What caught my eye this week.
The Bank of England is hellbent on crashing the economy, having recklessly raised interest rates by 0.25% to 0.75% this week.
No, that’s not my opinion. But it was a view sounded by many commentators in the wake of Bank Rate rising above 0.5% for the first time in a decade. Critics even included one former Bank Rate setter.
Really? Let’s remember that with inflation running at well over 2%, we still have a strongly negative real interest rate. (‘Real’ means inflation-adjusted, remember).
Even after this latest rise, the real Bank Rate is still MINUS 1.55%.
And that’s before we take into account the impact of all those rounds of quantitative easing, the point of which was to effectively lower real interest rates in the market.
Money remains historically very cheap.
Borrowers still blessed
It’s true that several million people on variable rate, tracker, and discount mortgages will see their monthly payments inch up a tad.
But many such homeowners have seen their mortgages being paid off by a decade of negative interest rates. For all the austerity felt by the poor, it’s been a super time to be a middle-class homeowner. Few should complain too loudly about a 0.25% rate rise.
On the flip side, some of the rate rise will be passed on to savers, though as we slowly return to something like normal rates we should expect this to lag.
UK banks never took the interest rates paid to ordinary savers below 0% in the financial crisis. Instead there was a compression of the spread of rates that banks usually profit from. This will have to be unwound, and so I expect savings rates to rise more slowly than mortgage rates.
I’m inclined to think that if the economy cannot take a slightly less negative real interest rate – fully ten years after the financial crisis and with employment and with house prices at an all-time high – then we ought to find out sooner rather than later, as opposed to speculating.
Star power
With the rate rise expected by everyone, perhaps the more interesting thing to come out of the Bank was an estimate what its wonks call r*. (Pronounced “r-star”).
r* is shorthand for the ‘equilibrium real interest rate’ – and if you think that mouthful is reason enough for the shorthand, wait until you hear the long definition:
The ‘equilibrium interest rate’ is the interest rate that, if the economy starts from a position with no output gap and inflation at the target, would sustain output at potential and inflation at the target.
Okay, perhaps that’s not too confusing. But then I have been reading the Bank’s deliberations for the past couple of hours, so perhaps I’m inured to banker-speak.
You can get up-to-speed on r* for yourself by reading pages 39-43 of the newly-published Inflation Report [PDF].
Basically r* is the Goldilocks interest rate – neither too hot (that is, a rate that’s too low) to stoke the economy and push up inflation, nor too cold (er, a rate that’s too temptingly high) to incentivize savers to move their money out to work fueling the engines of capitalism, as opposed to leaving it all sitting in a bank in cash.
Unfortunately, there’s no way of knowing exactly what r* is at any particular time.
Instead, policymakers have to infer it, in the same way that you have to try to figure out if he or she is really in love with you.
Various factors may weigh down – or boost – the equilibrium real interest rate. In the medium to long-term though there’s presumed to be an underlying trend rate – confusingly also called R*, though note the capital – which is where real interest rates could sit if the economy never fluctuated and Bank officials could spend their time at the beach instead.
Sadly in the real world, things do impact the rate – an impact that the Bank labels s* (where the ‘s’ supposedly stands for short-term but which I think stands for shit stuff happens.)
When s* would heat things up, r* would need to be higher than it otherwise would be (R*).
When s* is a drag, r* would need to be lower.
Right now the Bank believes we’re still in a sticky patch for ‘stuff happening’, what with the Brexit uncertainty, talk of trade wars, the lingering impact of the financial crisis, and also perhaps rates around the developed world being similarly measly.
This belief that r* is low is why Carney and Co. have been keeping Bank Rate so low, and why the Bank is raising rates so slowly.
The Bank’s assessment is that R* would be too high a Bank Rate to keep inflation on target at 2%, given the headwinds.
It believes r* is lower, and hence we still get low interest rates.
R-stars in their eyes
If you’re not asleep by now, no doubt you’re screaming: “Great, but what should R* be! Surely that’s the important bit!”
You’re right, like the Bank of England I’ve deliberately buried the lead.
After stressing that its best guess is just that, the Bank estimates that R* – the long-term trend real equilibrium rate, you’ll recall – is currently somewhere between 0%-1%.
What’s more, it estimates R* has plunged from around 2.25%-3.25% back in 1990!
This is all hugely significant.
Remember, R* is a real interest rate. Add the 2% inflation target onto it, and we get to where the Bank Rate would be in a perfect world (to over-simplify).
What the Bank is estimating is that absent those short-term / stuff happens factors, Bank Rate would now be at between 2-3% (as opposed to 0.75%).
In contrast, if R* was still where it was in 1990, the equivalent ‘normal’ Bank Rate would be 4.25-5.25%.
Clearly this has big implications for both savers and borrowers.
It suggests anyone waiting to get 5% – or even 3% – in a standard savings account shouldn’t hold their breath.
Similarly, mortgage holders shouldn’t have too many sleepless nights worrying about rates leaping back up to 5-7%, at least on current forecasts.
Playing for ratings
Of course if R* can come down then it can go up again.
The Bank thinks that the aging population, slower productivity growth, and the impact of more cautious financial regulation has likely pulled down R*.
Set against that, it believes the requirements of younger foreign savers and even the rise of the robots could affect R* in the future.
But it doesn’t expect anything to happen very quickly, to either r* or R*.
Absent some huge shock such as a Hard Brexit or a surprise election-related run on the pound, the bottom line is interest rates aren’t going much higher anytime soon.
What caught my eye this week.
I would love to start here with an analogy drawn from the film Synecdoche, New York. But I fear I’m quite possibly the only person on Earth to have ever seen it.
Allegedly others have. Reviews exist on the Internet. Some rightly hail Synecdoche a work of genius. A few fools label it pretentious twaddle. But I’ve never met these critics – I even saw the film in what seemed to be an empty cinema – so I can’t rule out those reviews coming from some weirdly highbrow Russian bot farm.
Anyway, Synecdoche, New York contains multitudes, but the bit I would like to be alluding to – which I’m going to explain in words instead, which is obviously ideal in an analogy – involves the lead character’s attempt to film a story drawn from his own life by rebuilding his life – and his house, and the surrounding city – inside an enormous film set.
Which is how I found myself proceeding when I tried to write about the Lifetime ISA.
You think I’m joking?
I’m not!
Lifetime sentence
I published a piece explaining how the Lifetime ISA worked in April 2017. This long post was what remained after I hacked out a big rant about the silliness of the product – and another multi-thousand word discussion about who should make use of one.
Instead, I just gave some vague pointers, then concluded:
In the next post we’ll see exactly who the Lifetime ISA might be good for, and who should say “no thanks”, and back away slowly.
And to this day I have never finished that follow-up.
My draft is huge, contains multitudes, and is unfinished. The knowledge of it sitting there has often given me writer’s block and stalled other articles. The thought of comment after comment pointing out this or that issue if I did publish it without chasing down every last use case makes me freeze up. Instead I kick it down the road for another week or six.
Even unfinished the article wanders widely into all kinds of areas of investing – risk, time horizons, shares versus property, taxes, early retirement versus traditional pension saving, employer pension contributions – because the Lifetime ISA forces all this onto the table.
That might sound like a good read, but it is very sub-optimal. We already have a couple of million words across more than a thousand Monevator articles trying to cover all that, and there are still holes. This Lifetime ISA draft article manages to be both insanely verbose and yet still not sufficiently comprehensive to ensure nobody is misled.
Now you might be thinking:
“Okay TI, I get that the Lifetime ISA is a bit convoluted with the pension and house buying bung combo rolled into one wrapper, but I managed to figure out that I should / should not use one.”
I believe you! It’s just about possible to figure out whether an individual should open a Lifetime ISA, if you’re there with the individual. 1 After two or three hour-long conversations for example I got there with my ex. 2
But you really do need everything on the table to make this decision, in a way that’s not true of any other financial product I can think of. Which means that while it might have been straightforward-ish for you to decide what you should do, generalizing advice for even broad groups is very difficult.
Seriously, the Lifetime ISA is like some kind of beneficial yet malevolent magical goblet in a Greek legend. One minute it’s refilling itself with ambrosia. The next minute it’s chomped your arm off.
I believe this complexity is why even today only around half a dozen financial service providers are offering Lifetime ISAs (and only a couple the cash version). The others may fear a mis-selling scandal. Or, like me, they were hoping it would be killed off sooner rather than later.
Which brings me finally to this exciting news from Treasury Select Committee 3 as reported by ThisIsMoney:
The Treasury Committee has today called for [Lifetime ISAs] to be scrapped due to their ‘perverse incentives and complexity.’
My heart just skipped a beat.
To throw out a spoiler for a film you’ll never watch, Synecdoche, New York ends on a gloomy note. The director’s project proves fatal. Don’t fire this one up for Netflix and chilling.
But could my own half-finished epic have a happier ending?
MPs might throw me a lifeline – if they can stop bickering for five minutes about when to start stockpiling prosecco – and give the Lifetime ISA the unceremonious death it deserves.
- More precisely, whether they should USE one. I’ve said anyone under the 40-year old age limit should open one with £50, simply to ensure they have the future optionality.[↩]
- Yes, I’m a thrill a minute of a boyfriend. Perhaps that’s why I am now an ex…[↩]
- Yes, I said ‘exciting’. Again, form a queue ladies.[↩]
What caught my eye this week.
The rebooted US financial blog Get Rich Slowly posted some interesting data this week about the benefits of working the dreaded One More Year – or even a few more – before retiring.
It’s interesting to see the results recast as ‘standard of living’ rather than just dollars banked:
Note that the last time I highlighted similar US data, a wise comment pointed out the US retirement benefits system is different to ours. That may limit the read-across for UK readers.
Also, I feel Get Rich Slowly skips over a big reason why standard of living increases – which is that the years left living in retirement decrease, so the money doesn’t have to stretch so far! We’re not playing with an infinite resource here.
Still, I do feel that the benefits of working just a little longer to get a little more spending money forever are often too quickly dismissed – especially by the heads down and head for the exits FIRE crowd.
Retirement Investing: In 12 month’s time
Consider the case of Retirement Investing Today. He revealed this week that working an extra year or so has given him a £300,000 buffer above his £1 million retirement target. That could be an extra £12,000 a year to spend on fun things – for life.
Of course that stupendous excess achieved in a short period of time is a massive extra lump of cash in anyone’s books. If you’re working on your local council golf course at £9 an hour it may seem pie in the sky.
But remember firstly that RIT put himself in this position through ten years of hard graft. He concentrated on working hard, as well as saving and investing – on climbing the corporate ladder, but saving rather than spending away the proceeds.
Indeed one reason why I applauded his decision to work an extra year was because it seemed to me worth harvesting the prime position he had put himself in. RIT will probably never be in such a position to sock away cash again.
And once you know you are financial free, the desire to actually deploy the F.U. fund diminishes. I’d bet his last year at work has been the least desperate.
The second thing? It’s all relative. If you’re looking to retire early and you’re on a lower wage, then you must have cut your cloth accordingly. (If you’re an ex-Cityboy sitting on a mega-nut and earning £9 an hour, feel free to call it quits yesterday).
The world is full of wonderful places, things, and experiences, but not all of them are free. I’m as big a fan of quietly reading a novel alone in a park on a Tuesday afternoon as you’ll find – I wrote the guide to living like a billionaire for next to nothing – but there are limits.
It’s also why I think those who do quit work should consider trying to find something they don’t mind doing for a day a week for money. Each to their own, but I feel some are too dogmatic about this.
A little more spending money goes a long way. We don’t have to be fanatics about this stuff.
Our plucky Slow & Steady portfolio is well on the road to recovery after last quarter’s bloody nose. It’s sprung back 5.9% in three months, despite the first shots in a trade war zipping past our heads.
Once again reality defies the instinct to pounce on a pattern:
- Last quarter’s biggest loser, Global Property, is the top performer this time. It’s up 13%!
- The UK stock market enjoyed a nice 9.5% surge, despite the Brexit turmoil.
- Like a golden UFO conveying cultists to paradise, the Bond Apocalypse has once again failed to materialise. Perhaps it’s timetabled by a British rail franchise?
- Our Developed World and Global Small Cap holdings are still powering ahead as the notoriously overvalued US market defies gravity – or at least the gurus’ predictions.
- Emerging markets are down nearly 3% this year despite being the asset class with the highest expected returns.
All of the above will change, of course, but about as predictably as a Trump press conference.
For now, here’s the blinding truth in Ultra-Dynamic-Dynamic-Dynamic Monstro-vision™:
The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £935 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.
Our annualised return is a that’ll-do-nicely 10.2% over seven years. I wonder how many people realize how good that is?
At that rate your money doubles every seven years. Knock off 3% for inflation and you double every decade in real terms.
Recently a good friend of mine ‘fessed that he’d been warned off investing by an ‘informed’ acquaintance who claimed low interest rates had left the stock market dead in the water. The aftershock of the Credit Crunch, an endless stream of media misery, and a decade of stagnant wages led him to believe the global economy had been clothes-lined.
How many others have missed out on double digit gains due to zero interest rate fairy tales?
The reality is we’re doing pretty well, aided and abetted by diversification. Last quarter the Slow & Steady Portfolio was down 3.1%. The FTSE All-Share was down 6.9%. We were cushioned by other markets doing less badly and our bonds bearing up.
Now our rebound is neck and neck with the FTSE despite our 30% bond safety belt. Viva global capital markets!
Before I sign off with the new transactions, my apologies for the late update this quarter. My day job got a bit out of hand these last few weeks.
New transactions
Every quarter we lay £935 at the feet of the Almighty Markets and hope they smile upon us. Our cash is divided between our seven funds according to our pre-determined asset allocation.
We use Larry Swedroe’s 5/25 rule to trigger rebalancing moves, but all’s quiet this quarter. We’re just topping up with new money as follows:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF 0.08%
Fund identifier: GB00B3X7QG63
New purchase: £56.10
Buy 0.269 units @ £208.67
Target allocation: 6%
Developed world ex-UK equities
Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%
Fund identifier: GB00B59G4Q73
New purchase: £336.60
Buy 0.972 units @ £346.27
Target allocation: 36%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.38%
Fund identifier: IE00B3X1NT05
New purchase: £65.45
Buy 0.218 units @ £300.41
Target allocation: 7%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.24%
Fund identifier: GB00B84DY642
New purchase: £93.50
Buy 59.29 units @ £1.58
Target allocation: 10%
Global property
iShares Global Property Securities Equity Index Fund D – OCF 0.21%
Fund identifier: GB00B5BFJG71
New purchase: £65.45
Buy 31.9 units @ £2.05
Target allocation: 7%
UK gilts
Vanguard UK Government Bond Index – OCF 0.15%
Fund identifier: IE00B1S75374
New purchase: £261.80
Buy 1.599 units @ £163.74
Target allocation: 28%
UK index-linked gilts
Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%
Fund identifier: GB00B45Q9038
New purchase: £56.10
Buy 0.298 units @ £188.32
Target allocation: 6%
New investment = £935
Trading cost = £0
Platform fee = 0.25% per annum.
This model portfolio is notionally held with Charles Stanley Direct. You can use that company’s monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.
Take a look at our online broker table or tool for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000. The Slow & Steady portfolio is now worth over £41,000 but the fee saving isn’t juicy enough for us to push the button on the move yet.
Average portfolio OCF = 0.17%
If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.
Take it steady,
The Accumulator
What caught my eye this week.
New research from Scottish Friendly makes dispiriting reading for anyone who has spent a decade trying to teach people about investing.
(*Looks around room* “Who me? No no, I was in it for the Brexit banter.” *Shuffles away*)
It seems that having surveyed 2,000 UK savers, the life assurance giant has discovered half of us are afflicted by what it calls ‘investophobia’.
Scottish Friendly says:
- Inflation is currently running at 2.4% yet the best easy-access cash savings rate available is 1.33%.
- Almost two-thirds (66%) of savers are aware that interest rates on savings accounts are less than the current rate of inflation.
- Despite that, more than half (53%) of UK savers say they wouldn’t consider investing in stocks and shares.
- Almost half (49%) say fear of potential losses is the main reason holding them back.
A decade ago, many web explorers who wandered into Monevator Mansions had sworn off shares forever. We seldom see such people anymore.
Ten years into a bull market, we – and often many of you, in the comments – are mostly reminding visitors that bonds, cash, and property still have a place in their portfolios, let alone that it’s not a great idea to go all-in on, say, tech stocks or emerging markets.
Yet out there in the wider world, the majority still wouldn’t touch a share with a barge pole.
Small mercies
Messing about with the tools at Portfolio Charts suggests that a UK saver who kept all their money in cash would have seen an average annual real return of about 1.6% since 1970. Standard deviation was 4%.
Remember ‘real’ means these are inflation-adjusted returns. Cash can lose you money when inflation is higher than the interest rate you’re paid. The tool suggests that happened in 31% of the years.
So what happens if we take a stiff drink and put a modest 20% allocation into global shares, while still keeping the rest in cash?
Mostly good things. The average real return rises to 2.6%. Standard deviation is only modestly higher at 5.1%. And the number of money losing periods actually fall from 31% to 27%, despite the inclusion of risky shares.
That difference between a 1.6% average real return versus 2.6% isn’t much on paper, but it’s significant over time.
A compound interest calculation reveals:
- Over 30 years, a 1.6% return turns £100,000 into £160,000 on a real money basis. 1
- A 2.6% return takes your wealth to £216,000 over the same period. That’s a significantly better result, with only a little more volatility and fewer outright losing years.
Of course you and I know that on a 30-year basis, having 80% of your money in cash is very sub-optimal.
- For the record, a simple 60/40-style portfolio split between global equities and intermediate UK government bonds chalked up an average annual real return of 5.3%, albeit with much higher volatility. That’s good enough to turn £100,000 into £471,000 in real terms.
Adding other asset classes can tweak the return profile further.
Here’s one I did earlier
So yes, agreed, having just 20% of your money in shares is far from perfect.
But remember, we’re not look for a home run here – we’re just looking at getting people off a terrible first base with their 0% allocation to the stock market.
And here simple – if sub-optimal – strategies can make a big difference.
I’ve mentioned before that I’ve often started friends investing with a 50/50 allocation split between shares and cash. (Now I’d probably favour a Vanguard Lifestrategy 60/40, unless they really insisted on seeing and cuddling the cash).
Nobody around here is going to suggest having 50% of your investment in cash is ideal. But I’ve seen it change lives.
For instance, a friend of mine – who was running a persistent overdraft when I first met her – agreed to try something similar to this and to start investing back in 2002 or 2003.
To supplement her work pensions held elsewhere, she began direct debiting money from her paycheck every month, splitting it between savings and an ISA stuffed with index funds.
At some point around the financial crisis she meddled without telling me, diverting some equity money into more expensive self-styled ethical funds. But besides that moment of madness/enthusiasm, she basically ignored the portfolio. She only rarely increased the contributions. Most annual statements went unread into a bottom drawer.
She still enjoyed a good result. In fact a couple of years ago she called to thank me for getting her started.
This painless strategy had compounded over 15 years into a significant six-figure sum – a deposit for her first flat, in fact!
I’ve visited her new family’s home in London, and it’s lovely.
The only way is up
Perfect can be the enemy of the good, as my old dad used to tell me. I wouldn’t attempt to turn anyone into The Accumulator overnight.
Know somebody terrified of shares? Try to get them to set up a direct debit to put say £100 – or whatever is a small but meaningful sum for them – into a global tracker every month.
Chances are after a few years they’ll catch the bug and lose their fear. Then they’re off!
- i.e. The spending power of £1 remains the same.[↩]
