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What caught my eye this week.

There’s a story in ThisIsMoney about what’s apparently the first-ever retirement interest-only mortgage that’s ‘fixed for life’:

The over-50s deal from Hodge features a fixed rate of 4.35 per cent with no term limit, meaning the borrower will never need to remortgage, or risk falling onto a standard variable rate.

The unique deal is a type of retirement interest-only mortgage, a relatively new type of home loan that lets a borrower take out a mortgage and then only pay back the interest each month.

We could have a spirited debate about the pros and cons of this innovation, but it actually sparked another thought.

These retirement interest-only mortgages have been a bit of a flop. They were introduced as a way to help stop the many people who took out interest-only mortgages in the housing boom from having to leave their homes because they’ve not actually been saving the capital required to pay off their mortgage.

Apparently only a few hundred people have signed up to them so far, even though there are tens of thousands of people who would appear to be in need.

Perhaps even 25 years isn’t long enough for some people to have a lightbulb moment – or maybe they all have a cunning plan?

Not all oligarchs

What I found myself musing on though is whether financial services firms will similarly start innovating for people at the other end of the spectrum – modestly financially independent and asset-rich early retirees?

I’ve already explained how hard it was for me to get a mortgage, despite my technically not needing one. I was an ultra-low risk for banks, but they wouldn’t look at me because I didn’t fit their profiles.

Similarly, blogger ermine has explained that as an income-poor early retiree he might as well not exist in the eyes of many financial services companies.

The financial independence community sometimes ponders what would happen if it became mass-movement. Would the capitalism that makes it possible fall over?

I wouldn’t hold your breath for an empirical answer to that question. But on the level of day-dreaming it’s fun to wonder how financial services might be reshaped by a widespread shift to extreme-saving and ultra-compounding.

If you were granted one wish from the financial services industry for something for the likes of us, what is the first product or service you’d ask for?

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My biggest FI demon – status anxiety

My biggest FI demon – status anxiety post image

Among all the foes I’ve faced on the road to financial independence, status anxiety has been the craftiest of assailants. Like a shadowy footpad it avoids frontal confrontation but knocks you off your stride with stealth attacks.

A few encounters spring to mind.

There was the neighbour who offered me some old furniture bound for the skip. “Please don’t be offended,” they said. “I thought it might help. We know you don’t have much money.”

I wasn’t the least offended. The offer was sincerely meant but that blunt assessment of our apparent financial state popped my ego like a party balloon.

Had our high saving rate turned us into the local raggedy rascals? Were we letting the side down with our rust-bucket on wheels?

That question answered itself when I thought of the time I strayed too near the window of an upmarket restaurant. The maitre d’ immediately activated his anti-riffraff countermeasures – swell to bouncer size, advance to block entrance, adopt a “You shall not pass” look.

I gave him mocking lip curl in return, channeling John Lydon for all I was worth. I think we both know who won that one.

More troubling than the judgement of others though is self-judgement. The pang I sometimes feel when a sleek German car slides out of the corporate car park as I get on my bike.

Increasingly the flashy motor is driven by someone younger than me.

Where’s my German car?

I don’t care about German cars. Or expensive restaurants. Or clogging Instagram with a show-reel of success.

That stuff doesn’t make me happy. I tried it.

Yet not spending hurts. It hurts my ego. It hurts my standing in the eyes of my peers and neighbours and society. Or at least I’m conditioned to think it does.

You can’t achieve financial independence without facing down status anxiety1. I can rationalise lifestyle inflation away by claiming convenience, comfort, and YOLO – but how much of our spending is actually explained by the need to assert our position in the tribe?

Our public financial statements are encoded in the language of shoes, clothes, cars, postcodes, holidays, labels, schools, clubs, watches, haircuts, and social circle.

Can you withstand the fall in your personal stock when you’re the living embodiment of a value investment?

Can you live with being an unfashionable, dogeared, and tatty-looking outfit whose real worth is apparent only to those prepared to give you time to show your true colours?

I try to. The less susceptible I am to worrying about status, the quicker I’ll reach financial independence and the more secure the rest of my life will be.

More to the point, the less I engage with that unwinnable game, the more time I’ll spend doing things that contribute to my well-being and the happiness of the people in my life who really matter.

Finding your truth

The answer that’s emerging for me is to create a counter-conditioning programme.

Society bombards me with false advertising. And as any smart propagandist knows: if you repeat a lie often enough, it becomes the truth.

The actual truth is buried under a daily downpour of bullshit.

I need a personal filter bubble to deflect as much of the toxic waste as possible whilst enabling me to access the good when I lose sight of it.

My bubble is lashed together from different materials. A simple starting point is to create a happy list.

What the Jeff is a happy list? It’s a list of the things that make you genuinely happy. It’s not a list of goals, or lifetime achievements, or perfect moments – it’s simply the things that reliably make you glad.

On my list:

  • Going for a walk with Mrs Accumulator.
  • Staring at the sunset.
  • My cycle ride home.
  • Helping a colleague at work.
  • Losing all sense of myself in a game of football.
  • That moment I finish a Monevator post and it isn’t a pile of old toss (TBC).
  • The thrill of learning new ideas.
  • Filling my nose with the scent of trees.
  • The end of a long journey.
  • Catching up with an old friend.

A happy list sounds like a cheap mind trick but it’s very revealing. Most people’s list is full of simple joys, not the stuff of high status. It’s a great way to uncover your truth and to retrieve it again when you forget who you are.

You’re booked

I didn’t always have much confidence in my truth though, so I recruited some cultural heavyweights into my corner.

Books are the foundation of my filter bubble.

Nothing imports strength into your life better than communing with great minds from the past, as well as modern thinkers who can translate humanity’s accumulated wisdom into contemporary language.

I’ve talked before about some of the books that have made a difference to me.

There are many more, but how much they speak to you depends on where you are in life. (Let’s bat some good book ideas back and forth in the comments?)

Renewing your faith

Read enough good books and eventually you’ll discover that you and the greats approximately agree on the essentials of human flourishing.

It’s just you keep forgetting them. Or forgetting to believe in them.

That’s where ritualising your truth comes in. Like a god-fearing creature in a city of sin, I can only maintain my faith by habituating it and by stiffening my resolve with regular brain-hackery.

Gratitude is the simplest and most amazing technique I’ve learned. Briefly recalling three things in my life which make me happy is a fantastic circuit-breaker that reconnects me with what counts.

The power pose also works. Not because it makes me feel powerful but because it makes me laugh. It’s wonderfully silly, sends up the need for status, and reminds me not to take myself so seriously. Try being Wonder Woman or The Hulk. Raargh.

Keeping a momento mori of my past spendy life is also useful.

I’m not naturally frugal. I used to blow the lot. Now that reminder of that amazing car we once owned reminds me it was nothing but trouble. Maybe I should also frame an old letter of a promotion and remember how good that felt for five minutes?

Checking in with my favourite financial independence writers is another important ritual. There’s little new to learn about the mechanics, but plenty of value in spending time with others who swim against the mainstream.

Keeping good company is another reason why no matter how many books I read on living life, I always like to have one on the go. I don’t think I’ll ever completely subdue status anxiety but returning to an old favourite or hearing ancient ideas reinterpreted by a new voice often helps me patch holes in the filter bubble.

The lightbulb moments flashed all the time when I first started this journey towards financial independence. The problem was keeping them switched on!

Storing the illumination in a repository of values has helped with that. For me, that’s a flow chart of the ideas, ideals, habits and behaviours that represent the life I want to lead. It’s charted because I wanted a visual that I can easily recall.

I revisit it often and in my mind’s eye I see it as a web of connections that link me to what really matters.

Take it steady,

The Accumulator

  1. Certainly not if you’re on a modest income and want it done in a decade or less. []
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How to get a 14% 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 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:

Provision Fund figures correct as of 1st August 2018. (Click to enlarge)

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 []
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Weekend reading logo

What caught my eye this week.

I am sure that with barely a glance at the clicks generated by its last story featuring Michael Burry dissing index funds, Bloomberg has returned to the well to quote him saying more scary-sounding things:

Burry, who made a fortune betting against CDOs before the crisis, said index fund inflows are now distorting prices for stocks and bonds in much the same way that CDO purchases did for subprime mortgages more than a decade ago. The flows will reverse at some point, he said, and “it will be ugly” when they do.

“Like most bubbles, the longer it goes on, the worse the crash will be,” said Burry, who oversees about $340 million at Scion Asset Management in Cupertino, California. One reason he likes small-cap value stocks: they tend to be under-represented in passive funds.

A few readers kindly forwarded the story to us for our views, and I sighed. Can’t we keep the passive indexing is a threat to capitalism bust-ups to a maximum once-a-month rotation?

Look, I’ve got as big a man crush on Burry as any active investor who has seen The Big Short three times. But comparing mainstream index funds to sub-prime CDOs is specious.

It’s true some ‘liquid-alt’ passive funds might hit some choppy air in a sell-off, but that’s hardly a secret – it happened in the flash crash, for example – and even then it probably wouldn’t have any long-term consequences for passive investors, who shouldn’t be holding anything too wacky, let alone be dumping them in a 20-minute moment of market madness.

As for the bigger picture, if markets are pumped up to irrationally exuberant levels then it’s true many people will take a hit if they sell in a subsequent downturn.

But that’s totally normal. Most people invest where most people invest, by definition. Doing so may involve index funds in the 21st century, but fear, greed, boom, and bust are as old as markets.

Luckily I don’t have to write more this week because the ever wonderful Ben Carlson has taken one for the team. His long post on these silly passive scare stories covers everything you can think of.

I particularly liked the emphasis in Ben’s post on the matter of practical choice for investors:

Are index funds perfect? No. They give you all of the upside of the stock market but also all of the downside. And indexes can go nowhere for years on end just like individual stocks. They can become overpriced and underpriced. They own the good stocks and the bad stocks.

But that’s nothing new. That’s the stock market for you.

Someone will occasionally point out an edge case where active managers are able to gain a few bucks at a passive fund’s expense – or they might make the case like Burry that a vanilla index fund doesn’t give you sufficient exposure to what he considers better value stocks.

But these things don’t matter to everyday investors, whose alternatives are expensive active funds with market-lagging track records, or else taking the opportunity to lose to the market picking stocks for themselves.

As Ben notes: “Index funds never lever up your holdings. They never receive a margin call. They don’t put 30% of your holdings in Valeant Pharmaceuticals. And no index fund has ever closed up shop to spend more time with their family.”

Boom!

[continue reading…]

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