A lifetime saving for retirement

Pensions - so I am thinking of retiring so let me share again (this article is built on earlier post) what I have learnt over a lifetime of saving. This is my way for someone earning good money in the middle third of their life having bought a house & got the mortgage under control (not easy these days). I do think that the Token Economy is relevant for long term saving. But for me tokens represent only a small percentage in a design of a portfolio. Maybe that will be different for the next generation?

Fouteen lessons I learnt

1. Equity always wins over 30 or more years - you save for 30 years & you drawdown for 30 years. As an asset class, equity trades off higher volatility for higher returns. But individual markets can stagnate - just look at Japan. So you need to balance over global equities with some hedging on currency rates. Your costs will be in your home currency.

2. Buy the index but you need to know what indexes to buy. Surprisingly the UK FTSE all share has not been a bad proxy for global equity though it is light on tech. so may not continue to be in the future. You can’t really avoid active management decisions on asset allocation across equity markets, fixed interest, property and other (bitcoin and commodities)

3. Focus on charges - always aim to keep charges as low as possible. They make a huge difference.

4. Don’t switch - stick to your strategy. Thank God I didn’t switch as the best advice changed every 7 years or so. Don't chase performance, be patient.

5. The best advice / consensus of opinions is usually wrong. If I followed the default strategy I would now be in some trouble as the “safe” funds all had a disastrous last 12 months. Unlike equity I can’t see them ever recovering.

6. Drip feed in your investments, little by little, so you don’t have to worry about when you invest as you are buying the average. Try to sleep at night when you are 50% down - it's a buying opportunity and markets will recover - at worst in 7 or so years. (Remember you are buying month by month so you don't measure against the peak but rather what you put in).

7. Do the same as you take your pension - stay invested and take it out little by little.

8. Always hold 3 to 5 years spending in cash - if you can. So you can buy at distressed prices & sit out bad bear markets.

9. I lived through 2 really bad market crashes (2000-2003) & 2007-2009. Both felt terrible at the time. On the graph now having followed exactly the same strategy for 25 years (70% FTAS + 30% US/other) they look like opportunities to buy.

10. Stay invested in equity over your whole life. The most valuable up swings can happen really fast & take you by surprise.

11. I worked on the third rule - first third of your life you are growing up & getting established, second third of your life you are saving, third third of your life you are retired. So if you save one third in the second third you live off half plus real growth in the final third.

12. For UK investors try to get a 40% pension tax credit in (now up to 45%) but pay no more than 20% out when retired. Use ISA’s & VCT to top up.

13. Finally plan how to leave it to your kids. The best way to do so tax free, in the UK once over 75, is a combination of Potentially Exempt Transfers (gifts > 7 years before death) & gifts from excess income which are especially valuable when you are in your 80/90 ies and might die within 7 years.

14. I remember the 1970’s - you didn't want to be depending on fixed interest in that decade! I remember 26% inflation in the UK when I was a kid. Might be a good idea to have a little bitcoin (just in case)

My strategy

This is my core strategy in blue (70% FTSE All share + 30% global equity of which two thirds or 20% of the overall total is in the US) with income reinvested, compared against a more balanced global equivalent fund (Growth plus) and a more cautious fund with a lot of fixed interest fund (Growth). The vertical axis is the fund unit price which is a matter of public record, so 800 represents ￡8 a unit. (I had to adjust for rebasing of unit prices as the funds were replatformed a few years ago, so these are historic prices and adjusted current prices of about ￡10 a unit back to the original base).

The crashes of 2000-2003 and 2007-2009 don;'t look so bad now, do they? But from 200 to 100 is still a 50% fall. And just look at the graph in the post covid recovery. That safer fund (in grey) missed out on most of the "up" and had the worst "down". The tech sector did brilliantly and then fell back, so the orange line did much better then did much worse than my strategy in blue, ending up in the same place.

And look at that gap at my retirement funds today between the gray and blue lines. Might be a good time to take some risk off the table? But with all that inflation around maybe I should continue to hold equities with pricing power, like Diageo - booze, which is a big part of the FTSE. Booze, baked beans, oil .... all good equities to own when inflation is around.

Watch out for inflation

Have a look at this chart - what is happening in fixed interest (bond & gilt) markets this year is not usual. The dark blue line. And June was even worse, July is looking a little better. Supposedly less volatile and safe funds investing in gilts and bonds have lost as much as 25% over the last 12 months. That isn't meant to happen! This year is the worst by a mile than any of the last 40 years for fixed interest. The last 40 years were characterised by falling interest rates (good for gilts and bonds) and now interest rates are rising (not so good for gilts and bonds).

Asset allocation is key to success

There are 5 main asset classes: equity, fixed interest (gilts and bonds), property (commercial & residential), cash and other (e.g. bitcoin or commodities or gold). You need to really think through how much you save in each of these 5 classes at any one time.

Back in the day you, in the UK, you had to be in financial shape on retirement day because you had to buy an annuity on that one day. So you had to de-risk in the 5 to 10 years up to the retirement day. Nowadays is much like the old days when folks used dividend income as retirement income. The level of volatility you want to trade off against higher returns is absolutely key. Sometimes you just need you keep the real value of what you already have. Why take a risk if you don't need to? This drives the design of asset allocation. This asset allocation changes with your own personal circumstances and attitude to risk - including inflation risk. Your asset allocation strategy is the key to success. That's why I pay for folks to do that for me on my SIPP/ISA - in real time - it's an ML algorithm I think.

Main Asset classes

There are 5 assets classes: equity, fixed interest, property, cash and other. You must allocate your savings across all 5, though you could decide to do 100%, 0%, 0%, 0% and 0% I think that is crazy. I always held lots of cash (I was always terrified IBM would fire me), I had a house and I tried to minimise fixed interest. Investments are held in tax wrappers: work Defined Contribution (DC) pension, SIPP (Self Invested Personal Pension), VCT (Venture Capital Trust) , ISA (Individual Savings Account) and none.?The 70:30 is my work DC pension. I also held SIPP (I used for Additional Voluntary Contributions and to contract out of the second state pension and to consolidate pre-IBM pensions)

Equity refers to share ownership in a company where value comes from your share in company profits. These are either distributed in cash (dividends) or retained for growth. The market values a share at something like 15 times expected future earnings.???Fixed interest refers to loans to companies or governments (these are called Gilts) issued at a fixed interest rate for the loan duration.?This rate charged reflects base rates on the day, loan duration and credit worthiness. If base rates rise then previously issued bonds are less good as newer bonds will pay more so their capital value falls.?With bonds I talk about the drop in their capital value.

Short dated bonds or gilts fall the least with interest rate rises. Long dated bonds and gilts fall the most. The very worst asset class of all this year so fall are long dated gilts (loans to governments) at minus 25%. These are the sort of assets behind annuities. It is well worth reading this paragraph again. Slowly. You save over a lifetime and just before you retire you put it in long dated gilts. Just to be safe as you want to buy an annuity. And overnight you lost 25% with no hope of getting it back. Ever.

Now is a good time to buy bonds if you think interest rates have peaked. If you think inflation will stay or even rise then interest rates will rise further and bonds will fall further. Also if there are negative real interest rates (base rates < inflation) any returns are nominal as you are making a real loss. Hence the need to invest in inflation proof assets like Diageo (the price of booze goes up so Diageo profits go up) or maybe property - as that has always done well especially if you pay a mortgage lower than the inflation rate and your salary goes up with inflation.

Focus on charges

I pay 0.06% on my 70-30 and about 1.6% on my SIPP. My real return, after inflation, on my 70-30 is 4.5% a year, over 25 years, so 1.5% charges is huge at a third of my real growth. The SIPP has some clever asset allocation tooling - but basically my 70-30 is my core pension and 0.06% is about as low as you can get. I pay an extra 1% on my SIPP/ISA/VCT as I have an advisor involved. This is hard to cost justify but I have done well on VCTs and quite frankly I need someone to bounce ideas off. My weighted average costs are about 0.8% which is still high but OK I think. Best in class for the fund costs plus the platform cost is, I would say 0.1% to 0.4% pa.

The best advice is for free

I tried really hard but still made mistakes. Advice is expensive -the best advice of all is free and comes from your Dad (or Mum these days). I can still remember the exact moment (I guess I was 14) when my Dad said "equity always wins." I never forgot that and fight with my financial advisor (I do use one - but carefully|) every time he tries to balance my portfolio into more fixed interest. My Dad's advice has served me very well!

Do your own research

This article is not intended as financial advice. Each of us is very unique in our wants and needs and you should do your own research. Each generation must find it's own way. All my thinking above is what has been true in my working life. It is unlikely to hold completely true for the next generation. Maybe younger guys need to invest in tokens? Only time will tell. But having said that I still expect much of what I have written to still be helpful moving forward - but who knows!

Just saying