Inflation is on the Increase

The recent inflation figures released this week show consumer prices rose faster in September, at 3%, than at anytime in the last five years. This is now well above the long term average of 2.5% from 1989 to 2017.

 Prices are rising in part because of the rising costs of imported goods due to the pound's fall in value since we voted to leave the EU last June.

September inflation rates are used by the Department for Work and Pensions to set how much pensioners receive from the start of the new tax year in April 2018.

In 2018 I will become eligible for my state pension at the grand old age of 65. The net effect means I will now receive an additional £5 per week next year and a starting pension of £164 per week (£710 per month).

Public sector pensions, such as those paid to teachers, police and NHS staff, will also rise in line with CPI. In addition, the 'lifetime allowance' on private pensions will increase, by £30,000, from April 2018. 

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That will mean an individual can have £1,030,000 across their private pensions without facing a tax charge.

According to the OECD, our state pension equates to ~23% of average earnings. This should increase to nearer 30% as more people retire on the new flat rate pensions which started in April 2016. Currently, most pensioners will be stuck on the 'old' system which is much less generous apart from those who are topped up with the means tested pension credits.

Benefits

Most welfare benefits such as Jobseeker's allowance are frozen until 2020 so they will not see any increase next year. However PIP (disability) and maternity benefits will increase by the 3% from next April.

Interest Rates

The continuing rise in inflation is now putting pressure on Mr Carney and the MPC to increase the Bank of England base rate which has remained at a 300 year low since 2009. It currently stands at just 0.25%. I am expecting a rise back to 0.5% maybe as early as next month.

In the US, the Fed have increased their base rate 3 times over the past year from 0.5% to currently 1.25%.

The other financial event will be the Chancellor's budget on 22nd November and speculation of yet more tinkering with pensions and help for the younger generation. No doubt the usual short-term political manoeuvers in response to the poor election result.

Leave a comment below if you are affected by rising inflation.

Workplace Pensions

In 2008 the government introduced new pensions laws designed to get people saving. The idea is to help people to save by giving them access to a workplace pension scheme so they don’t have to rely on just the State Pension.

Workplace pensions were launched back in October 2012 to address the problem of people living longer but failing to save enough money for retirement. It is aimed at the private sector where less than 25% of the workforce were saving for retirement compared to over 90% enrolled in their employers pension scheme in the public sector.

Under the new rules, every employer has to give their workers the opportunity to join a workplace pension scheme that meets certain standards. Depending on how old they are and how much they earn, many workers will be automatically enrolled into the scheme. Other workers will be entitled to join the scheme if they want to.

Workers earning over a certain amount will also be entitled to a minimum contribution into their retirement pot. It’s usually made up of money taken from the workers’ pay, money paid in by their employer and money from the government, although employers can pay the entire minimum contribution themselves if they want to.

The minimum contribution has been introduced at 2% of a worker's pay. This will rise to 5% from April 2018 and then to 8% from April 2019. Everyone aged 22 yrs and over and earning at least £10,000 per year must be enrolled. So far, around 8 million have been signed up and when the scheme is fully rolled out it is estimated that some 10 million workers will be enrolled in a workplace pension.

Some Providers

In addition to the more established pension providers such as L&G, Standard Life and Aviva, there are some newer providers for employers to consider. Some of the more popular new providers include NEST, NOW:Pensions and The People's Pension.

The National Employment Savings Trust (NEST) is the auto-enrolment programme set up by the Government to support the launch of the auto-enrolment initiative.

NEST is effectively a public body that’s accountable to the Department for Work and Pensions

Most NEST savers are expected to invest their pensions in retirement date funds – also known as target date funds. These are funds that are managed on the basis that you’re most likely to retire in a particular year.

So if your most likely retirement date is 2025, your pension will be invested in the 2025 retirement date fund. If your most likely retirement date is 2055, you’ll be invested in the 2055 fund.

If you’re joining NEST in your 20s, your early contributions will mainly be invested in low-risk assets. Only about 30-40% of your cash will be invested in the stock market. This provision is to protect newly enrolled workers from the shock of a dramatic market fall. 

For example, imagine that NEST invested 90% of all Foundation phase investments into equities. Let’s then imagine that the stock market had a bad year and fell by a quarter. If that happened, there’s a big danger that young savers would be very upset and opt out from auto-enrolment for many years to come.

But if twentysomethings have a lower risk portfolio, they’re more likely to carry on paying into their pension for the rest of their working lives.

NEST is low cost with an annual charge of 0.3% on all your assets plus 1.8% when you first invest the money. So if you invested £1,000 this year, you’d pay a 'contribution charge' of £18, and if your total pot was worth £10,000, you’d pay a £30 annual charge. If you invested a further £1000 next year, you'd be charged a further £18 contribution charge on that fresh investment.

NOW:Pensions  is backed by Danish retirement specialists ATP, which has run the Danish National Pension for more than 45 years. NOW:Pensions has used its experience in Denmark to put together an interesting investment approach. Indeed, there’s just one default investment plan.

Your money is split across five different risk classes including Government bonds, index-linked Government and other bonds, equities and commodities.

During the savings phase, the cash will be invested in the classes listed above through the Now: Diversified Growth Fund. On reaching the pre-retirement phase (ten years before your planned retirement date, though you can change this to five or 15 years before that date) the money will start being moved into less risky investments contained in the NOW: Retirement Countdown Fund.

There’s a 0.3% annual management charge, coupled with a monthly administration fee of £1.50 (which falls to 30p for those earning less than £18,000 a year, at least initially).

The firm behind The People’s Pension is B&CE, a company which has managed workplace pensions – particularly in the construction sector – for more than 30 years. There are three profiles to choose from which will determine how your money is invested: Cautious, Balanced and Adventurous. If you’ve stuck to one of the three main profile funds, your money will automatically be moved into more secure investments on a gradual basis from 15 years before the planned retirement date.

One of the big attractions of The People’s Pension is that it is a not-for-profit organisation, which means that the charges are relatively low – there’s just a simple, flat 0.5% annual management charge to pay. That’s much easier to get your head around than the NEST fee structure of 0.3% per year plus a 1.8% contribution charge.

Some Concerns

Millions are now signed up to a workplace pension but the first area of concern would be that contributions are taken after the first £5,876 of pay is ignored. So, from 2019, someone earning £15,000 will only pay in a total of 4.8% not 8%.

Secondly, the maximum level of income eligible for the scheme is currently £45,000 - no deductions are made on earnings above this figure.

Thirdly, there may be a further 10 million self employed as well as those who work part time and earn under £10,000 or who have several jobs each paying less than £10K and who do not qualify for auto enrolment. The government are currently reviewing the system to find a way to include such workers. It is estimated that as few as 1 in 7 self-employed are saving via a private pension.

I firmly believe the government should take a look at increasing the 8% minimum (4% employee, 3% employer and 1% tax credit) as this is not likely to provide much of a pension for many workers.

Someone earning £15,000 who joins the scheme at age 37 and pays in for 30 years would amass a pension pot of around £75,000. This would be sufficient to give a drawdown pension of just £3,000 p.a.

This much needed addition to help workers save for their retirement is definitely a good start but this appears to be a 'one size fits all' approach where someone in their early 20s will contribute the same proportion of income as a worker in their 40s or 50s. There is a rule of thumb which suggests people should contribute half their age as a percentage into a pension. Someone aged 30 would pay in 15% of their wage and a worker aged 50 would pay in 25% for example.

There needs to be some review process or dashboard which can show every individual what level of payment they can expect based upon the percentage they contribute and the length of time before they expect to take pension benefits from their plan.

In the absence of significant developments to the current system, I suspect many workers will be disappointed with the levels of income in retirement.

If you are paying in to a workplace pension or have any general thoughts please feel free to leave a comment below.

City of London Trust - Full Year Results

City of London is one of my steady, predictable, middle-of-the-road income trusts. It feels like a dependable, faithful old carthorse. I first purchased CTY for my personal equity plan (PEP) in 1995 - it has served me well enough over the past two decades and it represents the largest weighting in my IT portfolio (ISA and SIPP drawdown).

Results

City have just announced full year results for the year to 30th June 2017 (link via Investegate). Share price total return has increased by 16.7% over the year and moved from marginal discount to a premium of 1.8% above net assets. The performance was however less than the FTSE All Share benchmark of 18.1%.

Dividends have increased by 5.0% from 15.9p to currently 16.7p giving a yield of 3.9%. This represents over 50 years of rising dividends - quite an achievement if you think back to the start of this run when England last won the World Cup in 1966 - I remember it well! Dividend reserves were bolstered by the addition of a further £4.7m which translates to an increase of 0.8p per share to 14.3p.

Earnings per share rose by 2.3% to 17.8p, mainly reflecting the underlying dividend growth from investments held of 4.6%.

This is a UK income trust and therefore the majority of holdings are listed on the FTSE. Large companies (FTSE 100) now account for 69% of the portfolio, medium companies 19% and overseas-listed companies 12%.

Ongoing charges are 0.42% and remain the lowest in the sector.

Passive Index

For the first time, there is a comment on the rise of competition from passives. "There has been much recent comment extolling the virtues of passive investment strategies, on the basis that active managers charge much higher fees and rarely outperform their benchmark index over the long term".

Although the trust has underperformed the benchmark index over the past year, the Chairman responds :

"This is not an accusation that can validly be levelled against City of London. Our ongoing charges ratio of 0.42% is the lowest in the AIC UK Equity Income sector and is very competitive with the OEIC market, with most other investment trusts and with other actively managed funds. 

City of London has outperformed the FTSE All-Share Index over each of the last three, five and ten year periods. If you had invested £10,000 in the Company ten years ago and reinvested the dividends, your investment would be worth £21,908, compared with the £16,847 that same investment would now be worth had you tracked the FTSE All-Share Index over that period.

While investors may be content to replicate an index in a rising market, they may not be so sanguine when share prices are falling: there is a danger that the automatic buying and selling of stocks which is inherent in index tracking aggravates extremes in share price valuations.

It also remains to be seen whether passive funds such as Exchange Traded Funds provide sufficient liquidity in a bear market because they have not been tested in their current size. By contrast, City of London's gross assets now exceed £1.5 billion and its market capitalisation stands at just under that figure. Our size means that we provide investors with a ready liquid market in our shares and our closed end status enables us to ride out market setbacks without being forced into selling sound investments at inopportune moments."

The fact that such comments have to be made suggests the actively managed sector are worried about the threats posed by the rapidly growing market share of index funds.

CTY v Vanguard UK All Share Index 2010 to 2017
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I have been reducing my exposure to UK equity over the past year (shares/ITs) however, given the track record of this trust under the stewardship of Job Curtis, I am happy to continue holding CTY for the foreseeable…

As ever, please DYOR

The Emotional Investor

There is a widely held perception that investing on the stock market is very risky . I often read comments in the popular press money pages which suggest it is akin to gambling at the casino where the odds are heavily stacked in favour of the house. 

There must be a good reason for this - some will result from having a poor understanding of finance generally but others may have ventured into investing without understanding the nature of the risk they were undertaking or how they would react to a sudden fall in the markets. Many new investors are sucked in to making easy money when there has been a prolonged bull market (such as now!) but are totally unprepared for a 20% loss when the bull run ends and fear grips the market.

A little while back I set out some of the elements to becoming a successful investor. For me, this would include :

·                     having a simple plan - a good idea of what you want to achieve & how you will get there;

·                     an understanding of compound returns and the importance of patience/time; 

·                     the importance of keeping costs low; 

·                     maintaining a diverse portfolio and balanced allocation of assets; 

·                     understanding market volatility and mean reversion; 

We may spend a great deal of time researching our investments, maybe looking into some individual shares, comparing funds to ETFs, the costs of active funds v passive etc. without a thought on whether we possess the right emotional attributes to carry through a long term project.

Whilst all the above are important, the end result of a carefully researched plan may fall short without some understanding of your emotional/psychological make-up and ensuring this is a close match with your chosen investing strategy.

Emotions will play a large part in our lives - work, relationships etc. and it would be surprising if they did not come into play during the investing process. At times, the markets can be a rollercoaster ride - it can be just as challenging to stay with the plan during the upswings as when the markets head south. We may be driven by greed to maximise returns from our portfolio when markets are rising and then gripped by fear at the prospect of losing any gains during a bear market which seems to appear from nowhere.

Get to Know Yourself

"We have seen much more money made and kept by 'ordinary people' who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had an extensive knowledge of finance, accounting, and stock market lore"  Warren Buffett.

We therefore need a plan which takes into account our personal capacity and reaction to loss and then put in place a realistic allocation of assets to closely match the degree of risk and volatility we are prepared to take. Some people are natural risk takers and may be temperamentally well suited to a higher exposure to equities, whilst others are naturally cautious and require a more balanced allocation which may include a higher percentage of bonds, fixed interest and property.

However, staying calm when the markets take a tumble will present a challenge for the most relaxed investor. It is therefore important to have a robust plan for the long term so that your strategy does not collapse during the rough seas of market volatility.

Your Personality

We all possess unique personality traits and preferences combined with a range of emotional and cognitive biases which all impact on the way we invest - or even prevent us from engaging in the investing process completely. There are many academic studies of this aspect of investing known as behavioural finance.

An assessment of our emotional make-up does not need to be complicated. Most people will know whether they are naturally cautious/reserved or carefree/outgoing. Some people are natural risk-takers, others prefer the slow & steady option.

Knowing these basic types will help to select the most appropriate asset mix. You can use an online tool such as Vanguard's AssetMixer to show how various allocations of equities/bonds/cash perform over a set period.

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As a general rule, the anxious/cautious personality will be more suited to a steady, low volatility portfolio with a higher percentage of bonds and cash in the overall mix and correspondingly lower proportion of equities.

Wealth managers can try to understand their clients personality type by identifying four basic profiles - Preservers, Accumulators, Followers and Independents.

Preservers place more emphasis on preserving what they already have and do not feel comfortable taking risks to accumulate more wealth. They will keep a close eye on short term performance and will become anxious about losses. They may even have difficulty taking action for fear of making a wrong call...making no decision is better than making the wrong decision.

On the other hand Accumulators are confident risk takers who typically believe the path they have chosen is correct. They may have been successful with business ventures and believe they will also make a success of investing. The over-confident type typically believe they have an edge over others and will be attracted to active management and stock picking which are higher risk strategies.

Followers will typically latch on to the latest investing trend or pick up investing tips from friends or discussion boards. They do not work out their own plans and may follow the bandwagon without any real understanding of the financial markets or risks involved.

Independents take great interest in the process and can analyse a situation and then trust their own judgment to make confident and informed decisions. Independent thinking and having confidence in what you believe is much more important than being the smartest person in the market.
 

So, are you naturally cautious or do you like the thrills and spills?

Do you seek instant gratification or are you patient?

Are you more skilful than the average investor?

Can you accurately predict the direction of the markets?

Are you overly influenced by the so-called experts or do you do your own thing?

How would you react to losing 10% of your portfolio value?…25%?…40%….?

Stay the Course

Having a little insight on how you may react in certain situations will be a big advantage in the process of investing. It could make the difference between reaching your long term objective or falling at the second hurdle.

Personally, it has taken some time for me to understand the links between my investing strategy and behavioural biases and psychological temperament. I can well understand the whole process intellectually, but implementing a well-thought out plan for the longer term has involved coming to terms with my tendency towards over confidence and under-estimating of the risks involved.

I also have a tendency to over-activity which leads to tinkering. I am slowly coming to terms with the concept that doing nothing 9 times out of 10 is probably the correct course.

As a result of this increased awareness, I have made a few adjustments to my strategy in recent years. These include the moving away from the constant monitoring of my portfolio; deciding a basket of individual shares was no longer suitable; a gradual move from actively managed to passives;  simplifying the strategy by incorporating Vanguard Lifestrategy as a core holding.

There is no perfect strategy. Different plans will suit different investors with different circumstances. I suspect the best plan is one which is more likely to ‘fit’ with the individuals psychological make-up and is therefore most likely to keep them in the game and get them to their destination.

…the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness. (Warren Buffett)

What emotional aspects of investing cause difficulties to you? Feel free to leave a comment and share your thoughts and experience with others.