Gentle reader, I have a confession to make. As I have written before, a short spell working for a FTSE 100 engineering firm in the early 1980s had left me with a generous-looking pension as I approached retirement.

For years – literally decades – I had filed the annual statements, marveling at how projections of my annual income in retirement inexorably rose.

Gold-plated pension

Seven or eight years ago, the engineering firm’s pension trustees launched an early retirement enhanced benefit scheme. The hope was to persuade pension fund members to transfer out, or take higher immediate benefits in exchange for lower longer-term benefits.

They paid for a firm of financial advisers to offer advice, and calculate projections. I duly filled in the forms, wryly noted the resulting recommendation to take the money – and then I did nothing.

Why cash in a gold-plated, and partially inflation-linked, final salary pension fund?

As I turned 60, this pension had become – again, quite literally – one of my most treasured possessions, offering a retirement income of £5,000 or so a year, for as long as I lived. Even better, a reduced widow’s pension would be paid to my wife, should I die before her.

No longer. As of early April, that pension is part of my past, not my future.

Take the money

What happened? Last autumn’s bond market turmoil, in short. As gilt yields plunged in the wake of the Brexit referendum result, pension transfer values rose accordingly.

Some pension fund members were being offered transfer multiples of 30-40 times projected annual pension income. Not surprisingly, they were tempted to take the cash.

Among those tempted was former government pension minister and retirement activist Ros Altmann, who saw the transfer value of two pension schemes roughly double, with the transfer value of one scheme reportedly rising from £108,000 to £232,000, and the transfer value of another climbing from £57,000 to £104,000.

She took the money. As did, according to the Pension Regulator, about 80,000 other people.

Among them me.

Gulp

Now, a few caveats.

For a start, I didn’t get a multiple of 30-40 times that £5,000. More like 20 – but certainly a helluva lot more than the same firm had dangled in front me of a few years previously.

In part, I suspect, that lower multiple is because I wasted several weeks trying to resist the temptation.

I dallied because while I’m a fairly confident and experienced private investor, a pension transfer is a lot more than a transfer of a pension.

It’s really the transfer of a risk, and an obligation.

As a member of its pension fund, my former employer was obligated to pay me that annual income, and to shoulder the associated risks.

No longer. As of the transfer, all of that is on my shoulders, instead.

Repent at leisure

Now, not for nothing are pension experts and the Financial Conduct Authority (FCA) alike concerned about the increasing frequency of such pension transfers.

Just because a transfer value happens to be high is not a sufficient reason for executing a transfer. Particularly if you have no or little experience in personal investing – and even more so if one of the prime motivations is simply to get your hands on the tax-free cash.

And it’s of little help to point out that the rules governing such transfers call for mandatory advice from a financial adviser if the sum involved exceeds £30,000.

For a start, that’s arguably too high, and – perhaps more to the point – the advice that such advisers are obligated to offer can be of little help in real-world decision-making.

Short-term pain, long-term gain

What do I mean by that? Simply that central to the FCA-mandated adviser calculation is something called the ‘critical yield’, which loosely translates as the rate of return that you’d have to achieve in order not to be worse off, in income terms, after the transfer transaction.

Which scarcely figured in my own calculations at all.

I know I’ll be worse off, in the short term.

But what I’m interested in is longer-term income, longer-term inflation proofing (hopefully 100%, not roughly two-thirds), and the prospect of a six-figure lump sum to leave to my heirs. That is the trade-off in which I was interested.

Dilemma

The timing of the now-complete transfer was unfortunate. (And not solely in terms of the recent health scare which has unfortunately delayed my promised follow-up column on actively-managed ‘smart’ income ETFs.)

Basically, you don’t have to be Howard Marks – prescient though he can be – to worry that we might be in bubble territory with the stock market.

So my six-figure sum is currently uninvested, sitting there as cash, while I figure out what to do.

• Sit it out and wait for a hoped-for correction? I’ve succeeded in that in the past. But I might have a long time to wait.

• Drip feed into the market as opportunities present themselves? The trouble is, at present those opportunities seem few and far between.

• Dive in and lock in income now, rather than remaining uninvested?

What would you do? Dear reader, my confession is complete. But I’d welcome your answers in the comments below, please.

Further reading: See our article on one reader’s experience of transferring a final salary pension into a money purchase scheme.

What caught my eye this week.

Having made a case for higher inheritance taxes (IHT) in the past, I could have warned Abi Wilkinson to ask for danger money and a safe house when she wrote her piece for The Guardian this week.

Wilkinson writes:

Morally speaking, people who stand to inherit large sums haven’t done anything to earn that money.

An accident of birth placed them in a comparatively wealthy family and they’ve benefited from that their whole life.

This is the argument I make, too. People immediately start with straw man retorts – “Oh, so should rich children also not be allowed private tutors then?” or “Oh, so should rich children also be forced to live on Pot Noodles and never see a vegetable then?”

But I think that’s because in a world where we’ve decided to have a State and to fund that State with taxes, you have to go absurd pretty quickly to justify generous rates and reliefs for people who are (a) dead or (b) who did nothing to earn the money you are taxing.

These are taxes, remember, that rich kids not paying mean someone else has to pay. Maybe me or you? Maybe your kids, from their squeezed wages.

I understand – and was reminded by some of the nearly 2,000 comments on Wilkinson’s piece – that critics of inheritance tax (i.e. almost everyone) don’t see it that way.

They see 100% IHT as the State taking money from hard-working people who did the right thing and worked and saved all their lives and who are now being taxed twice. And they see the State giving it to indolent dossers via welfare and other benefits. (I paraphrase.)

Whereas I am full of admiration for people who work hard and save all their lives, but I see them as irrelevant once they’re dead. I see their children getting a freebie for doing absolutely nothing, on top of the other benefits having better-off parents gave them. And I see the victims not as the dead person in the grave, but rather the everyday people on minimum wages – or heck, the middle-class JAMs – who have to more tax on their incomes so that rich kids can get more money for free.

I’d tax inheritance at say 75% just because it’s the most moral tax. But I understand many of you feel differently.

Even my mum does – and I regularly urge her to spend the lot!

[continue reading…]

During this year’s Berkshire Hathaway annual meeting, Warren Buffett discussed the importance of his eventual successor as CEO having ‘a money mind’:

“People have to have a money mind. They can be very smart but make very unintelligent money decisions; their wiring works that way…

A money mind will know what needs to be done.”

Though I was in attendance, the importance of this commentary didn’t register right away. The more I thought about it, however, the more I realised it’s a great mental model for evaluating your financial skill set, as well as those of others such as fund managers and financial advisors.

We all know otherwise well-educated people who make dumb money decisions. That person might even be you from time to time, and I’m certainly in that camp.

Indeed, in a moment I’ll share why even financially-savvy people may not always be in the right ‘money mind’ state.

Putting your mind under the microscope

So, what is a money mind and why should it matter to you?

A money mind should:

1. Understand opportunity costs

Put simply, opportunity costs measure the gains you’ve forgone to make another choice.

Let’s say you choose to attend one university over another. Since you can’t attend both simultaneously, your opportunity cost is what you would have benefited by attending the other school.

As investors, we face opportunity cost decisions all the time, whether we recognize them or not. Cash or shares? Bonds or property? Company XYZ or the FTSE 100?

A money mind will acknowledge his or her objectives and time horizon, and balance those with current market opportunities.

For an investor with a 30-year time horizon, for example, the potential opportunity cost of holding cash is rather high when considering that the stock market’s returns over rolling 30-year periods have been consistently positive.

2. Have high emotional intelligence

Warren Buffett also famously quipped that:

“Success in investing doesn’t correlate with I.Q… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

There are four critical aspects of emotional intelligence, according to Travis Bradberry and Jean Graves in their book Emotional Intelligence 2.0.

These four aspects are: Self-awareness, self-management, social awareness, and relationship management.

As investors of our money or someone else’s capital, we must be able to recognize our biases (self-awareness), be able to act at times against those biases (self-management), understand the emotions of other investors (social awareness), and balance our emotional state with theirs (relationship management).

These requirements are a tall order, especially when we’re facing outside stressors in our personal lives.

A few years ago, for instance, my wife and I bought a car immediately after moving to a new city and buying a new house – both major life events. By the time we walked into the car dealership, I had decision fatigue and didn’t spend enough time preparing for the purchase the way I normally would have. I ended up overpaying.

An ideal money mind would have Spock-like reason and be immune to outside stressors, though this is more science fiction than reality.

Instead, seeking a state of controlled emotion seems the best strategy for most. A money mind will more frequently strike the right balance.

3. Be able to think and act long-term

Rarely will you find a capital allocator or company executive who admits to being short-term focused, but the numbers tell a different story. Capital allocators such as fund managers frequently feel the pressure of monthly, quarterly, or yearly results. Portfolio turnover is much higher than it otherwise might be.

For an investor to truly think and act long-term, they must have the personal capacity, the right clients, and the right investment vehicle to do so.

If you manage money for someone demanding quarterly performance, for instance, you will have a hard time executing a long-term objective. This could be a reason why Buffett operates a corporation with steady insurance float to invest, rather than managing an open-ended mutual fund.

We individual investors have a tremendous advantage in our ability to be patient, since we have no outside capital ready to flee following a year of market underperformance. Sadly, few investors fully capitalize on this valuable advantage.

Money minds will seek out environments that will enable them to execute their objectives.

4. Judge investments on value and not on price

One of the bigger mistakes that investors make is buying things that look cheap based on price alone, without consideration to quality.

It’s an issue we often face as consumers. Let’s say you need a new coffee maker. Prices might range from £10 to £200 for a top-of-the-line brewer. The ‘cheap’ shopper will simply grab the one with the lowest price but runs the risk of coming back to buy another when it breaks due to poor assembly. The ‘value’ shopper, on the other hand, will find the highest quality coffee maker for what she needs at the best possible price.

At this year’s Berkshire meeting, both Buffett and his business partner Charlie Munger discussed how important the purchase of the See’s Candy confectionery chain was to their development as investors. Leading up to that investment, Buffett in particular was more attracted to so-called deep value shares. But he came to understand the attractiveness of buying a quality franchise at a good price and holding it patiently.

A money mind will recognize the folly of being penny-wise and pound foolish.

5. Be insatiably curious and contemplative

When I interview company executives, my last question is typically a request for book recommendations. More times than not, the manager will look at me like I have two heads.

“A book recommendation?” they’ll reply. This isn’t the response I want to hear.

While most analysts ask about quarterly trends or expected capital expenditures for the year, I’m more interested in finding out if the executive is a learner and thinker. Some CEOs and CFOs have told me they don’t have time to read, which could be a sign they can’t manage priorities or don’t consider reading a priority. Neither is a positive sign.

Every so often, an executive will light up upon my request and talk about a book they read on history, business, or science. This is more like it. Money minds will be fascinated by new ideas and figuring out ways to glean lessons applicable to their operations.

Bottom line

In a previous post, I suggested that assuming a normal distribution of capital allocation skill among company leaders, perhaps 3-5% can be considered exceptional. A true money mind is rare and isn’t always consistently so over time.

Nevertheless, whether we aim to wisely allocate our own capital or someone else’s, possessing a money mind is a goal worth pursuing.

What other money management skills might you add to my list above? Let us know in the comments below!

Todd Wenning, CFA is an equity analyst based in the United States. Opinions shared here are his own and not those of his employer. A full disclaimer can be found here. For compliance purposes, Todd cannot reply to comments below, though he welcomes any correspondence sent by email. You can read Todd’s expanding collection of dividend articles here on Monevator or check out his book, Keeping Your Dividend Edge.