What caught my eye this week.

I was a little disappointed to hear (via DIY Investor UK) the Chairman of City of London Investment Trust making vaguely fearful noises about the liquidity risks of Exchange Traded Funds (ETFs).

City of London has a very good story to tell – its charges are low, and it’s beaten the market over three, five, and ten-year periods. It doesn’t get much better for an active fund, really.

And to be fair, compared to some outlandish charges you hear, the passive swipe made in its final results is pretty innocuous:

It also remains to be seen whether passive funds such as Exchange Traded Funds provide sufficient liquidity in a bear market because they have not been tested in their current size.

By contrast, City of London’s gross assets now exceed £1.5 billion and its market capitalisation stands at just under that figure.

Our size means that we provide investors with a ready liquid market in our shares and our closed end status enables us to ride out market setbacks without being forced into selling sound investments at inopportune moments.

But while all that’s technically true, I don’t think issues about the size and structure of the ETF market are very relevant to investors in City of London.

Yes, the ETF market is far larger than it was a few years ago. And yes, during moments of dislocation, ETF liquidity can be interrupted.

However these interruptions have tended to be very brief – think minutes, not days. Most of the time only smaller ETFs investing in much less liquid securities see any sustained mispricing. (I’d be cautious with so-called ‘liquid alt’ ETFs for that reason).

Moreover, as an active investor I see investment trust prices jumping around and spreads widening and shrinking all the time. Trading at a discount (or premium) to underlying assets is pretty much a feature not a bug for investment trusts. Indeed during the last bear market, the discounts to net assets on income investment trusts soared – as I flagged up at the time.

It’s true that the closed-ended nature of an investment trust means it does not need to sell underlying assets in a panic, which can be a benefit – especially if you want exposure to those less liquid assets where niche ETFs may struggle.

But the share price of the trust itself always fluctuates. And when the underlying market they invest in is in freefall – such as in a market crash – you can be pretty confident a growing discount will reflect that strain.1

Less knowledgeable investors who bought into reassuring words about the size and strength of a particular trust might be somewhat surprised if and when this happens. Especially as I am confident the biggest ETFs trading in the sort of liquid blue chip shares that big income trusts own will more or less function as normal and trade in line with assets for 99.9% of the time, even during a bear market.

Brief disruptions to ETF pricing may be a problem for some kinds of investors – say the hedge funds who use them in place of direct shareholdings to quickly shift their exposure to markets.

But most long-term private investors – exactly the sort who might favour investment trusts – would probably prefer the twice-a-decade 20-minute interruption to smooth pricing that an ETF might suffer over a persistent discount to the worth of their fund in a bear market.

I like the City of London Investment Trust – and not coincidentally my mum is a shareholder – but I’m not sure a fight with, say, a cheap and liquid ETF like the iShares Core FTSE 100 ETF is one it wants to pick.

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1. Presuming there’s no discount control mechanism in place – and that the trust retains sufficient financial flexibility to use it as the crash continues. [↩]

What caught my eye this week.

Another week in the time-warp that is Brexiting Britain. Don’t hold your breath if you’re waiting for Star Trek.

First we had prime minister Theresa May’s ‘Brexit vision’ in Florence.

While almost devoid of content, I thought May delivered a pretty rousing speech.

Unfortunately it was almost 18 months too late.

True, it wouldn’t have convinced me Brexit was a good idea back in May 2016. But I would have doffed my cap to her for making a stirring case.

But this wasn’t a wishy-washy Vote For Us campaign speech. This was a speech given more than a year after the UK voted to leave the EU! In a Referendum where many apparently thought we’d be more than halfway to the exit by now.

And it’s ever more abundantly clear that there is/was no idea of the scale of the challenges, no plan, no progress – just barely concealed panic.

The only content in this curious piece of should-be historical reenactment? An admission that – of course – there will be a transition period and – of course – the UK will continue to pay into the EU during it.

Both are entirely obvious requirements to anyone but the politicians on the Leave stump last June, and to a sizeable cohort of their voters.

You might consider May vaguely acknowledging these realities is progress, but it wasn’t delivered in a grown-up or rational way. Rather she offered a deeply couched acceptance to soften up the Brexiteers for the inevitable. It was in the same way flummoxed parents promise to the kids in the back of the car that there’ll be ice creams later but first we have to go to B&Q. Miserable.

Uber stupid

Meanwhile back in London – shining capital of a bold new Brexit Britain or Wiley Coyote running over a cliff-edge, depending on your point of view – we had Transport for London announcing it would not be renewing Uber’s licence to operate, potentially cutting off a service enjoyed by three million people at a stroke on 30 September.

True, Uber won’t just cease operations – there will be an appeal. An appeal I suspect they’ll win. We might be tending towards mob rule in the UK, but the mob wants Uber and I think they’ll keep it.

But to try to cut the service down at a stroke seems a Draconian way to do business in 2017.

Why not big fines? Why not notice periods? I’m not an expert on taxi cab licensing, so perhaps my thoughts are wide of the mark. But to me it seems like a return to 1970s-style local politics and protectionism, and emblematic of the irrational way we’re making decisions these days.

Uber is a far from perfect company, but the world and its dog knows that. The founder has been replaced. The internal culture is getting an overhaul.

Yes, there have been some horrible crimes committed by Uber drivers. If it has dragged its feet bringing them to light, it should be punished.

But those celebrating Uber’s apparent cessation in London should think about the bigger picture.

Firstly, as is often the case with capitalist innovations, it’s easier to overlook the massive way the company has improved life, just because it happens to make a profit.

Uber has facilitated millions of journeys in London – especially late at night or to out of the way places – that made living in this often difficult city easier. We’re talking tens of millions of hours of lives better lived.

Then there are the attacks and similar. Nobody wants to write “yes, but” and consider the bigger picture when it comes to such things – but that’s exactly what we should do.

Over the past two decades I have seen numerous friends – most often younger and arguably more vulnerable women – get into literally random cars on the street, despite my protests, for various financial and perceived safety reasons. Horror stories about rogue mini-cab drivers were ubiquitous until Uber arrived on the scene.

Are Uber-haters considering the alternative of going back to 2010 – many more people walking home late at night or getting into unlicensed cars at 3am drunk or similar because they can’t find/afford a black cab or even a mini-cab?

I agree Uber has not been the greatest company culture-wise and they need to upgrade their practices. But the technology is revolutionary and it has transformed late night London. The fact that all Uber journeys are logged and linked to a user makes it far safer than most alternatives. TFL should be working to roll this out everywhere, not seeking to roll it back.

Uber should have been fined or put on some sort of official notice or similar. They should not exist outside of regulation. But there’s no use being sentimental about it. Black cabs are as dead long-term as red phone boxes.

Let’s hope this decision isn’t the canary in the Brexit coal mine that Tyler Cowen at Bloomberg fears:

The new Britain appears to be a nationalistic, job-protecting, quasi-mercantilist entity, as evidenced by the desire to preserve the work and pay of London’s traditional cabbies. That’s hardly the right signal to send to a world considering new trade deals or possibly foreign investment in the U.K.

Uber, of course, is an American company, and it did sink capital into setting up in London — and its reputational capital is on the line in what is still Europe’s most economically important city…

Unfortunately, the U.K. is in a position where it can’t afford too many more mistakes. It just made one.

• You can petition against TFL’s decision here.

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This article about online retirement calculators is by former hedge fund manager Lars Kroijer, a regular contributor to Monevator. He is also the author of Investing Demystified.

The Internet has revolutionized access to information, as we have discussed many times on Monevator. Investors can now find a plethora of tools on the Web to help us better manage our finances and lower our costs.

But are you getting the whole story from these free resources?

Retirement calculators, for example, apparently serve a very useful function. You simply feed a few data points into the calculator and voila – the computer tells you whether or not you’ll have enough money for a happy retirement in your old age.

Job done? Sadly, it’s not quite so simple.

Calculated odds

Take a look at the CNN Retirement Calculator, for instance. This tool has all the standard options to change the inputs, but for the purposes of this article I stuck with its default assumptions:

• I am 35 years old (I wish!)
• I will retire at 67
• I have $100,000 saved up
• I earn $55,000 a year…
• …of which I’ll save 15%

Reading through the calculator’s methodology footnotes, we learn it assumes your income will grow 1.5% above inflation. Your investments (both current and future) are projected to return 6% per year, presumably before inflation of 2.3% (so a 3.7% real return). We aren’t told if that is a compounding return or annual average.

To calculate your future spending needs, CNN works out what it costs at retirement to buy an annuity that gets you 85% of your pre-retirement income. While CNN uses US dollars (USD), the logic would be the same in other currencies.

Choosing to input all this data in real terms amounts (that is, after-inflation) and with the assumptions listed above, the CNN calculator tells us we will have enough money for retirement.

Phew. It seems we’ll have $883,000 in today’s money, and that we actually only need $804,000.

That’s nearly $80,000 spare to put towards a big retirement bash!

Risk and retirement

Now before I start saying what is wrong with this logic it is important to mention that the CNN tool does do a lot of important and useful things for you.

It reminds you of the importance of saving for your retirement. It gives you an idea of orders of magnitude. It has figured out the math of long term savings and the eventual cost of annuities. And it’s done all this without charging you a penny.

However in my view the calculator also gives you a false sense of security that is important to understand.

In particular, the return assumption in the model is 3.7% after inflation. The yield after inflation of US/UK 30-year government bonds is currently around 0.8%. Since these government bonds are perhaps the most ‘riskless’ investments, we’ll obviously need to take some risk to get up to an annual return of 3.7% after inflation.

And therein lies the problem. These kinds of calculators lead you to believe that if you do what is said in their assumptions, then you’ll have enough money. End of story.

But that is only the half of it.

You see, if you need to take risk to earn that 3.7% post-inflation annual return, then there is obviously a risk that things don’t go according to plan and that you fall short of reaching your retirement goal.

And it’s critical that you know this before you blindly assume that your savings will be enough.

Risk and returns

How much risk do you need to take to get a 3.7% real return?

If we assume that we can get 0.8% from riskless bonds and that equities deliver about 4.5% a year in real terms (a little lower than what they have in the past) we can reasonably expect a 3.7% annual return from a portfolio that comprises roughly 20% long term government bonds and 80% equities.

But a portfolio that is 20/80 bonds/equities will have a broad range of potential outcomes – particularly over a whole working life.

How broad is the range, and in how many cases does it leave us with insufficient money?

It all depends on your assumptions of risk with respect to equity markets – or whatever other types of risk investment you make – and on whether you accept the calculator’s 4.5% return expectation.

The point is the certainty suggested by the calculator is really just an educated guess as to how on average things will turn out.

Calculators with caveats

Instead of saying ‘you will have enough’, or ‘you need to contribute more’, I would prefer such calculators to say ‘given these [stated] assumptions on risk of the returns, we think there is an X% chance that you have enough’.

This is important, because that is how it works in the real world. There are very few sure things in investing. If you’re saving for retirement, it’s best you know that from the start.

Instead of the false sense of security that the CNN calculator gives you, it would be better for you to know and understand the probability of falling short. Then you can think about how happy you are with that probability.

Would you be comfortable if I told you there was a 20% risk of falling short? What about a 10% chance? 5%?

It all depends on your circumstances and your feelings towards risk.

Your attitude towards risk – as reflected in different inputs you would then feed into your projections, and the outputs you’d be given – will demonstrably alter what spending power you can hope to achieve in retirement.

A more transparent exploration of risks and outcomes would also enable you to see how by changing your investment allocations or pension contributions today, you might influence your financial future.

Build your own retirement spreadsheet

Below you’ll find a video that further addresses the issues around the CNN retirement calculator:

I built a financial spreadsheet to address the issues in the CNN and other calculators, in order to enable investors to understand these issues and play around with the impact of different assumptions.

You can read my article explaining why and how you should build your own spreadsheet. Then check out my ongoing How To series for more on YouTube.

As with my previous Monevator pieces I’d really like to hear your views.

Please comment below on what you’d like to see added to my model or anything that you believe I could explain better. I’d like the model to be as accessible and useful as possible, and your feedback is greatly appreciated.

Check out the new edition of Lars’ book, Investing Demystified.