physically backed ETF company such as PHAU or PHAG is nowhere near as robust a counterparty as the US government – at least Uncle Sam is subject to getting voted out, or suffering the results of the Second Amendment, whereas the only thing that keeps PHAU or PHAG on the straight and narrow is whether Graham Tuckwell of ETF Securities feels he can beat it quickly enough with the gold bars to stop getting put in the nick.

There are other aspects of counterparty risk with ETF Securities – they produce a number of derivative products. Say they screw up there, which is not unknown these days, then the value of the physical holdings of PHAU and PHAG will be set to the company assets and used to spread across all creditors, all of which will take a haircut. Thus the physical backing will not have the protection value PHAU/PHAG buyers thought they had at first sight.

For all that, this sort of ETF does seem to be a hedge against slow, slipsliding currency death of a thousand cuts that the repeated bursts of QE are doing. Of course, the tragedy is every other investor thinks the same, so there are some bubble dynamics in gold at least.

So I will hold on to my GBS ETF and get some PHAG ETF with this month’s saving while I think about what to do with my regular savings. As described earlier, these have no place in my tin-hat portfolio – for that I have to get physical and bury gold sovereigns at a crossroads by the light of the last quarter moon. It’s a tried and tested method with a long tradition 🙂

GBS/PHAG therefore become part of my regular portfolio. I don’t want to buy shares in October, because the yields and PE of what I want aren’t right and I’ve seen two market crashes in Octobers past and I feel another one is ripe. There is also a general note of QE in the air, not so much from the Bank of England but from the Fed, and where the Fed goes the rest of the world will follow. I accept the risk that if the US dollar goes down and ceases to become a reserve currency (likely in the next 5 years in my view) that this sort of holding will be written off and destroyed.

Hopefully there will be a stock market crash in the second dip, and I can buy myself an income at good rates via a UK investment trust at rock bottom prices. I would prefer not to have to eat this sort of counterparty risk by buying NS&I index-linked certs, but I can’t do that at the moment.

This is a risk. It is a serious risk to take. But doing nothing is also a risk. I have seen my UK wealth drop by 25% in the last year, simply due to the devaluation in the pound caused by QE. Of course, the number that Quicken tells me for my net worth hasn’t dropped by 25%, it’s exactly the same. And since the USD is dropping too there aren’t the other obvious warning bells. But the value of stuff that the £ buys is dropping rapidly, be it measured in radio plugs or loaves of bread.

This is not so much an issue for readers at the beginning of your working lives, since your wages will rise to some extent to compensate for inflation, but I am approaching the end of mine, so most of my wealth is in stored capital. So I am prepared to start taking chances to hedge it against the increasingly rotten currency. There is always the possibility that the gold price is in a bubble and will halve. There is precedent – you’d have been pig-sick to have bought in 1982. On the other hand, there is a virtually certain possibility that the currency will depreciate, that’s what quantitive easing is designed to do, which somewhat offsets the downside. Do nothing, and I will lose out anyway. Precious metals ETFs pay no interest, but the interest on my cash ISA isn’t enough to compensate for RPI, never mind the 25% depreciation in the £ over the last year or two.

The other thing that RDPD introduced me to was something I had moved towards instinctively, but he called it out explicitly.

Investors for Growth take more Volatility then Investors for Income

Eh what? His example was drawn from the property rental model that seems to be a large part of his claimed portfolio. Now I tend to look askance at anybody advocating having anything to do with property, because it has been nothing but a world of hurt for me personally. I don’t even trust Monevator and his REITs though I’m sure he’s right, but I don’t touch property with a barge-pole! Any sort of property at all, other than owning my house outright.

However, the pathologies of property do back up RDPD’s assertion, that the volatility of the value of the property is far higher than the volatility of the rent income. Something similar seems to apply to investment trusts, such as this

Nasty hairy ride for the growth investor

Nasty hairy ride for the growth investor

easier journey for the dividend investor

Easier journey for the dividend investor. Obviously the trick here is to get a decent yield, so it’s not like the share price is irrelevant when you buy, but the takeaway is that if you rely on the dividend income you will have less of a white-knuckle ride than if you rely on the share price growth. To make this work you have to do a Warren Buffett and choose carefully when to buy, and then hold foreverThe income from dividends is lower than most people’s hopes for growth, so we are talking tortoise rather than hare. That means you need a lot of money to get an income – the yield is around the 5-6% mark.

I hadn’t read this article in 2009 which would have been the best time to load up, but the 6% yield I bought at was acceptable. I compared a number of UK ITs and of my shortlist observed a similar behaviour in the stability of the dividend relative to the share price. Naturally, under certain economic circumstances the centre cannot hold and everything will fall apart, but in a world where money is slowly dying on its feet due to sovereign debt and  competitive devaluation there’s no such thing as risk-free.

Another insight that RDPD offered me, though one I only use in my tin-hat portfolio, is the concept of control. With paper investments, the only controls you have are to be in or out, and to some extent how much. You can’t influence the ouput from the investment itself. If you buy an asset that you can use to make money (say a business or a productive capacity) then to some extent you have more control – you can sell more or work harder if you come up short. Self-reliance is an important aspect of resilience against a currency collapse and resource crunches.

There is only so far you can go, however. Cans of beans are okay, but when you start stockpiling weapons and tin hats you’ve run out of road. You have to sleep sometime 🙂

Finally, though it isn’t relevant to me because I have no mortgage, RDPD correctly classifies a mortgaged house as a liability, not an asset. It only becomes an asset when you pay down the last instalment, whereupon it becomes a sunk cost with an ongoing revenue stream defraying the amount of rent you’d be paying (less maintenance, and in the case of US readers, property taxes. In the UK property taxes are per resident, so renters pay too). This is because apart from a few exceptions most people need a roof over their heads.

Not everybody understands in their bones why a mortgaged house is a liability and not an asset. You get know that, when there is a house price crash and you get to see what you owe on your mortgage is more than the value of your house. There is a deep knowledge you get from that experience that is hard to get any other way.

So I got good value from the time I invested in reading Rich Dad Poor Dad’s Increase your Financial IQ. Rich Dad would approve of me using other people’s money to invest in his book by borrowing from the library, so he would say my ROI was infinite. Yes, he is arrogant, and yes, he is a blowhard, and he probably makes up a lot of his anecdotes. But he looks at the world in a slightly different way from normal PF author, and because of that different angle, he sees things hidden from the mainstream. If you are independent enough of thought to isolate the nuggets from the dross, he many have something of value to say to you. I am chuffed that I didn’t financially support his brand, however, it looks like a rum operation to me.