I recently watched a Swedish film by Ruben Ostlund called “Force Majeure” which had me squirming in my seat. Its the story of a family on a skiing holiday in the alps, who get caught up in an avalanche, which of course is merely symbolic of everything else that is going on in their lives. It’s a convincing story if somewhat realist and slow in pace. As someone that has only been skiing once (which I loved) but also knowing many people that have had fairly miserable and even tragic tales from the slopes, this film ended any thoughts I had about taking my family on a skiing holiday, even though I am well aware that it can be a wonderful experience.
I won’t spoil the story for you and it probably isn’t what you may expect of the story from simply using the words family, holiday, skiiing, avalanche. However this is an exhausting look at how stress is handled, magnified in the dynamic of a family holiday. In the film, the couple (Tomas and Lisa) seem much more willing to take risks and lead their two young children in a way that I simply wouldn’t even contemplate – because I think of them as being unsafe. However its deeper than that.. its also the risks people understand and assess (or not) on a much broader level. The nation that build Volvo’s (the safest cars?) flips the notion of risk on its head when reduced to the individual and relationships.
The film prompted much discussion and reflection, but with my my financial planner hat on, I tried to draw a few lessons. On the one hand, the setting of busy people carving out time to spend with their family and friends and enjoying “the good life” is some of the “stuff” that is talked about in a financial planning meeting… ie. how do you really want to spend your time? what do you value? what’s the purpose/reason for you working so hard? This is only part of the start of a conversation, which invariably lasts much longer than a single meeting…. after all we are discussing your life plans right?
In the design and implementation of a financial plan and experiencing the “process” I believe that many of our clients look for a sense of leadership and guidance, not in a patronising way, but one that reflects a weathered, seasoned expert that has been on the track getting people from A to B. I do not believe that they expect me to take shortcuts, go off-piste or compose a different version of reality to suit my perspective. There is far more to it than simply getting from A to B anyway… its the journey and your unique values and “milestones”.
Many of us were brought up to ask questions, but soon learned that to do so exposed a lack of knowledge. The peer pressure of school for many is more than sufficient to have the opposite effect to the one your teacher hoped for. For many this carries into adult life, not wishing to ask “dumb questions” for fear of being seen to appear foolish. I believe that there are no “dumb questions”… none of us knows everything. So in the perilous world of investing and planning a life (which doesn’t come with an instruction book) it is sensible to get a guide, someone that you can trust to help you with your journey. Even the best skiiers were taught and the very best still get coached.
The final sequence in the film reveals someone that is paid to take people from A to B yet appears to possess none or very few of the required practical skills, let alone social ones. As for me, I may have a different take on the risk of skiing, those of you that are skiiers may think I’m daft… that’s not really my point, but merely to highlight and understand the risks involved. Thats also partly what I do for clients – helping them to see the risks that they are really running, be that taking too much (or too little) investment risk, banking their future on the sale of their home/business, gaining an inheritance and so on… none of which is “wrong” provided that you know what you are getting into… its not a matter of “a different perception” but of seeing what is there. Just because I wouldn’t risk it, doesn’t mean that you shouldn’t… but you may want to benefit from taking a moment or two to ensure that your thinking and assumptions are “solid” and that you aren’t standing on very thin ice… or hurtling down a mountain in the fog. So what are the risks you are running within your own financial planning? Why not begin a conversation with me to make your journey much more sure-footed.
To my mind, one of the great ironies of financial planning is that a litigious culture, historic mis-selling, poor regulation, fearful professional indemnity insurers, better qualified advisers and RDR has meant that the cost of advising anyone has increased. Already this year our regulatory costs have increased by more than 10% (yet inflation is 0%). This will result in the continued rise of DIY investing (do-it-yourself).
I have tended to take the view that most people need to have a budget, a target, a savings habit and only when they have £50,000+ do decisions get complicated enough for me to get involved. Its not always the case, but largely. So it is alarming how poor most people are at investing – and by poor I mean really bad.
An academic study from 2012 “Just Unlucky?” by Meyer, Stammsschulte, Kaesler, Loos and Hackethal at Goethe University in Frankfurt, into the success or otherwise of online investors (who generally think of themselves as well-informed) concluded that 89% of them lost an average of 7.5% a year. Let me repeat that 89% achieved -7.5% a year! Those that performed better were basically no better, exhibiting the same performance metric as luck. The research is based on German investors.. a nation that is historically characterised as shrewed, efficient, conservative and risk averse.
91% of DIY investors fail – big time.
Why? It would seem a significant element is holding the wrong asset classes and not well diversified globally. There is also a high degree of fear and greed at play, selling at the bottom and buying at the top. I can only imagine that some were following the tips from journalists and media commentators “best buys”. If dealing costs are factored in (and this was DIY investors using online dealing accounts, which presumably they thought were low cost) returns were 1% worse at -8.5% and achieved by 91% of investors.
Part of my job is helping people reduce their mistakes. We cannot be perfect, but we do apply sensible disciplines to remove a lot of errors. We call this advisers alpha – adding returns by good advice. Other research (of American investors) by Dalbar suggests that most investors underperform the market by 4-6% a year. But this latest research suggests it is far worse than that. Yet from next week, the new pension freedoms will mean that more people will take it upon themselves to go DIY with their pension. I don’t imagine that it will be a favourable outcome. This does not bode well for those using “discount” online investments, who eventually become so disenchanted with markets that they try less mainstream investments – which invariably blow up in their face and due to a peculiar twist, advisers such as myself pick up the bill… which to makes the cost of advice higher… and so the cycle repeats.
Pension Freedoms and a Lamborghini
I’m sure you will have come across newspaper reports that some people are concerned that the new pension freedoms, (which come into effect from 6th April 2015) are likely to mean that some people make some daft decisions about their pension pot. You have probably heard that some may go a little mad and buy a Lamborghini.
This is an issue that I have talked about with clients recently, not because they were thinking of buying a Lamborghini, but I simply wanted to explain what the nw pension rules really mean. Admittedly as I don’t own a Lamborghini I’m not that familar with their prices. I’m not an avid Top Gear fan, though I do like Grand Prix. So just by way of a guide, perhaps you may like to know the reality of using a pension to buy a Lamborghini.
Making the wild assumption that you would want a brand new car, the cheapest model I can find available in the UK is the Aventador LP 700-4 which starts at £260,040 (I love the £40!). I’m sure the reduction in petrol prices will help, but I imagine that this is a car that with a top speed of 217mph and a combined urban/extra urban fuel consumption of 16 miles per gallon is also going to be expensive to run, let alone service.
On the Road Price
Assuming that this is an “on-the-road” price you need to write a cheque for £260,040 to the dealer from your pension. As of today a pension isn’t a bank account and does not come with a cheque book. But from April 6th you will be able take all of the money out (if you are 55 or older). The new rules allow you to take all your money out should you wish to – you don’t have to buy an annuity. However the original rules still apply, in that you can take 25% of the fund as tax free cash, the balance is deemed as income and taxed at your marginal rate of income tax (as it would be if it were an annuity). So, to buy the Aventador LP700-4 you need to pay £260,040, there are two ways that you could now achieve this.
1. Use the tax free cash – you could have a pension pot worth £1,040,160 and be able to take out 25% as tax free cash (£260,040).
2. Use the entire pension pot.You need a pension of tax free or have a pension pot worth at least £393,000. This would mean that you could take £98,250 as tax free cash and £294,750 as income (but suffer 45% income tax) leaving a net income of £162,112.50 and so have £260,362.50 to hand over the the Lamborghini dealer. Ok not all your income will be taxed at 45% – just the income over £150,000.. but most will be taxed at at least 40%, some at 20%, you would forfeit your personal allowance and in so doing pay an effective rate of tax of 60% on part of the income.
It would take someone with either considerable additional resources, or perhaps a very short life expectancy to decide to buy the car with their pension… essentially costing £393,000 rather than £260,040. It may surprise you and probably alarm you to learn that the average pension pot “at retirement” is about £30,000, so for most people, they are more likely to be able to buy a model Lamborghini car which will cost between £6 and £3,654 (according to the site) or perhaps you fancy a T-shirt starting at £43.
Given that your pension, in combination with your other resources is meant to last for the rest of your life, the key is to ensure that it doesn’t run out before you do. This is precisely what we do for our clients, figure out what income you need to support your lifestyle, how much is needed, what returns required and making some assumptions (which we review together) about inflation (currently 0% here in the UK) and life expectancy. When it comes to avoiding living on the street, you really dont want a pension withdrawal strategy that is too fast and too furious.
Should I Buy A House?
I recently asked for questions and so I’m going to tackle those that I get. So I’m starting with someone at the very beginning of their financial life asking if they should buy a house.
A house is an asset, it is also a home, but frankly whether you rent or buy, a home is something you create. In Britain, we laud home ownership as a goal to strive for, most of the world doesn’t and most of Europe rent.
The short answer is that you have control over where you live. If I may make the wild assumption that by the time you retire any mortgage is repaid, this means that you aren’t still paying rent or facing the regular prospect of renewing your rental agreement or moving. You can, within local bureacrat (sorry… I mean Authority) rules do what you like to your own home. You cannot knock through walls, convert a loft if you don’t own the property.
The Upside of Renting
You aren’t tied to a building, you don’t have to pay for upkeep or repairs. You have no mortgage, so no liability.
The Upside of Buying
You are “tied” but could sell – the issue is timing (no buyers?). Having an asset means other finances are easier – Banks think you are a lower risk, because you are a homeowner. Credit (which means debt) is easier to obtain.
Property prices rise and fall, but generally rise over the long term. It is as the TV pundits suggest, all about location, location, location.. which means where do people want to live? If you own the property you could rent (let) it, if you need to live away from it. However, this needs approval if you have a mortgage and you should never misrepresent the truth to a lender, that is asking for trouble.
Buying a home is a long-term commitment right?
Well yes it is… but one could argue that renting is a longer-term committment. Do you intend to rent for life? the cost of renting will also rise over time (with inflation). Renting is generally about afforability, in retirement, this means having a good pension or source of income to pay the rent… for the rest of your life.
Property prices have risen enormously. The real issue is “are properties overpriced?” the honest answer is – of course they are. The entire system is built on vested interests. Lenders need to lend, (Governments need lenders to lend), Estate Agents need to sell, Surveyors need to survey and so on… the prices have been pushed up because homeowners want to make a profit on their home when they sell and move on – to larger or smaller valued homes. The system isn’t particularly good or fair, but it is the one we have today and I dont see much likelihood of it changing.
Buying and Mortgages
Most people have to borrow money to buy. That means a long-term loan and one that you need to be able to afford. There are different ways to repay, but you have to repay the loan at some point. However inflation does help. Let me explain.. a property is £250,000, you have a £50,000 deposit and so need to borrow £200,000, which for the sake of example, will be reapid over 25 years. After 5 years how much is the property worth? the same? more? less?… and after 10,15 or 20 years? Well generally proprty will rise, let’s say by an average of 3% a year. Without doing anything to increase the value of the house, after 25 years the property is worth £523,444… the mortgage is repaid (because you agreed to repay it over 25 years). Your equity (what you really own) has increased from 20% to 100% over 25 years…. but if you rent, well you still own “nothing”.
Keep it Real
As an exmaple, if you can borrow £200,000 over 25 years at 4% interest, your repayments will be £1,067 a month. Making the huge assumption that rates don’t change (they can rise or fall, or you could fix) then your repayments will be falling in real terms due to inflation. Rent costs will almost certainly be rising, every year… let’s look at a possibility.
Mr Holmes earns £57,500 buys a property for £250,000 in 2015. He has to borrow £200,000 and begins paying £1,067 a month (£12,804 a year – about 22% of his income. His salary rises by 3% a year (lucky him! today… but not unreasonable looking back and I haven’t assumed promotions etc). After 10 years His income is £72,275 and he’s still paying £1,067 a month (now 18% of his income). His house is now worth more at £335,979… so he’s gained £85,979 since buying it. His mortgage is gradually reducing, it takes a while by £200,000 has reduced to about £142,000 – he’s cleared about £58,000 in 10 years. At the end of 20 years his mortgage is now only £56,500, his income is now £103,850 and his monthly payments are still £1,067 and about 12% of his income. Another 5 years and the mortgage is gone… no more payments. He’s done, but his home is still rising in value.
Mr Rentit earns the same amount and found a similar property to rent but it only cost him £700 a month to rent. He has the same job and earns £57,500 a year. Mr Rentit isn’t a fool, and he decides to save the £367 a month that his friend Mr Holmes is shelling out each month. He puts this into a tax free ISA which grows at 7% a year (he’s fairly adventurous). At the end of 10 years Mr Rentit’s rent has increased each year… but only by 3% the same as the price houses are rising by. So after 10 years he is paying £1434 a month – double what he started paying. But he has no mortgage, and his ISA is worth £64,259… ten years later he’s paying rent of £1,927 a month (still 22% of his income). His ISA is now worth £192,662 and he has no mortgage. However he’s now a little concerned that rent keeps going up and thinks that his ISA could probably buy a house – just like the one Mr Holme’s has. But that is now worth £451,000 and he only has £192,662. So if he wanted to buy he’d need a mortgage of £258,338.As it is he is facing a lifetime of rising rental costs…. so let’s hope his pension can cope.
To be fair, he had the same £50,000 deposit 20 years ago and it had been in his ISA it would be worth £393,117 and he would still need a mortgage of £57,883 and pretty much level-pegging. He might argue that Mr Holmes had 20 years of upkeep costs and home insurance – that boiler that was replaced.. twice! and so on. Yet Mr Rentit may also be forgetting those letting agent fees, the moving costs and the hassle that he spent trying to register with the local GP/dentist etc eaxh time he moved.
Now, my example is obviously flawed and full of linear assumptions about inflation and the largest being a 4% difference in ISA outperformance of inflation/property prices. None of this will become reality. We could make the numbers prove one case or another (with the wrong assumptions). The issue is one of having an asset or not.
My experience is that most would not be like Mr Rentit – they wouldn’t save the £367 a month and those that did probably were tempted to raid the pot, so would have less. Most investors panic in market crisis, so probably wouldn’t get a market return unless they had a decent adviser… Most homeowners do improve their home, making it more valuable – but there are certainly upkeep costs.
The short answer is really – few people are “better off” by renting. In 40 years time (perhaps at or in retirement) Mr Holmes would still be having to pay rent of £3,480 a month…which means his pension would need to be able to provide this, Mr Holmes would not. So part of the answer is about discipline… and Mr Holmes, being a client, would have saved more of his income despite his mortgage costs, we would have advised him to high-speed repay his mortgage, freeing up income later to squirrel away… but that’s another story.
Speaking up for Annuities
OK, let me be clear. I have long wished that the compulsion for people to buy annuities would be abolished. It seems that sometimes wishes do come true…as the Chancellor did precisely this in his Budget last year and on 6th April 2015 the new rules begin. However the general level of financial knowledge is very poor in this country… little wonder as its a dull subject for most people and full of very unhelpful jargon… and some maths… the perfect ingredients for neglect.
Annuities aren’t “bad”
Annuities aren’t good or bad. They are simply a financial product, designed to provide a guaranteed income for life. It is very true that annuity rates have fallen heavily over the last 20 years. This has nothing to do with “greedy insurance companies” but is due to low interest rates, low inflation, low gilt yields and increased life expectancy.
So when I came across an item from the Telegraph “I spent £100,000 on an annuity” I was drawn to it…. well.. thought I should read it anyhow. This is the sad story about Mr Archer, who following his purchase of an annuity decided to see his doctor, who suggested he has a scan and, as it turns out, had a large tumor growing and therefore posed some serious questions about life expectancy.
Now, we have probably all made decisions that we would like to reverse with the advantage of hindsight, but in truth the only real “mistake” made by Mr Archer was to fail to see his doctor and get a full medical prior to buying his annuity. Armed with such information his adviser would probably have provided him with different options.
A clean bill of health…
Normally in the world of financial services, you want a nice clean medical history… relevant when applying for any sort of financial protection (life assurance, critical illness cover, income protection and even private medical insurance). However when it comes to annuities you are more likely to have better options if your health looks… well not so good. In both instances you must be entirely honest, but quite obviously it would make sense to have a medical before an annuity application is made. This could lead to being offered an “enhanced” annuity (sometimes called an “impaired life” annuity). In short, meaning that your life expectancy is below average, so you are offered a higher income… perhaps 30%-40% more. Many retiree’s will qualify for an enhanced annuity.
You cannot change history… but can alter the future
This is not the fault of the annuity provider, or indeed the product. It is sadly a case of “if only I’d known”. Whilst some clamour for annuities to be unpicked, I think this very unwise. The new rules result in greater flexibility, but there are serious concerns that some will simply blow their pension. Indeed just because a doctor or insurer says you have a reduced life expectancy, does not mean that its a certainty… its all about likelihood and probability. The only certainty you can give yourself at retirement, is to book a medical with your GP first, then get a decent financial planner to outline your options. Please learn from the very understandable mistake that Mr Archer made and don’t make the same one. None of us are immortal, with age comes greater health problems… death is not a question of if, but when.. so please add some advantage to your hand.
Oldest Woman – secrets to longevity
Scotland’s oldest woman, Jessie Gallan recently turned 109 according to reports. She suggested that her longevity had been achieved by regular walking, eating porridge and avoiding men. Whilst I imagine this is is probably a little too reductionist, it does bring the issue of longevity back into the news again.
In April pension changes mean that it will be possible to encash an entire pension fund all at once. This would be very unwise for most people and there is concern that people will underestimate their longevity and thereby run out of money.
Living to a very old age is a mixed blessing and I imagine that you will have your own thoughts on this. As for anyone that is 109 now, if they began drawing a State pension at age 60, it has been in payment for 49 years… about the same as working life (16-65).
For those that wish to live a very long time, I guess its time to avoid the men and have a regular breakfast of porridge.
Dispatches: How to Blow Your Pension
Last night Channel 4 showed a 30 minute programme called “How to Blow Your Pension”. The premise being that the new pension rules might result in thousands of “pensioners” cashing in their pension pots, blowing the lot only to run out of money. You can see the show on the 4OD website should you wish to. The intention was good, but the execution rather miserable and once again missing the opportunity to educate people and whilst Michael Buerk had a good reputation as a BBC newsreader, clearly he doesn’t appreciate that a document from a pension provider is not actually advice – but information about options. Frankly it isn’t that much of a jungle out there, but you will need proper advice, this is not the time to become a DIY internet “expert” it has to work and last. Just because someone has teeth that they care for, doesn’t mean that they should do their own dentistry. Just because you earn, handle and spend money does not make you best placed to do a proper job of planning and generating income for the rest of your life… So I thought I’d have a go at explaining the issues.
New Pension Rules – Simple
Pension rules are changing, from April 6th 2015 anyone aged 55 will be able to access their entire investment based pension pot should they wish to. There will be no compulsion to buy an annuity (an income for life). The principles have not changed – in that 25% of the pot is treated as tax free and the remainder is treated as income when you take it, however you take it – and so subject to income tax at your relevant rate of tax. You can still buy annuities should you want to. That’s it.
Running out of Money
The difficulty is that for most people their pension needs to last as long as they do…. ideally a bit longer if they have a spouse that outlives them too. So in practice you need to be careful about how much you take, its got to last and once its gone, its gone. So you have to guess how long you and your spouse might live (clue – actuaries do this for a living and designed annuities).
Make a Plan
So you will also need to reflect on how much income you need, what plans you have and it would be sensible to allow for some unexpected costs. You may need to pay for your own care or medical treatment – if you wish to choose how this is provided to you. You will also need to reflect on the impact of inflation, which at the moment is at record lows – but do the things you pay for really have such a low rate of inflation? and making a guess now for the next 20, 30 or perhpas 40 years of retirement needs some proper thought. If you don’t buy an annuity (which for many will be a very sensible option) the fund will need to grow (just to stand still and keep pace with inflation at the very least) – so how much investment risk is appropriate? what returns do you really need? what happens if these aren’t achieved? how will the portfolio be looked after? … and so on.
Review the Plan
As a result of these new “freedoms” (which some already enjoy anyway) you have a plethora of choices and the truth is that these need to be reviewed – in fact thats the beauty of it all, you get to alter your decisions (unlike simply buying an annuity and having to live with the consequences for the remainder of your life). The ability to access the money means that the crooks are on the scent… be it “pension liberation” or rubbishy investments that aren’t regulated and promise more than they could ever deliver. An independent financial adviser can sort the wheat from the chaff, but a financial planner, will do that and also help you plan your income requirements to suit your unique requirements.
Was that really so hard?
Has War Just Changed?
As is often the case, out of something that seemed trivial, we may have witnessed a “significant moment” in history without grasping the implications. In short, we are asked to wonder if war has just changed. It seems to me that war is invariably about an inability to cope with or live with difference. Often this is expressed as a conflict of ideology but of course theology too. Some regard war as a battle over land, which perhaps is the case, but I’d suggest that this is merely the physically binding frame of reference used to galvanise support along lines of difference and to physically represent the boundaries of control. This week we learned that the boundaries shifted. The vast majority of the media missed the story, selecting to reflect the inane rather than the insane.
The story? this is about a executives at a film company bad-mouthing movie stars and being caught. The real story is that national boundaries have just been obliterated by hackers, who acted to squash something they didn’t like… but not just squash, threaten. Of course, some countries operate on the basis of a few bullies oppressing the masses – this is sadly nothing new and will probably never cease. I found myself looking at an image in a magazine recently, wondering how on earth so few, odd looking irrelevant men can control an entire nation, yet it happens all over the world.
The sadness is that film-makers and journalists are meant to be the ones that keep our focus on the truth, revealing darkness and oppression, helping to inform and change. Sadly many in Hollywood shirked this responsibility for fear of reprisal and financial cost. George Clooney couldn’t get anyone to sign his petition – ANYONE. So why should we be concerned if others aren’t? – after all haven’t Sony executives themselves to blame for expressing personal opinion and hitting that send button? Well, certainly some wisdom is needed in expressing opinion in a digital age, but the truth is that I doubt anyone has not said something about someone at some point in their life of which they are now not terribly proud. However, this isn’t really the point – the point is where does this lead? Can hackers now be hired by anyone, any nation to bully another into compliance? How does this impact our free speech? and surely this isn’t simply the domaine of terrified, narrow-minded tyrants, but also enters the arena of corporations who don’t like stories about their leadership or activities. Surely this has the potential to influence how we perceive and from a financial services perspective, appearance can be everything – just ask Tesco or BP.
This story has implications for you and I, our use of social media and the freedoms we enjoy. Obviously it isn’t wise to hurl insults and the adage, if you wouldn’t say it to their face, don’t say it at all seems pretty pertinent. But we surely cannot live in a world where we are terrified of legal action or reprisal. This is a “tipping point” for the double-edged sword of the internet, offering the prospect of genuine freedom of information to all (which we take rather for granted in the comfort of the West). As for me, I have never liked bullies, whether they come in the guise of a big kid in the playground, a teacher, boss, an investment bank, politician, pseudo military general, bigot, racist, rabid fundamentalist or of course my own tendency to think lazily and turn to petulant expression in frustration, which certainly in my “madder moments” it is a very good thing that weapons are not within easy reach…and sadly my own temper is easily fuelled driving, cycling or walking these very streets all too easily… which is of course the advantage of a society that doesn’t permit liberal gun ownership, encourages thought, education, tolerance and self-reflection, but unfortunately often seems more obsessed with narcissistic reflection in the eye of… well the media.