One of the disadvantages of saving money in a shortish time to retire early is you get a whole lump to manage at once. ISAs are designed for people who save in a civilised and steady way, not in a mad rush to get out of the workforce before the edifice falls around their ears. SG and TNT are great examples of how to do that task right, well done those guys!
I have saved a six-figure sum in pension AVCs, up to the absolute limit that I can save (25% of the total FS fund value) before being forced into an annuity for which I am too young. All the AVCs have to be converted to cash, which has already happened, then tax-unwrapped as a tax-free wodge of cash on leaving work.
The tax system identifies people with lump sums as rich bastards ripe for the picking so it’ll take me over 10 years to get the equity part into ISAs. I’ve made a hash of the post-work tax planning. For technical reasons I will have to draw my pension, actuarially reduced because it’s early, but still over the putative £10k basic rate tax threshold for 2015. So I need a long-term investing strategy, to give me an income for the next 40 years. Preferably one that doesn’t add to my tax burden.
Pensions are designed to avoid investing a lump sum all at once – either you get a defined benefit, like mine, or you have restrictions placed on how you draw down your pension or have to take an annuity. That is to avoid retirees blowing the lump sum on as frenzy of cruises and fast cars, resulting in penury afterwards. The most common question I’m asked when people hear I’m leaving with a payoff is ‘what am I going to spend it on?’ It’s a strange way of thinking. I’d rather give the lump sum a chance to earn some money before running it down 😉
There’ll be some people that will need to invest a lump sum like me, so this post might be of some interest in showing the thought process. It’s not advice – I might screw things up, and my risk tolerance and background are unusual in some ways.
A strategic overview
Initially, my pension is easily enough for my running costs plus a reasonable entertainment budget. It is to some extent RPI linked, but I will slowly lose the fight to inflation as the decades roll by. Inflation contains a lot of consumer frippery and iFads that I don’t consume, but which generally come down in price due to technological advances. Needs and services tend to go up over time. If I buy less of the stuff that is getting cheaper relative to the stuff that is getting dearer then overall I will experience > RPI inflation.
I started work in February 1982, without any long-term vision or strategy of life. You can get away with that at 21 because you have fifty-odd years of life remaining (as it was at that time, current 21-year-olds will be happy to know they are up for nearly sixty years from now).
It looks like I have picked up a decade of life expectancy in the intervening 30 years, I’m not sure why. I’m up for another thirty years according to the ONS. So I probably stand pretty much midway through my adult life. If I look at my family history I might be wise to think in terms of income for 40 years, rather too much than too little…
Let’s just get up in the crow’s nest and look out for icebergs in the seas ahead. What’s likely to happen in the next 40 years?
Relative decline of the UK (short, med, long term)
I expect the UK to fall down the pecking order over the coming decades, largely due to our decadence and nasty tendency to live beyond our means, combined with the rotten state of the education system because we don’t dare discriminate between the bright and the dim bulbs in case it hurts the dim bulbs’ feelings. We may turn this around – there is probably enough nascent dynamism in the country and the British have a decent track record of resilience in the face of adversity, but the low-water mark is still some way off IMO.
A relative decline doesn’t necessarily mean an absolute decline. Living standards in the UK have fallen in the last couple of years, but compared to the 1960’s London I was born into, we enjoy a fantastic standard of living. The problem is that humans are relative – people felt better about their lives in the 1960s than they do at the moment, because they felt things were looking up.
economic storms across Europe (short, med term)
Large swathes of Europe are not just bankrupt but seem hell-bent on becoming destitute. In the immediate future there’s an extremely high risk of a godawful crash as the Eurozone goes titsup and an awful lot of what used to considered wealth simply evaporates because it isn’t backed by anything. That’s the cheerful interpretation, for the Mad Max scenario look no further than George Soros in the FT, who opines
Far from abating, the euro crisis has recently taken a turn for the worse. The European Central Bank relieved an incipient credit crunch through its longer-term refinancing operations. The resulting rally in financial markets hid an underlying deterioration; but that is unlikely to last much longer.
The fundamental problems have not been resolved; indeed, the gap between creditor and debtor countries continues to widen. The crisis has entered what may be a less volatile but more lethal phase.
There are opportunities there. That explosion will probably trash share prices across the region, possibly the world. The brave and the reckless, who are prepared to fly into the storm rather than trying to run before it, may find value is cheap as they pick over the wreckage. The successful must have internal reference points. When the falcon cannot hear the falconer and the centre loses hold there will be no external references to steer by.
Will I hold my head when all around are losing theirs? Buggered if I know. I’ve seen three recessions up close and personal and was a teenager in the 1970s oil crisis and stagflation. I was a heavy investor in 2009 after appreciating the logic behind this, indeed looking at my AVC contributions I stole a march on the article by a couple of weeks, but it did stiffen the spine. However, desperation concentrates the mind, and a 40% tax-free discount makes courage easier. Even a dog can be a great investor with a 40% leg-up.
a multipolar world (med, long term)
The power centres of the world economy are shifting, and it’s not really possible to say where they are shifting to. America is bankrupt but has the advantage of being the money creator of last resort, China is an enigma within a conundrum, they seem to be top dog at the moment but it is questionable if they will get rich before they grow old. India seems well-placed, though it could do with reining in the backhanders. Russia, well, do you feel lucky, punk?
It’s pretty unclear where the engine of growth will be in the decades to come, or if there will be one. We will have resource wars, beginning with oil wars. We’ve already had a few, Iraq and Libya spring to mind, Iran is on the hit list. As for that growth, perhaps Uncle Sam will dust himself down, spit on his hands and show everyone how it’s done. Maybe Africa will do something with all that Chinese money and a few of the rotten ageing dictators will get bumped off and the economies soar. Perhaps Peak Oil will come along and the entire economic system must fall until some of us work out whether trade still has any meaning in a energy-starved world. Who knows?
young man – diversify
There’s only one way to handle that lack of knowledge – bet on several outcomes! Diversification comes in to flavours, coarse high level asset class diversification and fine level equity diversification, equities being a subset of the asset classes. I have now lost all equity geographical diversification from the UK, which I had emphasised in the AVC holdings.
Monevator has a listing of asset allocation strategies in his Lazy Portfolios Make Asset Allocation Easy post. That illuminated my thinking greatly, though I was initially confused as hell because all but the Harry Browne portfolio as asset allocation strategies as it said on the tin, but the Harry Browne one is in fact a asset class allocation strategy with a 1970’s era equity allocation.
1. Allan Roth. Nope. I may be reckless, brave, even mad, but I’m not young.
2. David Swensen. I’m not an Ivy League endowment fund with a 100-years plus investment horizon. Not unless we go through the Kurzweil singularity and I don’t know about you but I’m not sure I want to live for ever in a world of beings increasingly smarter than me.
3. Rick Ferri’s Core Four
Too much developed world for my liking. I think the developed world is likely to become a lot less developed over the next 10-20 years. So it doesn’t meet with my world-view. Rick Ferri may well be right, but heck, it’s my life so it has to go along with my beliefs, even if I turn out to be wrong and this sort of thing happens.
4. Bill Schultheis Now we’re getting somewhere, the spread is similar to my mind to Tim Hale’s which I preferred but this is the first one I’d be happy with in terms of equity asset spread (I lop out bonds and gilts from every spread because of my specific circumstances of having significant fixed pension income)
5. Harry Browne’s Permanent Portfolio. Fascinating geezer, Harry Browne, with his seminal How I found Freedom in an Unfree World. He’s somewhere to the right of Ayn Rand who looks like a pinko Communist in comparison so it’s kind of disturbing that his was the one that really resonated with my world-view. It matches my expectation that there are serious challenges ahead, his choice of four orthogonal asset classes is what I like. His domestic-only equity target is very much of his 197os world where the developed world ruled, so it needs adapting to the modern world. It’s more an asset class allocation strategy.
6. Six Ways from Sunday. I just didn’t get this, so no dice. I actually share Scott Burns’ viewpoint that energy is the ultimate currency, so I did pinch one ETF idea from him.
7. William Bernstein’s No Brainer. Same issues to my eyes as Rick Ferri’s portfolio, too much developed world IMO.
8. Harry Markowitz. Attractive simplicity. I don’t do bonds because of my special circumstances (a FS pension that is pretty close to bonds in characteristics of fixed and index-linked income). I probably want to weight more than the World ETF, but if I had a DC pension sum to invest this has a lot to be said for it., Being a fiddler, I’d weight to the UK (because that’s where I am) and after that underweight the developed world (because of my world-view). Thereby buggering up the simplicity, so not right for me and my resources.
9. Tim Hale – much to like here, though again I’d lop out the government bonds and index-linked gilts due to my specific circumstances. And translate the Vanguard funds into something I can access in an ISA without paying the earth. The bonds and gilts I’ve eliminated is 40% of the portfolio, but the capital value of my FS pension is a lot more than the free capital I am investing, so taking a high-level view I am overweight fixed income. I may get his book from the library to catch up with his thinking. I will use the equity distribution to illuminate my equities later.
Asset Class spread
Asset class diversification gets you out of the stock market in periods of irrational exuberance like 1999. And into it in times like 2009 when the world is caving in, and only Warren Buffet stands between the shattered wreckage of Wall Street and the Four Horsemen thundering in from all points.
As far as asset class diversification, I am drawn to Harry Browne’s Permanent Portfolio, which is roughly
25% stocks in the country you live in, 25% bonds, 25% cash and 25% gold
But since I’m an inveterate fiddler, and prepared to accept the consequences, I will consider this as
- 25% equity portfolio
- 25% bonds I shall consider my final-salary pension
- 25% cash I will hold as NS&I ILSCs (I don’t know what a money market fund is, this seems to be US-specific)
- 25% gold I will consider as including my non-financial investments.
I don’t know what Harry Browne was thinking of doing with his gold, but if he considered it his SHTF Bug-out stash I wonder if he considered the weight of it, he was a lot richer than I am and it was cheaper in his time. I wouldn’t want to run with it, particularly with in the form of coins. I may add some in the form of an ETF, but I’m happy to think about that later. My non-financial investments also fall into a similar role in that they gain as the financial system falls, but they don’t have the portability or divisibility of gold.
We should also remember that Harry Browne lived in a country where householders are encouraged to keep a shotgun handy and are entitled to take down intruders within the curtilage of their property. In Europe we are somewhat namby-pamby and effete for such gung-ho defence of one’s chattels, so holding physical gold is a lot less attractive for me than for Harry Browne.
Now the majority of my free cash savings come from pension AVC savings, and by the time I leave I will have driven this all the way to the 25% tax-free pension commencement lump sum limit. Given that the pension itself is in the fixed interest part, I’ll never balance that at 1/4, it will always be bigger.
Well, always bigger until this prediction comes to pass and the shares section eats the lot like Pac-man. Rebalancing keeps the right-hand-side in relative proportion but the whole would squeeze down the pension section 🙂 The reason the fixed interest isn’t 3/4 of the pie is because I have existing savings and the non-financial assets are substantial. And no, I still don’t include my house as part of my net worth because I have to live somewhere.
It’s obviously not pure Harry Browne because the cash and non-financial investments put together are about the same as the shares, which reflects my prejudices. I’m easy with that. I understand Harry Browne’s rationale and if I were working up from scratch over a working life I’d stick to his equal split. But I’m not, so I am going to do it my way, and take the hit for being an opinionated git if necessary.
The equity part of the Harry Browne portfolio, updated with Tim Hale
So I’ll take the equity portfolio, retain my HYP which is largely UK based, and already includes Aberforth for UK smallcap, turning it into a bastardized Hale variant like so:
- 20% HYP (for the UK part)
- 5% Aberforth Smaller Companies
- 20% s Dev World ex-UK Equity, consisting of four HSBC funds as used in the slow and steady portfolio. Asia Pac seems to be developed world in investing terms.
- 16% some sort of Global Emerging Markets LGAAAK seems to fit.
6% db x-trackers Stoxx Global Select Dividend 100 ETF (XGSD) TER 0.5
No, not doing any sort of index-tracking select dividend. I got slaughtered with IUKD a while back until TI educated me and TA showed me the 4% running costs that, basically, you can’t automate value plays. The huge attractors of value traps will always kill you. If you want to file that flight path you have to fly it on manual, or get sucked into the black holes on auto.
I’m going to swap that sucker with a gratuitous addition from Scott Burns’ portfolio to reflect my views on impending Peak Oil. And yes, it probably does overlap LCTY to some extent, life is just like that. It’s nothing like what IUKD is claimed to do, but since a HYP has a bias to what IUKD should do but doesn’t I don’t feel value is unrepresented.
- 9% Global exUK DW SmallCap
- 10% HSBC FTSE EPRA/NAREIT Developed ETF (HPRO) – this is property
- 10% Lyxor ETF Commodities CRB (LCTY)
- 10% db x-trackers Stoxx Europe 600 Oil & Gas ETF (XSER)
The proportions are higher than in the original article because I have chopped out the 40% for the gilts and Government bonds, which I don’t need, due to my fixed income.
There’s a lot of noise and hum associated with running something like this, so many funds, and rebalancing. Passive investing bores the bejeesus out of me, so one attractive alternative is to buy a Vanguard Lifestrategy 100% Equity fund ISA from Hargreaves Lansdown and be done with it. And then do the same next year. And the next. And the next, and so on. The HYP would skew that to the UK somewhat, but so be it.
The one thing that scares the hell out of me is Vanguard is so astronomically big. Big rewards mean big temptations. Somewhere, in that big monolith, I am sure there may be a young Nick Leeson or Bernie Madoff in the making, dreaming of riches beyond belief. Perhaps he is there right now, sitting behind the glowing light of a computer terminal in a ventilation shaft with nobody looking over his shoulder. Power corrupts, and it only takes one of them to get through…
ISA and temporal diversification
The annual limit on ISAs may work to one advantage, enforcing temporal diversification. Just as if you are going to quit the market to buy an annuity you should wind down your position over five years, the reverse is true on entering it. As it is I need > 5 years to enter anyway. There’s an argument to say I should use several ISA providers too, but this mitigates against rebalancing, as holdings in separate providers can’t be rebalanced across the divide. This isn’t a problem in the early buying years, but once the ISA has reached steady state it is. I’ll probably compromise and keep the HYP with iii and use a different platform for the rest.
What’s with all this passive rubbish all of a sudden?
I’m unashamedly active with my HYP, in the choice of what to buy, though I try and be Buffetesque in buying and holding; my churn is low, trading is not something I have any skill for. The income from that will be the first line of defence as my fixed income falls below the waterline. The UK is not a bad place at all to seek income from a HYP.
I can do okay with a HYP in the UK but if I want a slice of anywhere else I either have to pay someone like Anthony Bolton to understand it or I can go passive. There’s no point in me trying to pick stocks in areas I only know of as shapes on a map, but I’d like exposure to them. So the scattergun approach of passive investing becomes attractive in the face of no cheap alternatives.
Passive investing gives me concerns in big developed world indices tracked by lots of ageing Baby Boomers about to sell out of the stock market on retirement, like the FTSE100 or the S&P500. I don’t track the FTSE100, and I hate trackingthe S&P500 and would avoid it if I could – I’ve split the US one into 3% S&P500 and 2% US dividend aristocrats because doing the same as everyone else is never a good thing in investing. There seems no S&P allshare open to me. For all the other global stuff which won’t be tracked by loads of people I am relaxed about passive investing. In the end I want to do other things with my life than obsess about far-flung stock markets.
Perspective is also important. I will add value to DW’s project and the time may well come when my financial assets will be less significant. She has managed something I only managed on the side – and that is capturing the entire fruits of her labour by working for a company owned by herself.
There’s a common thought-pattern that you can never become rich when you trade your time for money. I love the American directness of this straight-between-the-eyes approach
This might offend some people, but as long as you are working for someone else, you are not working for yourself. With that kind of attitude, you are actually thinking as a poor person does. If you are not investing into yourself and your own business, you are going to stay in the position where you are.
I can’t complain too much, I did okay working for other people, and wasn’t entrepreneurial enough to work for myself full-time. I don’t regret it – in the end you will only know joy if you can recognize what enough looks like, and it looks different for each one of us.