≡ Menu
Weekend reading: Should we invest in the robots, or in the toys they’ll use to keep us happy? post image

What caught my eye this week.

Josh Brown at The Reformed Broker wrote this week about the rise of the robots – and of artificial intelligence (AI) – from an investing perspective.

The perceived danger of advances in AI is a common theme these days. (I just saw Blade Runner 2049, and very good it is, too.)

But Josh struck a novel note when he suggested fears about AI and automation mean some investors are no longer putting money to work to replace their income when they retire in their 60s – but rather to have a life-raft if AI kills their job long before then:

There is a sense of desperation underlying the way in which we’re investing. […]

A 45 year old married father of two with a mortgage and a pair of college educations to fund. The remote yet persistent threat of a nuclear war is not what keeps him up at night.

In fact, he might almost see it as a relief should it come. He is a bundle of raw nerves, and each day brings even more dread and foreboding than the day before.

What’s frying his nerves and impinging on his amygdala all day long is something far scarier, after all. He, like everyone else, is afraid that he doesn’t have a future.

He is petrified by the idea that the skills he’s managed to build throughout the course of his life are already obsolete.

“Just own the damn robots!” concludes Josh, and I agree you should have a few horses in the race.

Hopefully there aren’t many Monevator readers who only own the UK stock market or companies listed on it. But if you’re one of them, know that you are getting very short-changed in the robot department. When chip designer ARM was acquired by SoftBank we lost our last great listed tech titan. You have to look overseas.

Personally I own technology investment trusts and individual tech shares. If you are a passive investor with solid exposure to the US market (perhaps through a global tracker) you’ll be getting a lot of technology through that, too.

Fun and games

I wrote an unfinished post (actually a chapter of a very unfinished investing book) along the same lines as Josh a few years ago. I agree it’s worth some thought.

But actually, I am not at all sure that all the riches will go to the robot owners.

For starters, it’s very unclear whether robots and AI really will take all our jobs. I’ll grant you things do feel different right now, but historically technology creates far more work than it destroys. Also, my friends working in the field say progress is very over-hyped.

But even if robots do take all today’s jobs, that doesn’t mean they’ll necessarily take all the wealth.

When industrialization replaced 98% of the jobs in farming, farmers didn’t become rich, nor did the manufacturers of farm equipment inherit the world. You’d have done better to invest in companies benefiting from the resultant urbanization boom, and the changes to leisure and consumption.

What will we do if robots do all the work but fail to get all the pay?

Perhaps we’ll play more computer games. Maybe instead of shares in robot makers – or even companies that make use of robots – we should own game creators like Electronic Arts.

Think that’s a depressing future for humanity? Then alternatively you could buy shares in Diageo, the UK whiskey behemoth. Perhaps we’ll all drink ourselves into oblivion…

[click to continue…]

{ 21 comments }

Book Review: Living Off Your Money by Michael McClung

Cover of Living Off Your Money by Michael McClung

How should you manage your money when you retire? Should your portfolio change when you finally sign your F.U. letter to the boss?

Is the famous 4% rule really safe or is there a better way?

While the passive path to accumulating your pension pot is well lit by blogs, books, and preachers of the gospel, the more difficult question of how to safely ration your retirement savings has no simple answer.

Attempts to supply a silver bullet to retirement spending often flounder. Proposed solutions may be unrealistic, mistranslated, too narrow, or grossly oversimplified on their journey from academic journal to custom and practice.

Michael McClung’s achievement is to survey that landscape with the rigorous eye of an engineer who wants to build a house that won’t fall down.

He’s poured his findings into Living Off Your Money. It’s a practical, safety-conscious, and evidence-based manual that DIY investors can use to avoid the retirement quicksands.

Hazards ahead

One big thing lifelong savers need to grasp as they contemplate retirement is that we become more vulnerable as we rundown our stockpile.

An unfortunate sequence of returns can put us on a crash course early on. Inflation and even the blessing of a long life can put us on prison rations in our twilight years.

The situation is worsened because traditional retirement rules-of-thumb like the ‘4% rule’ are about as reliable as ‘red sky at night’.

The 4% rule is prone to failure, numerous caveats that don’t fit into 140-characters or fewer (or even 280), and it’s barely applicable outside the US. And where the 4% rule can leave some retirees on the brink of poverty, it can leave others departing the stage with most of their hard-earned loot unspent.

The system offered by Michael McClung takes a data-forged sword to those twin-headed terrors. His design relies upon two important techniques that many retirees may struggle with:

  • Dynamic asset allocation
  • Dynamic withdrawal rate

Dynamic asset allocation means that your yin and yang of equities and bonds is no longer fixed by some permanent cosmic ratio. Instead, your percentages can pitch up and down depending on the motions of the market.

A 50:50 portfolio could, with McClung’s system, average between 30%-70% equities over the course of a retirement.

In extreme conditions you could end up with 100% of your portfolio in equities. Conversely when equities are storming ahead you’ll convert them into high-quality bonds, ensuring there’s fodder in the barn for when winter comes. And when equities are blown away like dandelions in a category five hurricane you’ll live on bonds until they’re gone. There’s no automatic annual rebalancing here.

With a dynamic withdrawal rate, your income rate can also vary every year.

A tempestuous retirement could see withdrawal rates swing between 2.5% and 6%. Benign conditions might bless you with an average withdrawal rate of 7.7%. When your portfolio swells, a dynamic withdrawal rate lets you spend more. When conditions worsen you batten down the hatches.

All this may make the system sound random, but it’s rather that the plan flexes in response to market feedback. It gives you a brake and an accelerator to apply rather than putting you on rails until your retirement train terminates.

If that sounds like market-timing, it isn’t.

Trial by data

Living Off Your Money builds on the work of other retirement researchers. (These guys have lower profiles than North Korean late-night comedians, and are probably only familiar to you if you’re into obscure financial planning journals.)

All have sought to improve upon the cult of 4% inflation-adjusted withdrawals plus annual rebalancing.

For his part McClung reverse-engineers their systems, tests them to within an inch of their algorithms, and then bolts together the best parts to come up with his recommendations.

The major difference between McClung and most other retirement researchers is that McClung has subjected these formulas to more tests than a talking ape.

Standard practice is to pit your proposals against the historical performance of US equities and bonds and leave it at that.

The danger is that a system that worked well when US assets outgrew those of most other nations may not look so clever when planted in poorer home soils. Even US investors may not enjoy such sunny days again. Non-US residents have no reason to expect to.

McClung guards against this by testing his contestants against the UK and Japanese datasets. Neither has enjoyed the same hot-hand as the US.

No retirement strategy trumps all others, everywhere, every time. Optimisers are missing the point – you might as well try to optimise a baby. What works in one situation won’t always work in another. McClung acknowledges this and recommends a plan that:

  • Works well during historically difficult retirement periods
  • Is robust across geographies
  • Maximises withdrawals
  • Avoids catastrophic failure like a zombie plague
  • Leaves a large margin for error

He doesn’t stop there. McClung also checks his system versus the chilling effects of a low-growth world. His recommendations assume a globally diversified portfolio and performance. McClung’s mindset is world-first, not America-first, which makes his work directly applicable to UK investors in a way that most retirement research isn’t.

The Living Off Your Money strategy can also be calibrated for shorter and longer retirements. That is especially handy if financial independence is on your ‘to do’ list.

Don’t misunderstand me – McClung isn’t claiming his method is fail-safe. Very few retirement strategies would look good after a dose of German-style hyperinflation and being on the wrong side of two World Wars.

There are no guarantees, only probabilities.

The downside

There’s always a downside in investing and the trade-off demanded of you by the Living Off Your Money approach to retirement spending is that you can tolerate a volatile income and asset allocation.

Yes, you’ll probably be able to spend more over the course of your retirement. But there will be times when you’ll need to spend less. (The reality is that many retirees do naturally vary their income anyway outside of the confines of the retirement researcher’s lab.)

Sticking to the plan may also mean going all-in on equities in extreme conditions. Many retirees couldn’t cope with those strains.

To help alleviate some of these issues, McClung explains ways to take the edge off his purest prescriptions.

Floors and ceilings can be used to contain your equity allocation. There’s also an extensive section on creating guaranteed income to cover the bills when your withdrawal rate dips alarmingly low.

You may need to work longer to be able to afford such optionality. That’s the price of sleeping well at night.

Easy doesn’t do it

While McClung is a master of retirement theory, he doesn’t wallow in it. He never loses sight of his goal of creating a book that can genuinely help people.

The explanations are clear, and McClung carefully ropes off step-by-step practical sections that can be chewed on separately if you’d rather skip the methodology hors d’oeuvres.

Yet his work is steeped in integrity. McClung goes to great pains to explain his guiding principles and assumptions and – unlike some financial writers – all of his recommendations can be fulfilled in real life. There’s even a spreadsheet on his website to support anyone who wants to implement his strategy.

None of this changes the fact that reading this book and managing your portfolio by its light requires a fair degree of investment literacy.

The truth is, nobody should manage their retirement investments without a strong financial education and Living Off Your Money can help school anyone, regardless of whether you ultimately apply its teachings.

Long-term Monevator readers will be in their element. But if you just want to get by with a couple of blog posts and a few simple rules that could be printed on a tea towel then this isn’t the plan for you. Your best bet would be to accumulate so many assets that you are left with plenty of room for error.

On the other hand if you have a strong risk tolerance, genuinely enjoy engaging with investing, and want to do more with less then McClung might just change the course of your retirement.

If you’re not sure which camp you fall into then McClung has made three sample chapters available for free.

Alternatively, check Living Off Your Money out on Amazon and let us know in the comments below what you think of it.

Take it steady,

The Accumulator

{ 57 comments }

Weekend reading: Kensington vs Ebbw Vale

Weekend reading logo

What caught my eye this week.

I am heading away early for the weekend, so not much time to muse over any of this week’s abundant links.

So I’ll just highlight this rather striking statistic from the ONS, as reported by The Guardian:

“It now costs nearly £19,500 to buy enough residential floor space for a decent-sized coffee table in London’s priciest borough – but only £777 to accommodate the same small piece of furniture in a living room in south Wales.”

Obviously that’s an apples to oranges comparison (and I say that as a fan of South Wales!)

But can the London market really hold such a premium for much longer in the face of Brexit?

[click to continue…]

{ 35 comments }

Do you need income protection insurance?

Photo of Mark Meldon, IFA

The following guest post is by Mark Meldon, an independent financial advisor (and Monevator reader!) who we’ve noticed talking a lot of sense over the years. We thought we’d ask him to explain some of the more obscure or technical corners of personal finance.

Unfortunately income protection insurance is the least popular by sales volume of the three key kinds of personal insurance – life cover and critical insurance cover being the other two. Whether you need it is an important subject for serious consideration and debate.

In this article I’ll try and demystify this important personal protection policy, explain the features that you need to look out for, and offer two real-life stories to illustrate the potential importance of income protection insurance.

Your top financial asset: You

We all go to work for two reasons:

1. We love our job

2. We need the pay cheque

If I’m wrong about you loving your job then you should consider changing it. I’m sure I’m right about needing the pay cheque!

People forget how entirely reliant they are on being able to do their job. Yet this depends to a very great extent on our health – physical and mental. Lose one or both and you are quickly in trouble.

If you are 30 and earn £30,000 a year, you might bring home £1,050,000 in total between now and age 65, ignoring things like pay rises and inflation.

But what would happen if you couldn’t work because you were long-term sick?

If you have wealthy relatives and friends ready and willing to help financially then that’s great.

Most of us don’t though. We need to think about the risk of something unpleasant happening, and whether or not to offload that risk to an insurer.

What happens if it all goes wrong?

You might be lucky in that your benevolent employer has set up a ‘group’ long-term disability insurance policy. However only a small proportion of the population are so covered (around 11%, according to Canada Life).

Meanwhile you should know state benefits are meagre and ever harder to qualify for. Many people are surprised how quickly they can fall into a financial abyss should a problem arise.

For example, did you know that for most of its employees, the National Health Service pays full salary for six months, half for six months, and then nothing?

A private income protection insurance policy will provide you with a guaranteed source of tax-free replacement income should disaster strike. That’s got to be a good idea!

Back in the 1870s, so-called friendly societies sprang up to address this problem by organising sickness insurance policies, and mainstream life insurance companies soon joined them in doing the same.

Both types of providers are still around but there are important differences. I’ll return to these later.

Plan features

It’s very hard to compare policies as they can be quite complex and you have to consider other important factors like the financial strength of your chosen insurer and their claims paying history.

However there are several basic common features:

  • Sum insured – This is the amount of income you’d receive monthly should you suffer from a condition or illness that triggers the policy benefits. Most policies will not go higher than 55%-60% of your pre-disability income. This is to incentivise you to return to work in the fullness of time.
  • Payment period – The maximum length of time the claim would be paid. This should be throughout your working life to, say, age 65. Short-term policies with payment periods of two to five years are available but I rarely arrange them. I don’t think that they really provide adequate cover.
  • Proportionate benefit – This feature means that your insurer will pay part of the sum insured if you are able to return to work on a part-time basis. If you relapse, the full benefit would be reinstated.
  • Deferred period – The period that your illness or disability must last for before you’ll begin to receive the sum insured. This can be anything from one day to two years, but three or six months are the most common choices. The longer the deferred period the lower your premium will be. The period chosen should fit in with your employers sick pay arrangements. You can also arrange ‘split deferred’ policies, with some cover starting after six months with the full sum insured falling due after twelve.
  • Indexation – This means the sum insured and premiums are automatically increased each year by either a fixed percentage or by reference to an index such as the RPI. Some policies do this both before and after a claim, others one or the other. An essential ingredient, I think.
  • Guaranteed insurability – This refers to two things. Firstly, the ability to purchase further cover without providing health information (within strict limits). Secondly, the policy cannot be taken away from you once it has been issued, ever, unless you cease paying the premiums. This feature was reflected in the old name for this policy – ‘permanent health insurance’.
  • Guaranteed or reviewable premiums – Most mainstream insurers offer you a choice of guaranteed premiums where the ‘rate’ is locked in at outset or, for slightly lower initial cost, reviewable premiums where the premiums can be reviewed, up or down, depending on the overall claims experience of the company. I have a reviewable premium policy myself that I set up years ago and the ‘rate’ really did go down one time. My preference today is for guaranteed premiums, as you know where you are.
  • State benefits deduction – Some policies reduce the sum insured by any state benefits you might end up receiving. Less common, nowadays, but worth watching out for.

Definition of disability

Arguably the most important thing to look out for is the definition of the word disability.

The primary distinction is whether your policy covers ‘own-occupation’ or ‘any-occupation’ disabilities.

An any-occupation policy requires that to receive your benefits you must be unable to perform the material duties of any occupation. That’s pretty hopeless – the emphasis is on any. Perhaps uncharitably, this has been referred to as the ‘vegetable clause’.

I would say that the whole point of these policies is to help you protect your income, not someone else’s. So, unless you do something very unusual or risky, you need an own occupation definition of disability.

So, serious consideration should be given to buy a full-term policy with as long a deferred period you can afford by reference to your savings to age 65 or so. Make it indexed and seek the own occupation definition of disability.

Underwriting

Underwriting is the work your chosen insurer undertakes when assessing your proposal.

Although the process of looking at income protection insurance has a number of similarities to life assurance risk assessment – for example height, weight, blood pressure, and daily habits – there are a number of important differences, too. Occupation and hobbies are just as important considerations as your physical details.

I have noticed of late an increased interest in alcohol consumption. There is, apparently, a significant cohort in the UK who drink far too much and they are now in their thirties and forties when the risk of alcohol-related mental health and physical diseases suddenly increases. You might get a lot of questions about your booze intake!

Several insurers offer telephone-based underwriting, which I find very convenient for clients.

Often the insurer will request a medical report from your GP and can ask for a medical screening or other medical tests. They pay for these so you could say they are a free health check.

These can turn out to be lifesavers. I have seen two diagnoses of diabetes in recent years and one of life-threatening high blood pressure following insurance medicals.

Claims

In common with many peers, AEGON recently published their 2016 claims experience. Its split showed 61% of claims were by men, 39% women.

The biggest reason for a claim was mental health at 27%, with cancer, musculoskeletal and cerebrovascular claims taking 19% each, cardiovascular 12% and ‘other’ 19%. The latter includes Huntingdon’s disease, diabetes, and multiple sclerosis.

Some 85% of claims were paid totalling £343,000 a year with the average claim value £15,589 a year. The biggest claim was for £68,196 a year and the average age at claim was 48-years old. The average age of the policy at claim was eleven years and six months (Source: AEGON March 2017).

All insurers will want you to get well as soon as possible. They offer a great deal of help and support to genuine claimants.

Fraudulent claims will not be tolerated and the 15% of claims not paid were either due to non-disclosure at the outset of the policy (you must be honest when applying for any kind of insurance, it goes without saying) or the reason for a potential claim falling outside of the policy benefits.

Providers of individual income protection insurance

Policies come from a variety of well-known insurers such as AEGON, Aviva, and LV=, to name but three. They offer excellent contracts for most people in low-risk occupations.

However, we shouldn’t forget the ‘Holloway’ societies, named after the MP for Stroud who brought about their founding legislation in 1870.

These are friendly societies and, whilst they underwrite your health and lifestyle just like the life offices, they are rather more lenient as far as occupations are concerned as they were originally set up to insure the working man.

How much will it cost?

Costs are hard to estimate. It depends on your age when you apply, your benefit choices, expiry age of the plan, and your health, lifestyle, and occupation.

Mainstream insurers will have standard premiums, nowadays on a unisex basis1, but these are often only the starting point. Some 40% of proposals attract non-standard premiums in one way or another in my experience.

Friendly societies have age-banded policies – due to their legal constitution – so their premiums will rise with age every now and again.

Office workers tend to pay significantly less than teachers who in turn would pay rather less than an HGV driver. Some occupations are just too hazardous to cover, such as miners and oilrig workers.

The younger you are when you apply, the lower will be the cost if you qualify for standard terms.

The best thing to do is to ask an independent financial advisor to run some quotes. They will also draw upon their experience of the market for these policies when making recommendations.

Here are some example quotes for a 36 year old office clerk (gender immaterial) insuring for £1,000 per month benefit, linked to RPI, with a three month deferred period to age 68. Guaranteed premium rates. This is, of course, a low-risk occupation.

Non-smoker rates

  • Original Holloway £14.77 per month*
  • Legal & General £27.24 per month
  • LV= £29.17 per month

Smoker rates

  • Original Holloway £14.77 per month*
  • LV= £29.71 per month
  • Legal & General £43.88 per month

* Age-banded premiums so might be more expensive in the long-run.

Quotations are available from several providers – these are just representative (Source: Iress/Exchange 10 October 2017). It very much pays to shop-around or to use an IFA when comparing quotes, ancillary benefits, and policy provisions.

A couple of case studies

With names and other details changed, here are two true stories from my recent experience.

A few years ago I was asked to look after the private pension funding of a legal professional. When I first became involved he was in remission from cancer and explained that, being a prudent individual, he had arranged life cover, critical illness insurance, and an income protection policy some years before my involvement.

The critical illness insurance policy had paid him a lump sum and enabled him to pay off his mortgage in full. His income protection insurance policy had also been claimed. It was paid proportionately as his health improved and he was able to work part time, then suspended when he returned to work full time. The policy remained fully in force’.

Sadly, he became unwell again. The income protection insurer reinstated the full benefits under his policy without quibbling. Unfortunately, he died a few years ago after having been on claim, on and off, for six or seven years. But he was very grateful for the help and advice his provider had given him in those years.

More recently I arranged a friendly society income protection policy for another one of my clients. Michael is a self-employed tree surgeon and gardener; a lovely man, with a ready smile, but of modest financial means. He realised his occupation was risky and we set up a policy with The Original Holloway Friendly Society up to state pension age.

You guessed it! Michael fell out of a tree and badly damaged his back.

“They won’t pay out, will they”, his wife said when she gave me the news. “Yes they will” I answered and they did after just eight weeks deferment period, just as savings were running out.

Michael thought the Original Holloway were great in that he was given every practical help to get better as they paid for specialist consultation and “the policy kept the roof over our heads”.

He did get better after a few months and the claim was reduced and then came to an end. Then there was a (thankfully brief) relapse, and the policy kicked back in.

Michael is confident that he has made a full recovery. But you never know, so he has maintained the premium payments on the policy and will do until it finishes at age 67.

The bottom line on income protection insurance

If you earn any money, in my opinion you should insure your ability to receive an income if you are incapacitated, period.

You can only do this through the too-often overlooked income protection insurance policy.

Choose carefully, tailor the policy to your personal financial circumstances, and never bin it unless your employer offers adequate cover. (Even then what if you subsequently leave and your health is not as good as it was?)

Be prepared to pay up, as the premiums for these policies can seem expensive.

Mark Meldon is an Independent Financial Advisor based in Cheddar, Somerset. You can find out more at his company website. You can also read his other articles here on Monevator. Let us know in the comments if there’s a topic you think Mark could cover.

  1. Women tend to make twice the number of income protection insurance claims as men but pay the same premiums – or rather men pay more since gender-based premium equalisation – Source UNUM 2012. []
{ 24 comments }