On Target Newsletter
In this issue:
- Money for retirement
- Fed policy
- Why rich get richer
- Getting your cashability right
- UK tax for social care costs
- ESG fund
- China’s dangerous research
How to Invest When You’ve Retired
Retirement is a dangerous time. Much of your income is completely out of your control, determined by the state (your statutory pension), or by the contractual terms of your private pension. If things go very wrong because of huge unexpected expense such as medical, family crisis (you need to support a son or daughter), or a financial disaster, you’re very unlikely to be able to rebuild lost capital.
You have to plan your situation carefully when you retire, maximizing income, minimizing risk to capital, and doing as much as you can to prepare for survival of “black swan” events.
Much of your income will be pensions. The balance will need to come from investments. If you use capital to buy an annuity, that guarantees a stream of income until death, eliminating the risk of outliving your savings. But annuities, whose value is geared to interest rates on bonds at the time they’re bought, have become extremely expensive because of ultra-low, even negative, interest rates. You should look elsewhere for the additional income you’ll need.
How much of your savings will you be able to withdraw without running out of money?
You’ll need to estimate how many years you can expect to live based on your health and family history. American government tables suggest that the average life expectancy for a male of 60 in the US is 21 years. If 65, 17 years; for age 70, 13 years; for age 75, ten years; for age 80, eight years. The average is two to three years longer for a female.
There are several reasons why you are likely to live longer than these averages suggest. One is that medical advances are keeping people alive for longer. Another is that the mere fact that you’re reading this infers that you’re better educated – therefore you’re more likely to practise a healthy lifestyle and have access to above-average medical care.
You may worry that the pandemic increases the risk of your dying early but that fear is quite out of proportion to reality. Unless you have comorbidities such as heart disease, strokes, diabetes, obesity, the danger from Covid-19 is no greater than from flu.
You’ll probably live for longer than you expect, so err on the side of caution in
drawing on your savings and plan accordingly. If you have a partner it’s important to take her/his life expectancy into account in your planning as well as your own.
How much income will you need?
You may be able to trim your spending from current levels because you’ll need less for expensive luxuries such as foreign travel that you spent pre-pandemic. That becomes increasingly onerous and less pleasant as you age. On the other hand you’ll almost certainly need more help in the home and more medical care – your need to finance the latter will depend on your access to services and drugs paid for by the state or by medical insurance. You may wish to plan for help for family members, such as grandchildren’s university education.
In addition to income you need to plan to have some capital to meet unexpected major expenses.
Received wisdom used to be that retirees should favour bonds for security and a fixed income. Trouble is, for years central banks have been pursuing extremely aggressive policies that suppress the yields on bonds and make them very poor sources of fixed income. The same extraordinary policies keep bond prices very high and therefore very exposed to inflation risk.
Bonds, properties and equities
As bonds and bank deposits have become very poor investments they shouldn’t be used except to hold a couple of years of income.
Property rentals are a useful alternative source of income for retirees, but real estate requires active management (the older you get, the more difficult that is), and has well-known downsides of lumpiness (just one property is likely to be a big chunk of your capital), risk of voids (periods without occupying tenants); and illiquidity (cannot readily be converted into cash).
Most of the capital you have to finance your retirement will need to be invested in equities. It now makes sense to maximize holdings of retirement capital in equities – 80 per cent or more of a portfolio – to yield adequate income, shield your capital against inflation risk, and provide a pool to draw on for emergencies.
For most of us, the best source of additional income will be dividends. Once you stop working you may have to allocate a major share of your investment capital to “equity income” – shares held primarily for their income rather than capital gain. (Although, ironically, they sometimes turn out to be excellent long-term performers).
There are some very good specialist international funds, or if you prefer, ones focused on single countries such as the US, or regions such as Europe or Asia. An example of one I hold myself is the Henderson Far East Income fund yielding 7.7 per cent a year in sterling, payable quarterly.
Some advisers say that rather than resort to equity income stocks it makes more sense to focus on high-growth companies, selling small portions of a holding to yield capital as an alternative to income.
Diversification to reduce risk always makes sense in terms of different regions and investment styles as well as asset classes. This means you’ll be less likely to end up fixated on income-producing investments – a mistake in retirement planning that’s easy to make.
Of course income isn’t the only source of your personal wealth. Hopefully there are also capital gains. And presumably you know those from your regular monitoring of your investment performance. If you have accumulated enough capital, and if you’re a fair hand at investing, capital gains should be enough to cover any gap between income and spending.
How many more years must you need to finance?
Predicting what gains are likely to be is notoriously difficult. Yet doing so is important if you’ll have 15 or 20 years or maybe more to provide for yourself. And for your partner, if you have one, who is probably younger than you and therefore likely to live for more years than you, and is almost certainly less experienced than you about investment.
Total return from my own portfolio has averaged 9.5 per cent a year in sterling terms since I retired 20 years ago, of which I used 2.5 percentage points to finance lifestyle, the balance being reinvested. That return was not boosted by big bets on speculative stocks or options. Indeed, over the period the portfolio held significant components of “defensive” investments such as government bonds, gold and income-focused equities.
Of course it’s true that I qualify as a professional (financial journalist, not investment manager); often pursue very unconventional strategies that occasionally turned out to be big winners; and have had more than my fair share of good luck.
Given the generally mediocre outlook for global investments (valuations look far too high), I assume I won’t do as well over my remaining years. Perhaps averaging no more than 5 per cent a year, a bit less in real terms. That would probably be a sensible target for you to seek to achieve.
In planning your future the good news is that, providing you don’t have to, or wish to, leave an inheritance beyond that needed to support surviving partners or other family members, you can consume capital to maintain your lifestyle. On the other hand you do need to worry about living “too long,” or significantly longer than you expect to.
I suggest that you base your maximum annual withdrawal plan on the conservative assumption that you will live to reach 100. If you’re now 65, for example, you would plan to draw and spend no more than one 35th of available capital.
A final point about this kind of retirement planning is that it assumes you can’t change the cost of your lifestyle. Although that’s very difficult at an advanced age, it can be done. We relocated to Thailand when I had reached the age of 70. It halved our essential living costs. Or, to be more accurate, we got and continue to enjoy much more quality at much less expense.
Should We Anticipate Surgery at the Fed?
Is the Federal Reserve, America’s central bank, managing the economy cleverly… or failing to act because it’s paralyzed by fear?
Every month it’s pouring $120 billion into buying bonds; interest rates are kept so low that credit is almost free. These are policies so extreme, and so rare, that they only make sense as desperate measures to fight off a depression.
Yet there are few signs of such a calamity or anything like it. In fact the American economy has bounced back from the nasty shock of the pandemic and is growing at a healthy 4 per cent rate. Consumer prices are buoyant, house prices are bubbly, investment markets are “peak everything,” and most businesses have more jobs on offer than they can fill.
The only contradictory signs are the sudden sharp fall in consumer confidence index – attributed primarily to the rapid spread of the Covid Delta variant – and the sudden weakness in private-sector employment growth.
The major uncertainty looming over markets is inflation. Is the Fed right in its view that the wave of rising prices is transitory, not something permanent?
Mentions in American corporate discussions of cost inflation are at all-time highs, reports investment bank Morgan Stanley. Inflation is increasingly being cited as a key problem and risk to profit margins. Intentions to raise wages in response to labour shortage are increasing. In response to cost pressures, firms are raising prices at an historic clip.
If the strong earnings growth seen in the second quarter is to be sustained, that requires abundant liquidity (that depends on at least part of Biden’s $4½ trillion infrastructure and welfare bills being passed by Congress); continuing consumer confidence; and no further pandemic shocks such as the Delta variant.
The Fed isn’t expected to start trimming back its massive bond-buying programme before the beginning of next year or to begin raising interest rates before the end of next year.
What could change that outlook?
Bloomberg says Fed chief Jerome Powell is in the dilemma of needing to choose which is the bigger long-term risk for the US – become trapped in a disinflationary spiral like that experienced by Japan, as the forces of technological advances and globalization continue to press down on prices, or enter an inflationary zone of escalating cost pressures.
“Right now, he’s betting that the former is the bigger long-run danger, and holding off from tightening credit.” He’s seeking a soft landing for the economy with on-target (acceptable/even desirable) inflation and maximum employment.
But if it becomes clear that the current surge in inflation doesn’t turn out to be a transitory phenomenon, as the Fed expects, but something more entrenched, nasty and dangerous. That would force the central bank — as former Richmond Fed president Jeffrey Lacker puts it — to resort to “traumatic surgery.”
Guilty of Ensuring the Rich Get Richer
Central bankers increasingly like to talk as if they’re social workers rather than economists or financial regulators. It keeps them in favour with the politicians. And it makes it easier for them to duck questions about their guilt in promoting inequality.
Years of unorthodox monetary policy have been a bonanza for the ultra-rich to expand their wealth and banks to gain from lending to them. Over the past four years loans advanced by the wealth management arms of four major American banks increased by 50 per cent. That compares with growth of only 9 per cent by the banks as a whole. Over the past year alone the wealth managers’ lending rose 17 per cent. to $600 billion.
Their business since the 2008 crisis “has been primarily about lending money to finance asset purchases and carry trades” says Jefferies’ global head of equity strategy Chris Wood. Banks are lending more money to a small number of ultra-high-net-worth clients than to their millions of credit card customers, who are paying way higher interest rates. (The average level charged on US cards is still 16.2 per cent).
“From the standpoint of the wealthy, borrowing against potential illiquid assets can be very tax-efficient. It avoids paying high capital gains tax on the sale of an asset.” In California, for example, federal and state gains taxes on long-term gains are 37 per cent. In many respects it is even worse in the Eurozone after several years of negative rates, with many private banking clients being paid to borrow.
“It makes total sense for the wealthy to keep borrowing against their assets,” to own physical assets such as “equities, real estate, gold or digitally scarce sources of value such as Bitcoin.”
12 years of abundant nearly-free credit have produced “grotesque distortions.” There’s no sign that is about to change. It’s a system guaranteed to promote even greater inequality.
Getting Your Cashability Right
Liquidity is one of those jargon words that confuse a lot of people. It simply means the ease and speed with which you can convert an investment back into cash should you need or wish to do so.
Ordinary shares, mutual fund units, most bank savings accounts, even gold coins, are completely liquid investments as they can be turned into cash within 24 hours. Properties, on the other hand, are highly illiquid, as it can be months before you can get the cash from selling them.
Liquidity is important if you are likely to need cash in a hurry. That is why most people should keep the equivalent of three to six months’ income in highly liquid investments to finance unexpected financial emergencies, or expected major expenses.
Liquidity is also important in another respect. If an asset (such as ordinary shares) is falling in value, it is easy to cut your losses and escape further financial damage if it is easily saleable.
However, there are risks as well as benefits in liquidity. If you spend money too easily, liquid investments tend to evaporate. If you are a nervous investor, liquidity may permit you to sell assets at the wrong time. In fact you should BUY shares, for example, on days when the stock market is collapsing.
Which brings us to another important factor in investment – timing.
If you bought gold in March 1972 then within four years your investment would have multiplied 16 times. If you bought the yellow metal in October 1980 you would have lost 30 per cent of your capital 12 months later.
Unfortunately there are no simple rules for correct timing of purchases and sales. Even experts often get their timing wrong.
That is why one of the safest ways to accumulate assets of any kind is to use the technique of cost averaging. This involves allocating a fixed sum of money each month for purchase of the investments you favour. If the fixed sum you can afford is not sufficient to buy every month, then you can accumulate the money in a savings account and buy the desired asset when you have enough money to do so.
A more sophisticated approach to cost averaging, which I recommend, is that you invest a fixed proportion of your income each month. As your income increases, so does the amount you invest.
The advantage of the cost averaging technique is that you automatically buy more assets when their prices are depressed than when they are buoyant. This means you automatically follow the sophisticated counter-cyclical strategy of a conservative financial institution.
When I did a sample study of a regular fixed-sum purchasing plan based on average share prices over a typical ten-year period, that strategy would have accumulated 20 per cent more shares by the end of the period than a variable purchasing plan that followed the fluctuations of the market.
‘Bleak Future’ for the Oil Giants
The foundation for the next oil crisis is now firmly in place, argue natural resource investment advisers Leigh Goehring and Adam Rozencwajg. Global oil demand is recovering strongly and should be making new highs by the beginning of next year. Supply growth less so. In fact demand will match world oil pumping capacity for the first time in 160 years. The investment implications will be “monumental”.
In recent decades the oil giants have had to spend enormous amounts to maintain production and replace reserves, and it’s become increasingly difficult. Over the past ten years the four supermajors Exxon, Chevron, Total and Royal Dutch Shell have seen the cost of finding and recovering a new barrel of reserves nearly double from $14 a barrel to $26.
The companies are also under increasing pressure from political activists to cut back on expanding or even maintaining their production of oil and gas, switching their focus to new-energy products and services. Shell says: “We are investing billions of dollars in low-carbon energy including electric vehicle charging, hydrogen, renewable and biofuels.”
In May Exxon suffered what the New York Times described as a “stunning defeat” when an activist investor owning just 0.02 per cent of shares secured the election of three new directors to its 12-man board. A Dutch court ruled that Shell must cut its output of greenhouse gases by 45 per cent by 2030. The International Energy Agency publicly switched its traditional pro-oil policy position and said the industry should stop all investment in its fossil-fuel businesses.
The mounting political pressures, added to the increasing difficulties of financing replacing oil/gas capacity, means the future for the oil giants “has gone from challenged to incredibly bleak.”
In the short term, however, things may be the reverse. At a commodities conference in London in June the world’s top traders predicted that oil will return to $100 a barrel. Motorists’ return to the roads following the loosening of pandemic restrictions is pushing up fuel demand and the bottom lines of oil refiners.
Brits to be Taxed for Costs of Social Care
The British government seems to be about to grasp the nettle of meeting the rising social and medical costs of an aging population.
In 2017 the ruling party decided to address the issue of social care by proposing that anyone who received such public-financed care in his/her own home would have to pay for it out of the value of the home after death, apart from the first £100,000. In a subsequent general election this proposal, which came to be dubbed a “dementia tax,” so upset voters that even a softer version of it wiped out most of the Conservatives’ strong lead.
The National Health Service may be the nearest thing the British have to a national religion, says The Spectator’s James Forsyth, “but for the property-owning classes, the belief you should be able to pass on that asset is a close second.”
So if the current government won’t take the risk of returning to the toxic idea of taxing homes, and is trapped by a commitment made in the last election not to raise income tax, national insurance or value added tax, how can it raise the money it must?
Speculation is that it will introduce a new tax specifically to pay social welfare costs. Politically it would be wiser to get the introduction of such an unpopular measure years ahead of the next general election.
ETF for Environment-Social-Governance Investing
I suspect that Cathie Wood, the controversial fund manager who made her reputation by heavily backing innovative “hot” stocks such as Tesla, is on to another winner with a new fund excluding all companies that fail to meet environmental, social and governance criteria.
Environmental criteria, says Investopedia, consider how a company performs as a steward of nature; social criteria examine how it manages relationships with employees, suppliers, customers and the communities where it operates; governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.
Wood’s new Transparency exchange-traded fund will follow an index that screens out firms with low ESG scores in businesses such as alcohol, fossil fuels, confectionary and metals. It will invest in ones with good scores on transparency, privacy, diversity, ethical and customer standards, high corporate trust ratings and minimal lawsuits.
In contrast to her Ark Invest, which is the largest actively-managed ETF in the US, her new fund will be passively-managed – an investment style that mirrors the contents of an index and does not seek to beat the market with buying/selling strategies.
Range Anxiety Still Dogs Electric Cars
The big problem, as most electric-car owners know, is that it takes time to refill the batteries, and you can’t always find a charging station.
Claire Bushey reports in the FT that in America the charging infrastructure is still in its infancy. There are about 54,000 public and private charging stations. But that’s only half as many as there are petrol stations, where it only takes five minutes to refill. Some are not readily available (Tesla’s stations only supply Tesla cars), while many stations are of the older, slower-charging type.
If you live in an apartment block, there’s nowhere to plug in, Bushey says. “The owner of a single-family home typically spends up to $300 for the slowest Level 1 charger, which it can take up to 25 hours to fully charge a battery. A Level 2 charger takes between four and eight hours, and costs up to $2,000 including installation.” If you live in California you can buy a high-speed DC charger that can refill your car in less than an hour – but at a cost of $50,000.
Best Places in Europe to Retire
The best destinations in Europe for living in retirement are Portugal, Spain, Greece, Italy and France, says the international moneycraft consultancy Sovereign Man. The region offers hospitable people, temperate climates and low cost of living for retirees. Most Southern European nations offer easy residencies aimed at attracting the financially self-sufficient. The required income can be as small as a few hundred euros per month.
However, to keep your residency renewable you will have to spend at least six months or more inside the country every year (except in France).
With the exception of Portugal, you will not be allowed to seek local employment. However you will generally still be able to work remotely for a foreign employer, or your own overseas business.
While you’re not required to invest in property, you will be required to have a fixed address in-country.
Fossil fuels: The barrage of politically correct propaganda about green jobs and renewables successfully diverts investors’ attention from where easier profits are to be made… in unfashionable fossil fuels.
Coal is quietly booming. China, the biggest source of greenhouse gases, has announced it’s resuming operations in 53 mines to produce 44 million tons a year to satisfy growing calls for power. Prices for thermal coal have skyrocketed to record levels.
In the US, too, coal is booming despite Biden’s plans for “green” energy. Consumption in power stations is predicted to rise 17 per cent this year.
Germany: It looks as if the general election is going to see a stunning defeat for retiring chancellor Angela Merkel, whose CDU party has been in decline since 2015, when her stunning open-door policy triggered an inflow of a million refugees.
The most likely government will be a so-called Traffic Light coalition headed by Olaf Scholtz, easily voters’ most favoured choice as chancellor. Latest polls expect his SPD party to win 25 per cent of the votes, with the Greens taking 17 per cent and the liberal FDP 12 per cent.
Financing Debt: No wonder economists on the Left have been arguing that it doesn’t matter if governments run big fiscal deficits – their central banks will “print” whatever’s needed to buy the bonds to pay.
Chris Wood, Jefferies’ global head of equity strategy, reports that the Japanese central bank’s ownership of government bonds has risen from 7 to 48 per cent since 2009. The European Central Bank’s holdings have increased from 2 to 38 per cent since 2015; the US Federal Reserve’s ownership of Treasury securities from 6 to 22 per cent since 2009.
Become a digital nomad: If you’re unhappy where you live, or just sick of paying high taxes, becoming a digital nomad may be the solution you’re looking for, advises Doug Casey. “Leave your unfulfilling job and life behind and start exploring the world. Live in some of the most beautiful and exciting places on Earth – many of which also happen to have the lowest cost of living.”
Unless you have substantial savings or fruitful investments, you will need to find a way to sustain yourself abroad. Use your skills to find relevant freelance work on-line.
Covid-19: You will remember my report last month sourced from Israel’s ministry of public health that after six months the Pfizer vaccine’s efficacy plunged to 16 per cent. The FT has now reported that a study in the US by the famous Mayo Clinic hospital chain showed that after five months the Pfizer efficacy fell from 89 per cent to 42 per cent.
Also startling is that the study showed that the Moderna vaccine is far better. Over the same five months its efficacy fell from 91 per cent to 76 per cent.
Self-inflicted mania: Even before the pandemic, which no one saw coming, the global financial system had become “increasingly precarious,” says Price Value Partners’ Tim Price. The 2008 financial crisis “ushered in a decade of extraordinary monetary accommodation, debt issuance, bailouts of zombie banks, taxpayer-supported ‘crapitalism’ (crony capitalism) and a host of other financial shenanigans egged on by clueless central bankers and politicians.”
Education: Grade inflation continues to undermine the credibility of ratings. This year almost 45 per cent of pupils achieved A or A* grades in secondary school completion ratings in England compared with 25 per cent in 2019. Such high proportions of students getting top grades “makes them less useful for businesses and universities to identify the best-performing candidates,” says the FT.
Gold: Demand for physical bullion in Germany, traditionally the biggest coin and bar buyer in Europe, was the highest since 2009 in the first half of this year, according to World Gold Council data. In June the Bild newspaper published an article headlined Inflation is Eating Up Our Savings.
Wind turbines: They get bigger and bigger. China’s MingYang Smart Energy has announced that its new model going into production next year will have three blades each 118 metres long. Its generating capacity will be 15 megawatts.
If you’re not willing to react with equanimity to a market price decline of 50 per cent two or three times a century, you’re not fit to be a… shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament.
Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway.
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