What caught my eye this week.

A few of you have been asking what happened to our pal Lars Kroijer? And it’s true, there was a time when you couldn’t turn to Monevator without tripping over another great article by the ex-hedge fund manager turned index investing ultra.

Well, I’m pleased to report that Lars is well and so are sales of Investing Demystified. However there are only so many ways you can urge people to buy a global index tracker (tell us about it!) and I get the sense he’s enjoying a bit of a break.

Never one to ignore a hint, however, I was able to penetrate Lars’ chill-zone defenses and persuade him to make another appearance on this website.

Instead of an article though, Lars wants to do something different – a real-life Q&A where he responds to reader questions.

Lars suggested doing it live, but I watched too much Blue Peter as a kid for that and feared a calamity. So instead he’ll record a video answering your questions and we’ll post it here.

Of course that does mean we need some reader questions to ask him…

So, what would you like to know from a man whose career improbably straddles the spectrum from successful hedgie to best-selling passive investing author? Asset allocation, overseas bonds: yea or nay, whether the hedge fund world is really as witty as Billions, do they eat Danish pastries in Denmark – all fair game I reckon.

Please ask a few good questions in the comments below. Otherwise we’ll have to pad out the Q&A with karaoke requests, and nobody wants that…

[continue reading…]

I have long had a guilty fascination with The Sunday Times’ Rich List.

I remember its launch in the 1980s. It seemed a fanciful publication. As a teenager in a comp in the provinces, I saw TV skits about yuppies in London getting rich, but I doubt my family knew a higher-rate taxpayer. The Rich List was about as real as the Lord of the Rings.

Later, as a lefty student and then a mildly hedonistic 20-something, I continued to check in with the annual tally of the UK’s top 1,000 multi-millionaires. My parents kept it for me to read on my visits, and I watched as the List was transformed from a running scorecard of post-1066 jockeying to feature more financiers, entrepreneurs, and later oligarchs and other wealthy incomers.

Then, somewhere around the LastMinute era¹, digital start-ups became sexy and I became more annoyed that I hadn’t made my fortune.

True, it was hardly surprising. I was working in a low-paying media job mostly for the perks. I hadn’t started a dotcom, and indeed I hadn’t even begun investing!

But that’s what the Rich List does to you.

Just as other people are frustrated by six packs in Men’s Health or long legs in Cosmo, the future founders of financial blogs probably can’t help comparing themselves to the Monaco-going Joneses.

Friends (or acquaintances) in high places

Of course I should write a bit here about how enjoying an ice-cream on a windy British beach with your loved ones is the height of life’s riches.

Or how you can live like a billionaire on the cheap.

Certainly my co-blogger would pen a missive about the folly of chasing unicorn-founding unicorns.

Agreed, yes yes, the denizens of the Rich List have more money than most of us will ever need (some of them may be excused a requirement to fund small private armies in suspect states) and there’s much more to life than money. I learned that young, too.

Still, it would have been nice to have made the cut by now. I manifestly haven’t – I’m not sure I would even if the supplement was expanded to the thickness of a Yellow Pages. (There’s a lot of asset-rich oldies out there nowadays.)

Adding to my angst, the Rich List is no longer the outright fantasy it was back when Kentucky Fried Chicken was my birthday treat.

I’ve met hundreds of very rich people in the years since then. I’ve several wealthy friends (universally good sorts, but I pick them that way) and there are even a few people on the Rich List who’d reply to my emails. One or two I might conceivably have dinner with. And most of them got on to the list in the time I’ve known them.

So it Can Be Done. Just has not by me!

In the compound

This isn’t a shocker. I tried starting a business with some friends a decade or so ago but bailed out after a couple of years. It wasn’t for me.

Investing is for me, but even here I’ve not pursued some opportunities that presented themselves. (Specifically, I’ve never tried to set up or even get a job running a fund. Maybe that wouldn’t have worked out either – I didn’t pursue the slender openings for a reason – but who knows.)

So that leaves compounding my own wealth, on a decent but pretty average by successful Londoner standard’s income.

Is it feasible? Can you invest your way onto the Rich List?

Zero-ing in on millions

I turn reflexively to the last page of the Rich List first, to see the current cut-off. This year it’s £120 million to make the final 1,000.

Can I compound my way onto the List before I’m more likely to trouble the obituaries?

Obviously we need an expected return rate to plug into the Monevator compound interest calculator. And since my last dalliance with revealing more about my active investing stalled, I don’t propose revealing precise figures here.

Additionally, my income is still rising and I’m not even rich enough for savings not to make a big difference to the final sums.

I’m also now using leverage, effectively, with an interest-only mortgage set against my flat.

And I’m only going to do rough-and-ready sums anyway. This is just a thought experiment, not a submission to the FCA!

In consideration of all that, let’s pick a reasonable ‘rate of wealth growth’ (ROWG) to plug into the compounding machine.

• If I consult my investing logs, I can see that over the past ten years my ROWG has been about 23% annualized.

Nice!

However that’s growth pretty much from the nadir of the financial crisis – a time when I was literally selling possessions to buy more shares.

Clearly that was a generational basing opportunity for anyone who wants to produce a high ten-year return figure. What about over five years?

• My five-year annualised ROWG comes down to about 16%.

We need to knock a bit off for inflation, so we can compare the £120m today with the same amount in 2040 or 2050. In practice the rich are getting richer ahead of the rate of inflation, but I’m going to ignore that to keep things simple. And who knows if it will last, anyway.

My investment returns would surely become constrained as my wealth grew in this (fantastic) scenario, although I’d hope to offset some of that drag with more direct investing in businesses and property, and perhaps a bit more debt-juicing. Savings will eventually be irrelevant to growing my net worth, too, whereas they have definitely been a factor in reality.

• I’m going to settle on a real² ROWG figure of 10%.

You may well feel that’s ludicrously high. Fair enough. As I say, all this is just for fun.

I will ignore the rampages of tax. I’ll assume everything is in a tax shelter and not withdrawn, or else is locked-up as capital gains.

Plug all that into the interest-upon-interest adder-upper, where does that leave me?

Well, unless I’ll be approaching my telegram from an equally geriatric King William to brighten up my mornings, I will probably not be making it onto the Rich List through my active investing prowess alone.

Stand down The Sunday Times!

Loadsamoney

What about you? Maybe you’re very rich already, much younger, or a true once-a-generation investing genius?

All of that will help. Could you become one of the UK’s 1,000 wealthiest simply by compounding savings from your 9-5?

Here are a few scenarios showing how you could hit that £120m in today’s money, and how long it would take to get there. (Position your mouse over the footnote numbers to see my assumptions.)

Future Rich Listing Non-Professional Investor	Starting pot	ROWG3	Years
Young inheritor4	£20m	3%	60
The Next Spare Room Warren Buffett5	£20,000	17%	46
The New DIY George Soros6	£20,000	27%	32
Ultra high-earning global indexer7	£50,000	5%	75
The cryogenic investor8	£5,000	2%	275

Note: You probably don’t want to try anything but saving-and-indexing at home. Especially the cryogenic stuff.

You can see the assumptions I’ve chosen for my table in the various footnotes. And I am sure that in the time it takes to read them, many of you will find objections.

Fair enough. This is just an arbitrary illustration of a few scenarios as a conversation starter. Feel free to plug in your own numbers. Let us know what you discover in the comments.

However I think the table does illustrate:

• Why nobody on the Rich List got there by investing their down-to-earth wages.

• Why it’s important to remember that even Warren Buffett first made his starting pot by running a hedge fund.

• Ditto George Soros, whose legendarily high returns weren’t actually achieved for a period as long as 32 years. (I strongly suggest you don’t use 27% for your sums. Try 7% if you’re bold.)

• It does help to start very rich to end up truly filthy rich, but even that’s not enough unless you take some risks. If our inheritor had put the family silver into a global tracker it would still take 37 years to turn their pot into the £120m in today’s money that’s required. Most rich people are more concerned with wealth preservation.

• Grow very old to get rich and be remembered.

• As I’ve said before, if you want to make easy money do something hard. Starting a business that becomes a household name – or at least big enough to get into scraps with governments – is the only real chance most of us have of making the Rich List. (That or starting a hedge fund.)

Deflated? Oh well, remember net worth =/= net wealth.

Feel better now? Thought not!

Who wants to be a multi-millionaire, anyway?

To conclude, I’ll stress that if I actually was loaded enough to be in the running for Rich List positioning, I’d do my damnedest to keep it a secret.

I’m a very private person. The last thing I’d want to see is a photo of myself in print standing next to my wife/dog/double oven trying to appear smugly relaxed.

When it comes to my Rich List daydreams, it’s more the thought that counts. Agreed, it’s not a good thought. It’s not a good competition. But I’m only human.

Luckily it seems the maths will save me from myself.

Anyone out there feeling punchier? (Any Monevator readers actually on the List?)

1. c. 1999. [↩]
2. i.e. Inflation-adjusted [↩]
3. Inflation-adjusted, and unlike the ROWG figure I used above NOT including savings from income. Those are plugged in separately. [↩]
4. Assume a 3% safety-first real return, no spending capital, no net savings from fun Trustafarian job. [↩]
5. 20% annual returns, adjusted down 3% for inflation. Savings add flat £10,000 a year. [↩]
6. 30% annual returns, adjusted down 3% for inflation. Savings add flat £10,000 a year. [↩]
7. 5% annual real return. Saves flat £75,000 a year over period. [↩]
8. Saves £10,000 a year, much kept in cash. Freezes her brain in a jar. [↩]

Good news! RateSetter has brought back its £100 bonus for investors who put away just £1,000 for a year. To get the bonus, follow my links to RateSetter in this article. I will also be 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 won’t 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 hard to get a decent interest rate on cash for the past few years.

Even the Bank of England’s rate rises haven’t done much. High Street banks always drag their feet in passing on rate rises.

But in this article I’ll explain how you can effectively get a 14% 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 some risk.

In practice, no Ratesetter investor has yet lost a penny. Every lender has received the rate they expected.

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

If you can accept the risk and have 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.

Not a few Monevator readers have taken advantage of this win-win RateSetter offer over the past couple of years!

About RateSetter

RateSetter is one of the new breed of peer-to-peer lenders aiming 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 get up to 5.4% as a lender with RateSetter by putting your cash into its five-year market.

Since March 2018 you’ve also been able to open a RateSetter ISA, which means you get your income tax-free.

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).

RateSetter charges no lending fees, which is great news for savers like us. Borrowers do pay a fee.

Over £2.5 billion has now been lent through the RateSetter platform. This is no longer a tiddly operation.

And importantly, of the 66,942 investors who’ve lent money with RateSetter not one has yet lost a penny of their investment.

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 initial approach of rivals like Zopa. Back then you were encouraged to spread your loans widely and accept a few would go bad, reducing your return.

The RateSetter approach is different.

But as sensible people of the world, we should understand there’s no magic here.

Downside protection

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 have gone to lenders through a higher interest rate.

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

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

Note that the Provision Fund does not provide complete protection against a situation where all the loans made at RateSetter default. Far from it!

Rather the Provision Fund aims to cover the bad debts predicted by RateSetter’s models, with a margin of safety on top.

At the time of writing, Ratesetter says:

In the event that credit losses were to increase significantly, the following things would happen:

• The Provision Fund would reduce in value as it reimburses investors for missed payments.

• The Provision Fund is large enough to cover credit losses up to 116% of expected losses. If credit losses rose above this level, the Provision Fund would be depleted and investors would earn less interest than they expected, but their capital would be unaffected.

• If credit losses rose even further and exceeded 231% of expected loses, investors would start to lose capital, which means that they would get back less money than they put in.

• In this instance, it may take longer than expected for investors to receive their money back and access to funds may be restricted.

What would happen if losses did exceed the RateSetter projections?

First the Provision Fund would be used up, and ultimately exhausted.

After that interest payments could be redirected to repaying capital. You’d lose on interest payments, but it could cover lenders’ losses on capital unless the default rate got too high.

Finally, in a doomsday scenario with very high default rates, capital could be eroded. I’d expect other investments like equities and corporate bonds would also be taking a pummeling. But cash in the bank would not.

At the end of the day, I believe for most people the Provision Fund approach is preferable to the lottery of individual loans defaulting. 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 14% 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.

This £1,000 minimum investment can be made up of new subscriptions and/or transfers from other ISA providers.¹

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, which matches the period required to qualify for the bonus.

The one-year market is paying 4.7% as I type.

So after one year you’d have your 4.7% interest on your £1,000 and you’d also receive your bonus, which works out as a return of 14.7% on your £1,000.

Very nice!

I’ve ignored taxes here because everyone’s tax situation is different.

The good news on taxes is that:

• You can now open a RateSetter ISA and collect the bonus. You can fund this with a transfer from another ISA provider. In an ISA the income you earn is tax-free.

• Most people even outside of an ISA will pay 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, 4%, while paying you an effective rate of nearly 15%.

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

RateSetter must be hoping this is the start of a multi-year relationship with its new sign-ups, after they become comfortable with its platform.

Once you get over the initial hurdle, peer-to-peer is straightforward. I’ve used these platforms for ten years now.

RateSetter will 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.

Finally, I expect the cost of this offer is allocated internally to its 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.

I do think it’s a smart question to ask, though, 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 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 bail you out like they would for up to £85,000 with a High Street bank savings account.

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 (in my opinion) worst-case scenario, the Provision Fund would not be able to cover all the bad debts. This would mean some loss of interest.

• According to RateSetter, as of August 2018 the loss rate experienced to date is 2.29%.

• It currently projects this to rise to 3.33%. (Loans take a while to go bad.)

• If credit losses rose to 127% of expected losses, RateSetter‘s model indicates the Provision Fund would still cover interest.

• In what RateSetter terms a severe recession, you’d get no interest but it believes you’d get your initial money back.

• If we saw 400% expected losses, investors might lose 5.6% of their capital.

This illustration is summarized in the following chart:

Source: RateSetter

As for the worst worst-case scenario, like with any business it is possible to imagine catastrophic situations where you’d lose much more.

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 a hint of what might have gone wrong came in 2017, when the company intervened to restructure several businesses and cover repayments from one via its own funds. This prevented its bad loans from being defaulted to the Provision Fund. This decision to intervene reportedly² delayed authorization from the FCA. It has subsequently been granted.

RateSetter says: “This intervention was an exception and will not happen again.”

As I understand it, RateSetter has since withdrawn from the wholesale funding operations that produced this situation. (Wholesale funding is when a company lends money to third parties, who then lend those funds on themselves.)

You invests your own money and takes your choice.

Personally, I am happy with the risk/reward here. Not everyone feels the same. My 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 have always taken 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 low single-digit percentage of my net worth with any particular platform. 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 peer-to-peer articles barely mention it, 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 enjoy those bonus-boosted returns.

1. Note: Terms and conditions apply with transfers, so check the small print. The money must be transferred over within a certain time period, which may be down to the ISA provider you’re transferring from. Just setting up a new RateSetter ISA with a fresh £1,000 should be straightforward. [↩]
2. See this article at Reuters: https://uk.reuters.com/article/uk-interview-ratesetter/ratesetter-recovering-after-asteroid-strike-bad-loan-discovery-idUKKCN1BN1PF [↩]