≡ Menu

Weekend reading: Funny money

Weekend reading logo

What caught my eye this week.

I am late with the links this weekend, so let’s get stuck in with a “show me the money!” moment.

And not just any money, mind, but the 8,800lb coins of Yap Island in the Pacific Ocean:

A Yap island coin: We’re going to need a bigger sofa.

Writing on Medium, Jamie Catherwood explains that:

For centuries, the natives of Yap have used ‘rai stones’ as a form of payment, and store of value.

These ‘stones’, however, were actually gargantuan limestone discs weighing up to 8,800 lbs., and standing 12 feet tall.

The natives ‘minted’ (mined) their currency on Palau Island, and upon their return the Chief of Yap valued each rai stone in front of the entire population.

In the same ceremony, locals would then purchase the currency.

Money is nearly always an abstraction. Trust is usually where the value lies, not in any intrinsic value. Even the gold and silver coins of antiquity were debased and inflated away.

Catherwood writes:

After considering Bitcoin’s value within historical context, it should be clear that criticizing the crypto-currency for being “based on nothing” is a weak argument at best.

He points out that in the past even rather ghoulish religious artifacts have been used as a store of value.

I haven’t made my mind up about Bitcoin yet.

But I’m pretty sure it’d be an easier sell if instead of the dollar, Visa, or PayPal it was up against giant limestone discs and the teeth of long-dead saints…

[click to continue…]


Taking more risk does not guarantee more reward

Taking more risk does not guarantee more reward post image

When you’re teaching somebody a new subject, simplifications can creep in. Rules of thumb at best. Outright untruths in the extreme.

For example:

  • The simile “as blind as a bat” isn’t true – many bats see better than we do. (Maybe they’re also better than us at similes?)
  • Christopher Columbus didn’t think the world was flat. The notion combines scientific and terrestrial exploration into a neat historical parable, but even the Ancient Greeks and Romans knew the Earth was probably a sphere. (Columbus owned books that told him so.)
  • Teaching children the classical laws of motion wouldn’t be made any easier by telling them they’ll eventually learn the whole shebang is a gross simplification – that Newtonian physics is a shadow on the wall approximation of the statistical weirdness of quantum mechanics. (Yes, I know I’m oversimplifying here, too!)
  • The “i before e except after c” rule often works – but not enough that foreign students can seize the weird exceptionalism of the feisty English language. (Spot the rule’s deficient idiocies there?)

So it is with investing. We say higher returns come with higher risks. That assets that go up and down a lot in price such as shares should to be held with a long-term view, and that braver investors can eventually capture higher returns this way.

But reality isn’t quite so simple. Those higher returns are only expected – not guaranteed – and not all risk is rewarded.

For starters, some risks don’t even come with the expectation of higher rewards:

…the relationship of more risk, more reward does not always hold.

In some circumstances you take greater risk, yet you can’t expect the market gods to reward your chutzpah with greater returns.

Academics call these lousy bets uncompensated risk.

Read our previous article on uncompensated risk to learn if you’re gambling for nothing.

Not every stock market has read the textbooks

It’s also important to realize that even the ‘right kind of’ risk can go unrewarded.

You might expect higher returns, but higher returns are not guaranteed.

For example, we say investing in risky equities can be expected to deliver higher returns than super-safe government bonds. But there’s no guarantees, and no timescales.

Indeed there have been long periods where the return from bonds beat shares!

Over the ten years to the end of 2008, for example, the annualized returns from US and UK shares were negative. In contrast, bonds soared.

So much for risk and reward over that decade.

And in case you’re thinking you can handle a ten-year duff stretch – and you will have to over a lifetime of investing – some have had it much worse.

How would you feel if your well-founded risk-taking wasn’t rewarded for half a century?

In 2011 Deutsche Bank reported that:

…for three members of the G7 group of leading industrialised nations, Italy, Germany and Japan, returns from equities have been worse than those of government bonds since 1962.

Indeed, the Italian stock market has even managed to deliver a negative real return over the past half-century, -0.38 per cent on an annualised basis versus +2.64 per cent for bonds, “a remarkable statistic in a world where we are all used to seeing equity outperformance increase the longer you expand the time horizon”, wrote Jim Reid, strategist at Deutsche.

In Japan, government bonds have delivered a real return of 4.17 per cent a year, beating the 2.72 per cent of equities, while in Germany bonds have won by 4.28 per cent versus 3.46 per cent for equities.

Academics – and professional investors – struggle with findings like these. They go against the theory of efficient markets I discussed earlier.

For the market to get it wrong for 50-odd years might suggest:

  • Those markets were unusual for some reason.
  • We don’t have enough data. (A tossed coin coming up 10 times in a row doesn’t disprove probability theory. Try tossing it a million times.)
  • The efficient market theory has limitations.

Personally I’d plump for a mix of all three in the case of Germany, Italy, and Japan.

But I’d also point out that all the leading efficient market academics hailed from the US, a country that has had the strongest, most consistent, and least ‘anomalous’ markets – with the best data, tracking a period including two World War victories, or three if you count the Cold War, and a transition from emerging market to sole global superpower status.

Could this very positive North American experience have biased the research or the conclusions? It seems feasible, but we’ll leave going down that rabbit hole for another day.

The important point here is expected returns are not guaranteed returns. Real-life investors in some countries never saw a sniff of them over a lifetime.

There are several important practical takeaways. For example, somebody on the point of retiring should not have all their money in equities, despite the higher expected returns.

Stock markets usually crash once or twice a decade, and that can chew up your higher returns in the short-term. That’s a big risk, especially for an imminent retiree or a newly-retired one. Statistically you might think it’s unlikely, but if it’s you, and you had no back-up plan, you’re somewhat stuffed.

This is called sequence of returns risk. It’s not a reason to have no shares or own only gold, or any of the other dramatic things people write in the comments on blogs. It’s a reason to own fewer shares, and to diversify.

Risk in real life

I was set thinking about this recently by a family friend.

Having come into some money, she bought me that quintessential millennial brunch of avocado on toast and picked my brains about what to do with it. (The money, not the toast.)

My first step when this happens is usually to send over a bunch of Monevator links, and wait to see if they get read.

If the person doesn’t do their homework (and they usually don’t) then that helps inform where I steer them next.

But in this heartening case my friend read all the suggested articles, and she was keen to let me know so.

For example she explained to me that she now understood that she should never sell, that stock markets always come back, that you have to take risks to win… right?

Er, right, I said. Sort of.

It’s complicated!

Investing is like that. You have to learn a lot to realize there’s a lot you don’t or even can’t know for sure.

One excellent if rather gnomic definition1 of risk is:

“Risk means that more things can happen than will happen.”

Whereas my friend had taken risk to basically mean “what goes down will come up.”

We can have expectations, given time, but there can be no certainty. If there was certainty, there’d be no extra risk. And if there was no extra risk then there’d be no expected higher returns – because they’d have been bid away by the market, at least in theory.

As blogger Michael Batnick says, you are owed nothing:

This is how stocks work. The stock market doesn’t owe you anything.

It doesn’t care that you’re about to retire. It doesn’t care that you’re funding your child’s education.

It doesn’t care about your wants and needs or your hopes and dreams.

Batnick stressed in that article that he still believes shares are “the best game in town” for long-term investors.

But you must have realistic expectations about your expectations.

Shit happens

To conclude, I’ve long wanted to include this graph in a post. It’s from Howard Marks’ wonderful investing book The Most Important Thing:

The right way to think about risk.

Source: The Most Important Thing.

What this graph shows us is that expected returns do indeed increase with risk – but there’s a range of potential outcomes along the way. Some are dire. Plenty are bad.

It is a good graph to sear into your brain.

This graph is why most people are advised to use widely diversified stock funds, not try to find the next Amazon or Facebook.

It is the reason to hold some money in cash or bonds even when savings accounts pay you nothing and bond yields are negative.

It’s why we should stay humble and diversify our portfolios across asset classes, even ten years into a bull market. (Or make that especially ten years in…)

As with many things, expect the best outcome when investing – but be prepared for the worst.

  1. I first heard it from Elroy Dimson of the London Business School. []

How to get a 13% return from RateSetter

Mixing RateSetter’s £100 bonus offer and high interest rates should deliver a tasty return

Good news! RateSetter has brought back its £100 bonus offer for investors who put away just £1,000. To get the bonus, follow my links to RateSetter in this article. I will also get paid a bonus by RateSetter if you sign up via one of these ‘refer a friend’ links to claim your £100 bonus. This doesn’t affect your returns – it is paid by RateSetter.

I am not going to cause any readers to fall to their knees screaming “No! How can it be? Why didn’t somebody tell me!” if I say it’s been very hard to get a decent interest rate on cash for the past few years.

But in this article I’ll explain how you can effectively get a 13% return on a chunk of your cash by taking advantage of a bonus offer from RateSetter, the peer-to-peer lender.

True, this very attractive potential return does not come without risk.

Peer-to-peer does not have the same protections as normal cash deposits, and you should think about it differently to cash in the bank. More on that below.

If, however, you have the risk appetite for it and the spare cash to hand, I believe this is a pretty safe – though not guaranteed – way to make a good return.

It also exemplifies how being nimble with your money can enable you to achieve higher returns – even in today’s low rate world.

About RateSetter

RateSetter is one of the new breed of peer-to-peer lenders that aims to cut out the banks by acting as a matchmaker between ordinary savers and borrowers like you and me.

Rates change all the time, but as I write you can for example get up to 4.8% as a lender with RateSetter by putting your cash into its five-year term market.

Meanwhile borrowers can get a loan charging less than 4%. RateSetter claims that rate is competitive with the mainstream banks, and says banks are its competition (rather than it simply getting all the bank rejects).

In April 2014 RateSetter scrapped its lending fees, which was great news for savers like us. Borrowers do pay a fee, though.

Importantly, of the 62,877 investors who’ve lent money with RateSetter not one has yet lost a penny of their investment.

That’s because in 2010 RateSetter set-up a ‘Provision Fund’, which is funded by charging all borrowers a risk-adjusted fee.

Money from the Provision Fund is used to repay lenders whose borrowers miss a payment, for as long as there’s money in the fund to do so.

It’s a different model to the earlier peer-to-peer approach of platforms like Zopa, where instead you were encouraged to spread your loans widely and accept a few would go bad, reducing your overall return.

Zopa has since introduced its own Safeguard protection that aims to cover lenders for losses, similar to and following in the footsteps of RateSetter.

As sensible people of the world, we should understand there’s no magic going on here. Some loans will still go bad. And those bad loans will still reduce the returns enjoyed by lenders in aggregate – because the Provision Fund fee levied against borrowers as part of the cost of their loan could otherwise go to lenders in the form of a higher interest rate.

However what the Provision Fund (or Zopa’s Safeguard) does is share those losses between all lenders, reducing everyone’s return a tad.

This makes returns more predictable, as your outcome should be dependent on the interest you receive – rather than being distorted by the bad luck of being personally hit by an unusually high number of bad debts.

Note though that the Provision Fund (obviously) does not provide complete protection against all the loans made at RateSetter defaulting. Far from it.

Rather it aims to cover the bad debts predicted by RateSetter’s modelling, and in addition a margin of safety.

If the Provision Fund ever ran out of money then interest payments could be redirected to repay capital unless the default rate pushed past 8.6% or so, according to RateSetter’s projections. Bad, but still quite a safety cushion given the relatively high rates on offer.

I think for most people, the Provision Fund approach is better than the lottery of individual loans defaulting and it is a comfort, but don’t mistake it for a panacea or a guarantee.

You could conceivably lose money if defaults are much worse than expected. More on that below.

How to bag that 13% return from RateSetter

At last, the good bit!

RateSetter is currently offering a £100 bonus to new customers who invest at least £1,000 in any of its markets and keep it there for a year.

The £100 bonus is paid once that year is up. It will be deposited into your RateSetter account, after which you can choose to do with it (and the rest of your money) as you please.

Clicking on any of the RateSetter links in this article will take you directly to the sign-up page for the £100 bonus.

For full disclosure, RateSetter will also pay me a £50 bonus if anyone does sign-up via my links, which would obviously be very welcome! My bonus doesn’t affect your returns. It’s paid by RateSetter.

As for your £1,000 investment, you can put it into any RateSetter market, which range from a rolling one-month option to a five-year lock-up. But you must keep it within RateSetter for a year to get your £100 bonus.

To keep things simple, let’s assume you invest your £1,000 in the one-year market, given it matches the period required to qualify for the bonus.

That one-year market is paying 3% as I write.

So after one year you’d have your 3% interest on your £1,000 and you’d also receive your bonus, which works out as a return of 13% on your £1,000.

Very nice!

I’ve ignored tax here on the interest because everyone’s tax situation is different.

And anyway, the good news on tax is that:

  • You can now open a RateSetter ISA and collect the bonus – and in an ISA the income you earn is tax-free.
  • Most people even outside of an ISA will be paying no tax on cash interest thanks to the new-ish Personal Savings Allowance that covers the first £1,000 of interest earned by basic rate taxpayers, and £500 for higher-rate payers.

Is this bonus too good to be true?

A great question.

Clearly it’s not sustainable for RateSetter to lend your money out at, say, 7%, while paying you an effective rate of 13%.

(The cost is even higher to RateSetter if it pays me a bounty, too.)

However RateSetter will surely be hoping this is the start of a multi-year relationship with its new sign-ups once they become comfortable with its platform.

It will also hope many customers deposit more than £1,000 and ultimately prove profitable in the long-term.

Like all peer-to-peer lenders, RateSetter will be aiming to scale as quickly as possible. Greater size will improve its margins and enable it to continue to meet demand in both the savings and loans market. Scale is a critical factor in virtually all money-handling businesses.

I expect the cost of this offer is allocated internally to the marketing department. If 5,000 people sign-up for the bonus that’s clearly a lot of money – but it wouldn’t buy very much TV airtime. At least this way RateSetter can precisely calculate the return on its investment.

But I do think it’s a smart question, and it neatly brings us back to risk.

A final word on the risks

I have already stated that peer-to-peer lending is not a straight swap for a cash savings account. The risks are much higher.

Firstly and crucially, there’s no Financial Services Compensation Scheme coverage for peer-to-peer lenders. If you lose money, the authorities will not be bailing you out like they would for up to £85,000 should your conventional High Street bank get into difficulties.

That’s important because even though no savers have yet lost a penny with RateSetter, that’s not a guarantee they will not do so in the future.

The economic situation could change markedly, say, or RateSetter could get its sums wrong on bad debt.

In the most likely worst-case scenario (in my opinion) the Provision Fund would not be able to cover all the bad debts. This could mean some loss of capital.

  • According to RateSetter, as of April 2018 the default rate experienced to date is 2.22%.
  • It says its Provision Fund would not run out unless the default rate breached 3.5%, beyond which point interest payments could be used to cover capital losses. Interest payments would fall, accordingly.
  • Up to an 8.7% default rate, RateSetter still projects lenders getting their capital returned wholly intact, albeit with lower than expected interest payments.
  • Even if defaults hit 14%, RateSetter says lenders would still only lose 5.3% of capital – so they’d get just under 95p for every £1 they’d put in.

RateSetter argues these figures actually underestimate the strength of the Provision Fund, since they presume the contribution rate to the fund is static, and they also assume no recovery of any funds in default. (In reality it would expect to get some of its money back.)

As for the worst worst-case scenario, you can imagine catastrophic situations where you would lose everything.

But to my mind these would probably require fraud or massive incompetence within the company, and/or a far deeper recession than anything we saw in 2008 and 2009. (Probably both at once – as Warren Buffett says you only see who has been swimming naked when the tide goes out.)

Obviously I don’t think that’s at all likely, otherwise I wouldn’t have put any money into RateSetter.

But you invests your own money and takes your choice.

Personally, I am happy with the risk/reward here. Not everyone feels the same. My own co-blogger, for instance, doesn’t use any peer-to-peer platforms.

As a halfway house to reduce risk one could perhaps only invest in RateSetter’s monthly market, in the hope this would give you more chance of getting money out relatively quickly if say the economy was coming off the rails. The price is a lower interest rate, of course.

I think it’s worth stressing again that nobody has lost money so far with RateSetter. And even if the economy turns very far south, you probably won’t lose more than a small percentage unless something very bad or criminal happens.

That would be a much worse situation than with cash, but not a catastrophe.

However we all know by now that bad things can happen, and every investment can fail you. Do not invest money you cannot afford to lose.

RateSetter and your portfolio

Personally I use take a pick-and-mix approach to spread the risk with these sorts of alternative opportunities.

For instance, I have used both RateSetter and Zopa, I’ve invested a little in mini-bonds and retail bonds, I have money with NS&I, and I have taken advantage of high interest rates and cashback offers with accounts like Santander 1-2-3 to boost my returns.

When putting money into the riskier alternative options, I only invest a very low single-digit percentage of my net worth with any particular one. Like this I aim to mitigate the risks of being hit by some sort of systemic or company failure.

I’m not going to labour the point on risk further – most articles barely mention it when discussing peer-to-peer, and I’ve devoted half this piece to it. Consider yourself warned, and read the company’s extensive material if you want to know more.

I think peer-to-peer and other cash alternatives are interesting additions to our arsenal as private investors, but they’re not slam dunk safe bets. I size my exposure accordingly.

Get your £100 while it lasts

So there you have it – a hopefully even-handed assessment of the risk and reward potential of this £100 bonus offer from RateSetter.

From here you’ll have to make your own mind up.

I do hope some of you found this article interesting and go on to enjoy those bonus-boosted returns.

Painting: Two friends compare their investments.

Working out the best online broker or platform1 to use in your investing can be frustrating.

Just when you have got your head around shares versus funds, corporate bonds versus James Bond, and you’re finally ready to start investing, you discover dozens of different brokers to choose from.

All have their own similar-but-different fee structures.

We have long kept track of the different broker platforms and what they charge via our fee comparison table.

But comparing the charges levied by say Hargreaves Lansdown with those of Interactive Investor can be fiddly work.

Details matter. Some brokers charge lower fees for trading but sting you with high withdrawals fees. Others offer cheap trading, but make additional annual charges for each different kind of account you open with them – once for an ISA and again for a SIPP. There may be entry and exit fees, too.

You also need to compare fixed annual platform fees – for instance £15 a quarter – with the alternative method of levying a percentage fee – say 0.25% year – on your investment pot. Which is more cost effective for you?

What’s more, the winner of this equation will probably change as your nest egg grows! You’ll need to run the numbers every few years to keep your costs as low as possible.

Get tooled up to compare investing platforms

If you find all this fun then you’re in the right place. We’re investing nutters around here.

But most people frankly do not.

Out in the wider world, people use interactive tools to compare things like insurance products and energy bills.

Well, that is now possible with investing platforms, too.

We’re hosting an interactive comparison tool created by our partners at Broker Compare. We hope it will help casual investors get their money onto a suitable investment platform with a lot less hassle.

In fact anyone who wants to hone in fast on the best potential brokers will find it a quick way to generate a shortlist of candidates.

True, if you want to work out precisely what you’ll pay – in your specific situation – you’ll always need to do the sums for yourself.

There are just so many quirks out there, and any tool needs to make a few assumptions. Only you know exactly how you plan to invest and why.

But for many people, getting a good idea of the best platform to use quickly is the most important thing.

They’d rather know approximately what they’re going to be charged than laboriously figure out the exact costs from a dozen or more competitors.

Compare the brokers and save hundreds of pounds

Monevator regulars love to debate the minutia of different platforms with all the passionate enthusiasm of trainspotters arguing about the best non-standard railway gauges found in the wilder mountainous regions of Europe.

And long may that continue. (You’re among friends here.)

But the average person has little idea of their broker’s fees – or how what they’re paying compares to the competition.

For these people, five minutes with a comparison tool could be a quick way to save hundreds or thousands of pounds.

So what are you waiting for?

Note that just as with the price comparison websites we all use to compare energy bills or mortgages, Monevator may receive a payment from a broker that you visit or sign-up with via the table or tool. This does not affect the fees you pay – it’s made by the company to us for introducing you to their business.

Happy hunting – and let’s save some money!

  1. We tend to use the words ‘broker’ and ‘platform’ interchangeably. A broker is a stock broker – a person or company who trades and holds investments on your behalf. The platform is their website that lets you see and adjust your investments. []