Good reads from around the Web.
Are you a prudent saver who regularly runs the numbers on your potential post-retirement income?
Or are you a Scrooge McDuck who has fallen in love with money for its own sake?
The title of a John Authors’ article in the FT this week – Is Greed Good? No, It’s Seriously Bad For Your Health [Search result] – implies that this isn’t an academic question.
Authors even cites research suggesting it’s not just your physical health that could suffer from an excessive love of money, but also your financial health.
He writes:
Psychologists now have a clear definition for love of money. It is not about any instrumental need for money to fulfill our other goals, which all of us have, but rather about a love or need of money for its own sake.
Using the Money Ethic Scale developed by Thomas Li-Ping Tang in 1992, State Street developed an Investor Love of Money Scale (ILOMS).
Researchers asked interviewees in 20 countries a series of questions designed to find out how important money was to their self-esteem.
They also tested how they would respond in a series of financial situations.
For example, they would ask if money was a symbol of success, if they talked about it a lot, or if they wanted to be rich.
The results were clear. The more someone had an emotional attachment to money, the more likely they were to make mistakes with money.
A series of behavioural biases that lead investors into predictable mistakes have been diagnosed over the years. Avarice exacerbates all those biases.
The article goes on to list investing vices, from over-trading to buying high and selling low.
Being in love with money could be counter-productive, in other words, even for intentional money-grabbers.
Money, money, money
It’s a nice morality tale and life is more complicated, but I do agree that concentrating on wealth can at least change you as a person.
I’ve seen a bit of that in myself.
When you first start saving and investing, the idea that you’re in love with money feels fanciful.
Unless you inherited the family pile – literally – you start with nothing (or these days likely less than nothing, after student loans).
You’re just trying to be sensible, at a time when money is scarce, too.
However as the years go by, your wealth grows and snowballs. At some point it becomes so much that when you’re adding the sums up you’re looking at quite a wodge.
And you wonder.
Of course, you probably rationalize this wodge away – as I believe you should. It’s for financial freedom or to keep the lights on in retirement. Your friends might not nurture their nest eggs to the same degree, but they face the same challenges and have likely stashed some of their cash, too.
Being conscious of these challenges and actively trying to confront them doesn’t seem like the same thing as being in love with money to me. The FT quote I highlighted above agrees.
Then again, I know that in my 20s I seriously didn’t care much about money.
I saved it because I am by nature a saver.
But I earned a relative pittance compared to my university peers and I rarely thought about it.
I considered gambling away ALL my life savings in a business venture in my-mid-20s – and I did put about half of them into one in my early 30s.
I can’t imagine taken such proportionate risks with my wealth barely a decade later. Have I fallen in love with money?
I don’t think so. Rather, I know I’ve gotten older and I believe there’s less time left to make good.
That said, unlike most Monevator readers I have probably fallen in love with active investing and with keeping score.
Good reads from around the Web.
I was not shocked to read this week that Jim of the SexHealthMoneyDeath blog has gone back to work.
It was obvious he found being retired early pretty boring. I was surely just one of many who suggested he should “get a job”, in kinder tones than that might be uttered.
Jim confessed:
I was struggling a bit with the retirement lifestyle, and finding the change from a full-on, full-time working week to a zero-hour one quite difficult to handle.
I just couldn’t shake the notion that I was too “young” to put my feet up, that I should be working and that I should be out there earning money.
I might not have “needed” the latter, but it never quite felt that way.
Few of us are really frustrated artists, office-caged adventurers, or wondrous philanthropists desperate to be out in the community doing good deeds for free instead of paying the mortgage.
Most of us are social creatures who like fitting in with the Joneses, even if we manage to shake off the urge to keep up with them.
And in our society, that involves somehow making money.
Even as a self-styled bohemian investor, I am fairly confident I’ll not give up entirely on “doing stuff for money” at anything younger than 80, and with luck and health not for a while after that.
On this planet, in this era, and with my mindset, it’d probably be easier to give up wearing clothes.
Many of you feel differently, of course. My co-blogger The Accumulator and I have debated this endlessly.
But I believe almost everyone will benefit from having an ongoing economic relationship with society while they can – even if only for a day or two a week.
Sadly, by the time most people reach the point of having options, they seem to feel too burned out by the workplace to explore all the various other ways of making money more freely.
If you can do it, you probably won’t
Personally, I think gaining financial freedom – the ability to say “no” to any boss or client, and to walk – is a truly worthwhile goal, but that retiring early will often prove a pretty futile outcome.
I think that’s especially true for the few who will be able to achieve it these days under their own steam.
That is, not the old 1990s way of being retired early by being shuffled out of a firm on a hefty company pension aged 55, but rather the modern, self-made save hard and invest like fury – or start a successful business or lucrative side-hustle – way.
Few people who can do that want to watch Pointless every afternoon waiting for their friends and family to finish work or school.
I know, I know, you will begin early retirement by doing an Open University degree course in archeology while making great strides in hybridizing apple trees in your back garden and teaching disadvantaged children Esperanto in your local youth center.
But most people won’t have your imagination…
So it’s no surprise to me so many high-profile personal finance bloggers who retire early go back to work – or never actually stop working.
Anyone who can create a very successful blog while generating enough money to retire at 45, say, is likely to be bored to tears by doing nothing – however much “doing nothing” is disguised by the flowering of (supposedly) constrained passions, travel, family life, or the gentle slide into somnolence.
Incidentally, I also think retiring early is bad for your health.
Commentators often describe index trackers as plain and simple vanilla funds, benign enough for even the most inexperienced retail investors. But in reality, the investing industry is a hothouse of evolution, continually breeding products that pass themselves off as cuddly trackers, but which can conceal retractable claws.
The following product types may all be classed as index trackers, although I only use the term to describe index funds and ETFs in my Monevator articles.
These other varieties are weighed down with features and risks that need to be properly understood before you dive in.
Index funds
The most straightforward tracker type of all, low-cost index funds should be first choice for inclusion in your passive portfolio. Index funds:
- Generally invest in a diversified range of equities or bonds.
- Physically own the assets of the indices they track – though the fund may only own a sample of the index.
- Are open-ended so their price closely matches the underlying index.
- Trade once a day.
- Don’t incur trading costs when bought through a percentage fee broker.
Physical ETFs
Physical Exchange Traded Funds (ETFs) are very similar to index funds except that:
- They’re traded on the stock exchange, through brokers.
- You can buy and sell ’em throughout the day like shares.
- They incur trading costs, so are more suitable for larger investment sums.
- Huge product diversity lets you fine tune your portfolio.
Synthetic ETFs
Synthetic ETFs are riskier and trickier than physical ETFs. They should only be used if you fully understand the differences between the two.
Synthetics trade like physical ETFs, except:
- They don’t actually own the assets of the indices they track.
- Instead, they buy a total return swap. That’s an agreement with another financial entity to pay the ETF the return of the index.
- The ETF is exposed to counterparty risk if the swap provider defaults.
- European regulations limit the exposure to 10% of the ETF’s net asset value.
- Collateral should cushion the ETF from counterparty disaster.
Investment Trust trackers
There aren’t many of these beasties about. They’re quite similar to physical ETFs in that they’re:
- Listed on the Stock Exchange.
- Bought through brokers.
- Traded in real-time.
The additional complication with Investment Trusts is that they are closed-ended funds. They have a fixed amount of shares in circulation, so the trust’s price at any moment reflects supply and demand for the fund itself, as well as for the underlying index. Investment Trusts can therefore trade at wide discounts to their net asset value and sometimes a slight premium. You can lose or gain on an investment trust as the discount fluctuates, even if the index remains absolutely flat.
ETCs – commodity or currency tracking
Exchange Traded Commodities (ETCs) can track everything from gold to leveraged lean hogs but they’re not as straightforward as their ETF namesakes:
- Only a few precious/industrial metal ETCs can afford to physically hold commodities, which enables them to track the current (spot) price.
- Most ETCs track their commodity’s futures market. Returns on futures differ from returns on spot prices.
- Some ETCs track single commodities, others a broad basket.
- ETCs are structured as debt instruments to avoid UCITS rules on diversification.
- Investors are exposed to counterparty risk (up to 100%).
- You don’t get dividends.
Exchange Traded Currencies are similarly structured and track the foreign exchange fluctuations of pairs of currencies.
ETNs and Certificates
Exchange Traded Notes (ETNs) and Certificates are cheap and potentially nasty. There are many variations on the theme, but basically they track an index, are tradeable on the Stock Exchange, and:
- They’re debt instruments issued by a single party (normally a bank).
- The bank agrees to pay the return of the index on the product’s maturity date.
- The underlying assets are not physically owned.
- If the bank goes kaput you’re in trouble.
- Counterparty risk exposure is up to 100%.
- They’re a low cost way to enter hard-to-access markets.
- Tracking error is low – it amounts to just the fees.
Structured products
There’s a whole soup of structured products out there that are labelled as trackers. Normally they’ll follow an index of some sort and lure investors with alchemical promises of outsized returns and capital protection.
Broadly:
- They’re close ended.
- Have a finite lifespan.
- Capital protection is only offered if you hold for the full lifespan of the product.
- The return is provided by derivatives.
- It’s counterparty risk time again.
- You give up your dividends.
- You’ll scratch off your scalp trying to fathom how they work.
- There’s no free lunch!
What you track matters mightily
Just because you’ve invested in the kind of fund you’d happily take home to meet your mother – a traditional index fund or physically-replicating ETF tracker – that doesn’t mean you’ve necessarily bought a vanilla fund in terms of the exposure you’ve taken on.
I’ve described the different tracker type vehicles – but I haven’t got into the passengers in the vehicle, or where you hope it’s going.
An index fund may seek to track a mainstream index like the FTSE 100 index of the UK’s largest companies, the S&P 500 in the US, or the entire global stock market.
But innumerable funds are available that seek to track all sorts of other weird and wonderful indices (and yes, “weird and wonderful” may be considered a euphemism for “odd and unsuitable” for us passive investors).
I’m thinking about specialist indices creating in-house by fund managers to track niche sectors – companies involved in robotics or selling to teenagers or global arms, say.
These products might have their place for thrill (/loss…) a minute active investing sorts, but they have nothing to offer us sober passive investors.
You might also come across ETFs that aim to, for example, double the daily upside or downside of the index being tracked. Again, back away slowly.
More respectable from our perspective are funds that track indices dedicated to winkling out the potential return premiums from certain cohorts of shares (sometimes called Smart Beta funds) that focus on value, profitability, and similar factors, where you might hope to boost your annual returns by a percentage point or two over the long-term.
But such funds have extra risks and other downsides, too, so make sure you do your research.
Just remember the type of index tracker you plump for is one thing – but the index being tracked is a separate matter.
Take it steady,
The Accumulator
Good reads from around the Web.
Hey you! Are you a Monevator reader living outside of the US or the UK – or at least a speaker of another language – who is pursuing financial freedom?
Then we need your help!
Every week or two I’ll get an email that goes something along the lines of:
“Dear Investor, I love Monevator but I’m based in Croatia [or Singapore or France or wherever] and some of the regulations and financial products are different here.
Also we have better cheese [/beer/monkeys].
Anyway, do you know any good Croatian [/French/so on] bloggers that are into investing and financial independence who I can also follow?”
And the answer is – no, I don’t.
However I was thinking that perhaps YOU do.
So this is the day when I’m asking you to tell us all via the comments below about any good non-UK/US blogs that you think your countrymen and women should know about.
Please share a link, and a few lines (in English) about why it’s worth reading.
No big media websites or similar. Personal bloggers are what we’re after here.
Of course perhaps the reason I keep getting asked this question is because there aren’t very many such websites out there in the wider world.
But if we do get a decent list then I’ll put together a post that can serve as a reference for future queries.
Oh, and please don’t abandon Monevator for your new foreign flame!
I don’t know if Bank of England governor Mark Carney is a Monevator reader (perhaps he’s the guy signed up as FoolsGold65) but whether or not he read my Brexit articles he seems to have reached a similar conclusion to me.
Some said I was a doom-monger when I suggested it was prudent to prepare for a probable recession in the face of the decision to leave the EU.
One Brexiteer told me to “Can it!”
But for his part Mark Carney hasn’t yet had enough of experts, which is just as well because he actually is one.
And he and his expert monetary policy committee have looked at deteriorating data such as the fastest drop on record in the PMI survey numbers, and they’ve seen enough.
They’ve just announced the biggest cut to the BOE’s economic growth forecasts since it began making projections in 1993.
True, the BOE doesn’t quite see a recession – but it does see likely GDP growth in 2017 of 0.8% as opposed to the 2.3% it forecast as recently as May.
Here’s the latest projection in graphic form:
Source: BOE
Of course one reason the BOE thinks we might escape a recession – as indicated by the dark green line in this graph skirting above the 0% level – is because it has just implemented a bunch of measures to try to ward one off.
Carney to the rescue
In response to the plunge in business activity and the crunch in GDP projections, the Bank of England has:
- Cut Bank Rate to 0.25%.
- Created a so-called Term Funding Scheme to try to ensure banks pass the cut through to customers.
- Announced a new move to buy up to £10 billion of corporate bonds issued by companies the Bank believes most directly impact the UK economy.
- Expanded the asset purchase scheme for UK government bonds (i.e. QE) by £60 billion, to take the total stock to £435 billion.
These moves are no panacea. The Bank still projects unemployment will rise over the next 12 months, for example, and that GDP growth will plummet.
And personally, given the uncertainty – as well as the probable subliminal pressure on BOE forecasters not to assume a worst case scenario, which the BOE said in its press conference it had avoided – I would not be surprised if things turn out even worse than that.
But time will tell, and I certainly hope we do better.
What’s most striking for our purposes today though is the outlook for savers.
A real headache
As most of you will know, the biggest visible impact of Brexit so far has been the fall in the pound versus other major currencies.
The pound had fallen by about 9% since the EU Referendum when Carney began making his announcements. It dropped another 1.5% afterwards.
For globally diversified UK investors, this six-week slide in Sterling has helped cushion any impact of the Brexit decision on our finances to-date.
In fact, as you will have noticed if you’ve peaked at your portfolio in the post-Brexit kerfuffle, most assets are up for UK investors.
Our Slow & Steady Passive Portfolio has bounded ahead, for instance.
One reason assets are up is because equities and bonds alike have risen as investors have correctly anticipated lower-for-longer interest rates will follow the shock of Brexit.
But our portfolios are also higher because our overseas holdings have risen in value as the pound has fallen, lifting their value in pound terms.
Note: We haven’t magicked real money out of nowhere like this.
The pound is down around 10% – and so we are actually 10% poorer than the Trumps, the Merkels, the Hollandes, and the Paul Hogans in the country next door as a consequence of Brexit.
That may or may not be a price worth paying, depending on your own views – but it IS a real price that we’ve paid.
Now cash savers are set to pay an even higher price.
Inflated expectations
We may not yet be in negative rates territory in terms of the official Bank Rate, what with it hanging on to 0.25% like a cinematic damsel in distress clinging on by her fingertips to a cliff edge.
But in real terms (that is inflation-adjusted) we’re headed down, down, down.
Interest rates on cash savings are already very low. The best one-year interest rate I can find right now comes from IKEA-owned 1 Ikano Bank, which pays a pitiful 1.6%.
That’s puny, but CPI inflation is depressed at the moment also. It was just 0.5% in June, according to the Office for National Statistics ( ONS).
You can see just how low in a 10-year graph:
Source: ONS
Why exactly inflation has been running so low – well below the BOE’s 2% target – is a subject for another long day.
But the relevant point here is that with CPI inflation at, say, 0.5%, even a wretched 1.6% savings bond is delivering a better-than 1% real return. Hence it is slowly making you wealthier.
However two things are now likely to happen.
Firstly, it’s likely savings rates of even 1.6% will soon be gone, because the Bank Rate cut will pull down yields across the money markets.
Soon you may only get say 1.5% or lower for locking your money away for a year.
The other thing that will likely happen is CPI inflation will rise. The weak pound that has so far been such a salvation for our perceived wealth will push up the cost of imports, and hence the prices we pay in the shops.
The BOE said as much today, and conceded its latest measures will make things worse. It sees too-high inflation as – probably rightly – the lesser of two evils.
The other option would be to take no action, and allow GDP growth to fall further than otherwise, for unemployment to head higher, and for us to perhaps be left with an even more precarious economic outlook in a year or two.
Whether or not you think such ‘economic cleansing’ would be valuable, it’s not in the BOE’s remit.
So CPI inflation is likely going up. A lot.
Here’s the bank of England’s latest forecast for inflation, taken from the August Inflation Report:
Source: BOE
The BOE now projects that under the new 0.25% Bank Rate regime, CPI inflation will probably be running at 2% by early 2017, and that it could well be approaching 3%.
In terms of the BOE’s official mandate, 3% or more is no worse than inflation at or below 1% – but it does present a bigger headache for everyday savers.
Let’s assume – optimistically perhaps – that you can still get 1.5% on your locked-away cash in such a climate.
At 2% CPI inflation, a 1.5% interest rate is not good enough to deliver a real return.
Instead, your cash will be becoming less valuable every year, because:
1.5% minus 2% = minus 0.5%.
And obviously if we were to see CPI inflation at 3% you’d be losing even more money in real terms.
The curve ball
I don’t believe the BOE mandarins are high five-ing each other at the prospect of pensioners getting poorer via a negative return on their cash savings.
True, the bank warned this kind of thing was likely if we voted to Brexit. And the pensioners voted for it anyway.
Which is fair enough – there’s more to life and the EU decision than money – but I will be pretty pee-d off when the inevitable sob story articles start to appear featuring income-starved Brexit-voting OAPs.
Own your decision, Brexiteers!
But while punishing savers isn’t the direct goal, making cash less desirable to hold in general is very much part of the rationale for the sort of QE operations the BOE extended today.
As a result of the likely move into negative real returns on cash, more cash savers will move into UK government bonds (gilts), more gilt owners will swap them for corporate bonds, some more will move into equities, and a sliver of risk-takers will use cheaper financing to start businesses or take out loans to build property.
And hopefully all that will help blunt the worst economic impacts of the decision to Brexit, by bolstering economic growth.
But make no mistake – by moving more of us out of super-safe cash and gilts and into riskier assets like peer-to-peer savings, corporate and retail bonds and equities, the stakes are being raised for everyone.
- And FCA-regulated.[↩]
