Here at Greybeard Towers, the economy has taken a turn for the worse. Like many other freelance writers and editors I know, I’ve seen a softening in the marketplace in which I sell my skills.

These things happen. Ten years ago – exactly ten years ago, as banks imploded, and stock markets plunged – the same thing happened.

Back then we had kids still living at home, and the last few thousand pounds of a mortgage to pay off. Today, my wife and I are far less encumbered with fixed outgoings. Nevertheless, the experience has been instructive.

Firstly, it’s been instructive in that I took a decision to cushion the hit to our lifestyle by withdrawing a monthly income of several hundred pounds from my ISA-sheltered share portfolio.

This was a weird sensation, and left me – no, leaves me – feeling oddly guilty. For the first time in decades, instead of reinvesting dividend income, I am withdrawing it, and spending it.

Somehow, it doesn’t – yet, anyway – feel right.

All change

The second instructive experience has been less angst-inducing, but is still challenging.

Namely, I have decided to accelerate my plans for retiring. Or, rather, semi-retiring. I hope to carry on working, but I’ll also be taking a pension income.

As readers with long memories may realise, this wasn’t the original game plan.

For years I have planned to retire at 70, gradually winding down as my seventieth birthday approached. And – to be blunt – probably carrying on doing a few simple commissions for long-standing clients, if such opportunities came along.

But having just turned 64, with the state pension two years away, it seemed sensible to consider taking income from my two SIPPs.

Former pension minister Steve Webb’s much-vaunted pension freedoms have not only made that easier, but also introduced new options such as UFPLS1 flexible drawdown.

Frankly, why not take advantage of these freedoms?

From strategy to tactics

Right from the outset, the broad strategy seemed clear:

• Disregard the annuity option. Some form of cautious drawdown on my assets should leave an inheritance for the kids, as well as hold out the prospect of a growing income.

• To this end, take the natural yield, rather than eat into capital. With tax-free ISA income from a share portfolio, some freelance earnings, other investment income, two state pensions, and my wife’s occupational pension, that would be ample.

• Although (as I’ve written before) I’m attracted to the more flexible end of the new pension freedoms – and in particular, to UFPLS – it would be necessary to figure out some way of mitigating the effects of the £4,000 Money Purchase Annual Allowance (MPAA) limit, which would severely restrict my ability to shelter freelance earnings in a SIPP, away from the beady eye of the taxman. This wouldn’t be a problem with an annuity, or with drawdown (as long as I didn’t drawdown any income, just tax-free cash), but would be a problem with UFPLS.

All good stuff, but I was uncomfortably aware that it was very high-level stuff, as well. The practicalities would need thinking through, and organising. And I would need to be very careful about avoiding any hidden bear traps.

Plus, of course, there was a significant element of irrevocability. Once I’d triggered drawdown, for instance, there would be no turning back.

A summer of careful reading and researching beckoned.

Here’s what I found, along the way.

A route to follow

One immediate realisation was that multiple pension providers offer an abundance of free literature, readily downloadable. I devoured stacks of it.

I could also send off for pension projections and illustrations – including my personal state pension forecast of £148.88 a week, or £7,768.35 a year, which was curiously empowering.

The government’s Pensions Advisory Service and Pension Wise websites also contain a wealth of useful information.

Not all the advice I obtained was through the written word. Determined to do things ‘properly’, I took up my option of a free pension consultation with the government’s Pension Wise service, booking a Pension Wise appointment, which duly happened in early August.

The adviser, named Colin, was incredibly knowledgeable, and we went the distance, going for the full hour. Well worth doing, and highly recommended.

Right from outset, it was clear that the inflexibility of traditional drawdown posed a challenge.

Essentially, I was turning on a tap, releasing a flood of income. Should the freelance market pick up, I’d face an awkward choice between turning down work or getting clobbered by higher-rate tax. Due to the MPAA rules – designed to clamp down on tax-rebate ‘recycling’ – once I’d sheltered £4,000 in a pension, any further earnings were taxable.

This in turn reinforced the attraction of UFPLS as an option.

While UFPLS is a form of drawdown, it’s a flexible form of drawdown. If the freelance market picks up and my earnings look to leave me exposed to a hefty higher-rate tax liability, I can simply turn the UFPLS income tap to the ‘off’ position. Like this I can maintain a level income, by using UFPLS as the balancing factor.

On the other hand, the initial plan of a monthly UFPLS income seems unrealistic. Providers do offer it, and apparently people do take it. But the paperwork seems disproportionate, with every UFPLS drawdown triggered by a completed UFPLS application form, and accompanied by an ensuing (and legally required) UFPLS illustration.

Being pragmatic, it probably makes sense to combine my two separate SIPPs into one, and going for three-monthly or six-monthly UFPLS payments, rather than monthly payments. The downside: to some extent, this will limit my ability to ‘flex’ income to avoid higher-rate tax.

Finally, the rules around the taxation of pensions after death seem unduly harsh. If I die after age 75, and my wife survives me, the remaining pension investments she will inherit are taxed as income. That’s not a good option for a sum that should amount to several hundred thousand pounds.

To avoid a massive tax hit – repeated again when the kids inherit it after my wife dies – it’s necessary to set up a dependents’ drawdown account, from which an income is taken.

More research is needed here, but at least I’ve got 11 years to undertake it.

Ready, steady… go?

So what have I done? Nothing, so far. But at least I know the broad outline of what I will do, when I push the button.

Our income, at the moment, is just about adequate without massive belt-tightening. (If you’re looking for a first-class writer and editor, get in touch…)

What have I learned? More than I thought I would.

Moving into retirement – and making the right choices – is a complicated business, unless one goes for the straightforward annuity option. I knew that already. Even so, I’m still surprised at the complexity of the choices I face.

The government, it seems to me, has brought into being a range of pension freedoms, but hasn’t invested the time and energy to provide a regulatory and tax framework to help retirees readily access those freedoms. That is regrettable.

Making the right retirement choice was difficult enough in the old ‘annuity versus drawdown’ environment. It’s tougher still, now.

Read all of The Greybeard’s previous posts on deaccumulation and retirement.

1. Uncrystallised Funds Pension Lump Sum [↩]

What caught my eye this week.

Most of us moan now and then about life sneaking some booby-traps across our path to financial independence.

But few of us will face the hurdles overcome by The Humble Penny’s Ken Okoroafor and his family.

I’ve always been inspired by recent immigrants. In the main, statistics show they work hard, contribute more than they take out, and they are more entrepreneurial, too.

As I wrote back in 2007:

Mostly those who’ve taken the plunge and come to the UK don’t say, “We are very lucky to come here and scrounge from you stupid, lazy rich British.”

They say, “You British are very lucky to live here, to be able to make such money.”

They’re on a mission – the kind that happens when you decide to reinvent your life and choose your own path.

One of the many dismaying aspects of the Brexit referendum centered on immigration.

When the saner elements of the Leave campaign realized they couldn’t solely target EU migrants as a drain on the state – because such migrants contributed more than they put in – they shifted the argument to claim they were taking our jobs and driving down wages. Again with scant-to-no evidence.

One of the best retorts I ever read came in a comment from a Monevator reader:

The difference between “the poor Northener” and the “the poor immigrant” is that the poor Northeners can catch a train to visit their families on their days off, that they don’t have to learn a new language, and that they will have it even easier to find a job.

But because they don’t want to use their right for free movement (not even within their home country, FFS!), they decide to take that same right from other people.

[…]

London is a challenge for everybody who comes here, no matter where you are from.

I see 19-year-old girls who are still babies in their head leaving their family and their nice sunny beaches in Spain or Italy to come here and work 50-hour-weeks for £7.20 per hour and getting told off by their managers for being late for their 5a.m. shift, which happened because they don’t know what “this bus is on diversion” means.

They are afraid to lose their jobs for minor mistakes, because how shall they pay their rent…actually, how shall they pay their rent?

They don’t have a bank account and to open a bank account you need a proof of address and they don’t have a proof of address because flatsharers seldom have their name on utility bills, and their NINO appointment is only due in four weeks.

They are tired all the time, because they spend too much time commuting, and running errands or shopping for groceries takes five times as long in London as in any of their home towns.

When I say that my main reason for being here is that I love to be here, they look at me as if told them that I love to swim naked in the Thames every morning. I could go on forever.

The struggle is real, as they say. At least it is for those who take it on.

For others, easier to find a scapegoat.

Note: I’m publishing early this week. If I’ve missed anything good, please do feel free to pop it into the links below. Also, if people do want to debate immigration please do so respectfully. I’ll be moderating hard anything I personally deem racist or inflammatory. There are other places for that.

[continue reading…]

Since when do tortoises move sideways? In the three month’s following our last Slow & Steady check-in, we’ve made our least dramatic gain ever.

Our passive portfolio is up £313. Or 0.74% on last quarter.

Hey, it’s better than a punch on the schnoz.

Emerging markets are having a tough year, as are our government bonds. UK equities aren’t looking too chipper either, for some reason… The rest of the world is doing just fine, though, especially the US.

Here’s the view through our Unaugmented Reality Spread-sheeto Goggles™:

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £935 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

Since we last spoke, there’s been lots of fanfare celebrating the longest bull market in history.

And also why it isn’t the longest bull market in history.

Confused? Is the end nigh? Either way, equity valuations are high. Okay, US equity valuations are high. Many other regions look fine. Just make sure you’re not overexposed to Belgium and Denmark.

Sigh.

Ben Carlson of A Wealth Of Common Sense fame wrote a great post that encapsulates why high valuations are worrying.  Yet worrying about it is as useful as sacrificing goats to save the harvest.

It’s true that high valuations have historically been associated with poor returns over the subsequent ten to 15 years. You can expect a median annualised return of 2.2% from US equities for the next decade and a half, according to Star Capital’s financial archeology1. But expectations are not certainties. History shows the average return has ranged from 7.9% to -2.2% per year during similar periods when valuations have been frothy like a McFlurry in the mush.

Other researchers are equally or even more pessimistic. The average US return could be -0.6% over the next ten years according to the expected return chart of fund shop Research Affiliates2.

So are we like Wile E. Coyote after he’s run out of road and just before he looks down?

Perhaps, but Ben Carlson’s post also quotes research concluding that you can do precious little with valuation information.

Valuations can warn you of hazards ahead. They can’t help you swerve them.

Achtung! Achtung!

You may have heard of asset allocation strategies that adjust for market valuations. For example Ben Graham, mentor of Warren Buffett, suggested trimming equities when they seem expensive.

You could look to go to 25:75 equities:bonds when valuations are high, 50:50 when markets are fair value, and 75:25 when equities are a bargain.

Taking action like that might make you feel more in control. There’s every chance it won’t achieve much though, according to investing luminaries Cliff Asness, Antti Ilmanen, and Thomas Maloney of AQR.

Their paper did show that a simple valuation timing strategy edged a buy-and-hold strategy from 1900-2015. But it hasn’t worked for the last 60 years. The result was a draw from 1958-2015. And that’s before counting the higher costs of timing.

Here’s what AQR says about using valuation as a timing signal:

Valuations can drift higher or lower for years or decades, making it difficult to categorize the current market confidently as “cheap” or “expensive” without hindsight calibration, and therefore it is difficult to profit from such categorizations.

There are also reasons to believe that measures of valuation such as Shiller’s Cyclically Adjusted PE Ratio (CAPE) may no longer hold sway.

As AQR comments:

There may have been a structural change that keeps real yields low and inflation moderate for at least another five to ten years – perhaps a slowdown in equilibrium growth rate or a secular private sector deleveraging following decades of rising leverage. Or larger saving pools and investors’ better access to global capital markets at lower costs may have sustainably reduced the real returns investors require on asset class premia, and we’ll never see a reversal.

We simply do not know.

If they don’t know, then I don’t know. Especially when plenty of other credible sources also advise caution on using CAPE to tame the bull or the bear. See these posts from Larry Swedroe and Early Retirement Now (ERN).

As Big ERN says:

If you think that today’s CAPE of 31.3 is high, would you have sold equities back in the 1990s at a CAPE level of 31.3?

That would have been in June 1997 when the S&P 500 stood at 885 points. The S&P had another 79% to go before the peak (dividends reinvested).

The best valuation metrics have historically explained only about 40% of returns anyway, according to Vanguard.

Remember, too, we’ve been here before in this not-so-long bull market. For example, you might want to review a post by The Investor from June 2014. He also found many pundits warning the US market was over-valued – but he suggested passive investors sit on their hands.

The US market is up around 50% since then.

Inaction stations

So what to do? The main reason today’s post is a link-fest is because I wanted to put plenty of quality information at your fingertips – in case, like me, you’re prone to wondering when change must come.

And after reviewing it, I can’t award myself a meddle.

If you, on the other hand, must be master of your fate, then investigate overbalancing. It is a crude valuation timing strategy but a relatively benign one.

In the face of a world beyond our control, humility is a good answer. If you don’t like that answer, then diversification is the other good one.

The Slow & Steady portfolio is around 29% in US equities right now. If they flounder then we’ll look to fairly-valued Europe, the UK, and the Emerging Markets to carry on regardless.

New transactions

Every quarter we toss £935 down the bowling alley of global capitalism, hoping not to end up in the gutter. Our cash is divided between our seven funds according to our pre-determined asset allocation.

We use Larry Swedroe’s 5/25 rule to trigger rebalancing moves, but all’s quiet this quarter. We’re just topping up with new money as follows:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.08%

Fund identifier: GB00B3X7QG63

New purchase: £56.10

Buy 0.272 units @ £206.27

Target allocation: 6%

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%

Fund identifier: GB00B59G4Q73

New purchase: £336.60

Buy 0.931 units @ £361.18

Target allocation: 36%

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.38%

Fund identifier: IE00B3X1NT05

New purchase: £65.45

Buy 0.214 units @ £305.81

Target allocation: 7%

Emerging market equities

iShares Emerging Markets Equity Index Fund D – OCF 0.25%

Fund identifier: GB00B84DY642

New purchase: £93.50

Buy 60.24 units @ £1.55

Target allocation: 10%

Global property

iShares Global Property Securities Equity Index Fund D – OCF 0.22%

Fund identifier: GB00B5BFJG71

New purchase: £65.45

Buy 32.21 units @ £2.03

Target allocation: 7%

UK gilts

Vanguard UK Government Bond Index – OCF 0.15%

Fund identifier: IE00B1S75374

New purchase: £261.80

Buy 1.633 units @ £160.29

Target allocation: 28%

UK index-linked gilts

Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%

Fund identifier: GB00B45Q9038

New purchase: £56.10

Buy 0.304 units @ £184.76

Target allocation: 6%

New investment = £935

Trading cost = £0

Platform fee = 0.25% per annum.

This model portfolio is notionally held with Cavendish Online. Take a look at our online broker table or tool for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000. The Slow & Steady portfolio is now worth over £41,000 but the fee saving isn’t juicy enough for us to push the button on the move yet.

Average portfolio OCF = 0.17%

If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.

Take it steady,
The Accumulator

1. Scroll down to the second chart. Which distribution of returns followed on comparable valuations over 15 years? [↩]
2. Click on Equities in the left-hand column > Expand all > Scroll down to US Large and US Small – the expected return appears in the chart, followed by the volatility number e.g. -0.6%, 12.8% [↩]