I have decided to reverse my usual policy of looking at my portfolio about as often as Dracula out the window on a sunny day. Why? Because while we’re being roughed up I might as well discover a few home truths about my risk tolerance.

How big a beating can I take?

I don’t think I know.

Sure, I’ve done some tests. According to Finametrica’s industry-standard metrics, I’m quite the risk jockey – in the top 2% when it comes to laughing in the face of volatility.

But, but, but… the only test that counts is real life.

How do I feel when the numbers are actually streaming red down the screen? As they are right now – we touched bear market territory last week. A true test of nerve as the FTSE veered 20% below last April’s highs.

Obviously 2008 was bigger. The FTSE buckled by 31% then.

But I had a lot less to lose in those days. I got a statement at the end of the year and everything looked shot to hell, but it didn’t seem to matter much.

I was more worried about my job. Retirement was a faraway land – a 30-year pipe dream, minimum.

In skin-in-the-game terms, I chafed my pinky in 2008.

But now I could lose an arm and a leg.

It’s a test designed to provoke an emotional response

So I’m staring my numbers straight in the face.

And it’s weird.

Somehow, when I wasn’t really looking, my portfolio crossed a threshold. It grew up.

Now a day or two’s volatility can wipe off thousands from my name. Look again and the thousands are back. (Some of them, anyway.)

Wipe on, wipe off.

It’s like watching time-lapse photography of a watering hole. It shrinks in baking tropical sun. It’s replenished by the rains. It expands, it contracts, it expands, it contracts, at unreal speed. The only thing missing is a cameo by a curious water buffalo.

If that sort of money disappeared from my bank account I’d phone the Police.

I’d be on my knees sobbing, “It’s gone, Lord help me, it’s gone.”

If I won it back on a gameshow I’d be dancing like Topol.

But when money is dangled and whipped away faster than a card sharp playing Follow The Lady, it doesn’t seem to matter. It isn’t real, even though it is.

My emotions are caged. My pulse low. No sweat prickles my brow.

Why, why, why?

Is the risk tolerance test accurate? How much rougher does the sea have to get before I feel out of my depth?

That’s why I keep looking at my numbers. It’s a staring contest between me and the market.

I want to know how much wealth I can watch evaporate and not blink.

When I hit my limit, I want my withdrawal to safer ground to be orderly and gradual. Otherwise, I could risk years of gains.

Early warning

Some clues that you’re nearing the limit:

• Feeling down, queasy, or panicked by the decline.

• Not sleeping well.

• Not able to rebalance into the teeth of the storm.

That last one is the best friend you’ve got, because who wants to live with the first two?

If it’s too scary to rebalance into the losers now then how would you feel if losses ramped up to -30%, -40% and beyond?

Dialing back your equity allocation and upping government bonds will reduce your exposure – but do it gradually in the coming months and years.

Not in a panic when equities are on sale.

To give you a sense of what carnage looks like, the biggest real terms stock market drop in UK history was -71% between 1973 and 1974.

It took the market ten years to return to its previous level. If you were accumulating equities on the cheap in the meantime then your portfolio recovered much earlier.

But if you were selling off then it took much longer. Possibly never.

For me, education is the best armour. Knowing that crashes are normal makes it easier to shrug off bad times.

The Irrelevant Investor has posted some brilliant stats about double digit declines in the US. We don’t have those figures for the UK but they’re likely to be in the same ball park.

• 64% of all years experienced double digit declines.

• 36% of all double-digit decline years ended positive.

There’s an even starker chart from Larry Swedroe that shows how often the US goes into the red even when the year ends in the black.

(Spoiler – all the freaking time.)

So we’re down a fair chunk. This is normal. Equities across the globe are now cheaper and that raises the prospects for future expected returns. If you’re still accumulating then this is good news.

The rewards of investing come to those who can take the pain when the world mood darkens. Many people can’t. That’s why they fold and sell out at lower and lower prices.

Do that and the spoils go to the winners who scoop up those unwanted assets and sell only much later when the fearful have returned, confidence restored, and confidently buying back those self same assets from you at much higher prices.

So hang in there and use the pain.

Take it steady,

The Accumulator

Good reads from around the Web.

I have half-written several posts over the years about how ordinary savers have been shafted by the aftermath of the financial crisis, while the reckless were rescued.

While we still hear angry complaints that the bankers were bailed out by the Government1, the big winners were the millions of middle-class consumers who over-stretched to buy houses they couldn’t afford in the boom and then saw interest rates fall to near-zero levels – and who have since enjoyed bubble-like returns from property in London and the South East.

Many Monevator readers are homeowners who got lucky on interest rates. But before you get too indignant I’m not castigating everyone as fortunate chancers.

It’s those at the extreme end – who would have got their comeuppance in a typical recessionary purge – that should be glad things got so bad it saved their bacon.

Similarly, it’s not cavalier risk-tolerant active investors like me who’ve suffered from low interest rates.

It’s more normal successful young people who earn say £30,000 a year and who have saved what would have once been considered a heroic £2,000 to £3,000 a year towards a house deposit, but whose savings have (relatively speaking) gone nowhere while prices – at least in the South East – have gone into orbit.

The new normal

A young couple who bought a two-bed flat in Tooting in 2007 when prices were already high, using a £25,000 deposit from his grandmother and a four-times multiple of her salary, because they had to start somewhere, they wanted children in five years, and they needed to get on with their life – they were pragmatic, not reckless, as I see it.

In contrast, the 10th decile who paid 6-10x their income for their properties, who employed self-certification to make up their income anyway, those who created deposits from credit card advances, and those who had their parents remortgage the family home to enable them to buy a ritzy flat in Fulham where they couldn’t afford a bicycle shed – they are the ones for whom the financial crisis was like a windfall Monopoly card that reversed the normal run of recessions.

• Those who had bought a second or third buy-to-let property at the peak of the bubble.

• Those who had paid a year’s salary for a brand new BMW, on credit.

• Those who acquired a holiday flat in Paris by re-upping their mortgage in Westminster.

All saved by a situation so dire that interest rates went to 300-year lows.

Now, I can already hear some of you loosening your fingers to bash out an angry defense of these buccaneering go-getters…

• Perhaps I’m just seeing through my own circumstances?

• Hasn’t the stock market or even bonds been fine for investors – bad luck for those dumb enough to stay in cash?

• Was the Bank of England supposed to sink the economy for the sake of moral hazard?

• And so on.

True, these points all have some reality behind them. The older I get, the more I realise there are three sides to every argument – my view, your view, and the truth – and the less tolerant I am of those who believe they have a monopoly on two of them.

Alas, the Venn diagram of those who believe they are always right and those who comment on blogs is very large, too – even among our readers, who are in general about the smartest and most sensible in this sphere that I’ve encountered.

And to be fair, perhaps the overlap is large among those who write blogs, too.

“The first principle is that you must not fool yourself – and you are the easiest person to fool.”
– Richard Feynman

The result is I’ve avoided too much crusading about all this over the years.

But maybe that was a mistake, given the magnitude of these shifts.

Sinking the marshmallow test

While I muse on whether it was wisdom or cowardice that has so far prevented me climbing more frequently into the bully pulpit, I will point instead to an article on the virtues of saving by Gaby Hinsliff in The Guardian of all places.

Despite writing for a paper that has never seen a consumer that doesn’t deserve compensation or a family that isn’t hard-pressed, hard-working, and yet let down by Government, Hinsliff has written eloquently on the dangers of not rewarding those who get by under their own steam:

Saving teaches self-discipline, impulse control, the ability to forgo instant gratification in exchange for future reward – all the things famously measured by the Stanford marshmallow test, in which four-year-olds were offered the choice of one marshmallow now or two if they could bear to wait 15 minutes.

What makes the experiment so famous is that those few kids who resisted temptation didn’t just grow up to get higher exam scores, but were also still leading more successful lives four decades later.

But what if it had all been a con, and there hadn’t been a second marshmallow?

What happens when you save and save for a whole lot less reward than expected?

For eight years I’ve written a blog based on the belief that a second, and a third – and fifty more – marshmallows will come to those who do the right thing.

We’ll see.

Is this the best we can do?

Now, perhaps you’re alright, Jack. (As I am, as it happens). You bought your flat in 1997 and didn’t go on holiday in that year, and anyone who says the current system is distorted is a hopeless whiner.

But even if you believe that, if you’re reading this blog presumably you believe in the power of incentives?

And to that end, don’t we want to see more marshmallows instead of:

• Homes located where people want or need to live looking permanently out-of-reach to everyday successful young people?

• Kids lumping around great tranches of debt acquired from often pointless university degrees instead of starting to save for the future?

• Saving and investment to pay better than borrowing and betting?

As for the expected upcoming changes to pension tax reliefs (featured in two links below, and I could have included another half-a-dozen) I appreciate this is a tricky issue for various reasons we all understand.

But should we too readily swap a level playing field for one that looks set to be made massively less generous to those responsible middle-class higher earners who save for an increasingly uncertain future, compared to the perks enjoyed by previous generations?

We’ll pay for this

We had a financial crisis driven by debt – yet so far those with debts have won the day.

In fact the single best financial move of the past 20 years was to skip university, scrape together all the money you could from rich relatives, lie about how much you earned to get a dodgy mortgage, and then take a massive punt on the biggest house you could buy in the priciest part of the country and cross your fingers.

[continue reading…]

1. Tell that to long-term Northern Rock, HBOS, RBS and even Lloyds shareholders. [↩]

Want to do the unspeakable deed? The following guest post by Auld Tattie Bogle, a Monevator reader, explains that it even if you’re convinced it’s right for you, it might not be so easy to transfer a final salary pension.

I have almost reached my half-century, and along the way I have enjoyed a fairly long career in IT with a variety of different employers.

This scenic route through the workplace had resulted in me acquiring several relatively small pensions.

Most were defined contribution schemes. But one was a defined benefits scheme.

Following the pension freedoms that came into effect on 6 April 2015, many people may have been tempted to transfer money from such defined benefits scheme – also known as final salary pensions – into a more flexible money purchase scheme, also known as a defined contributions scheme.

Now for most people, undertaking such a transfer is likely to be a bad idea. This is because a final salary scheme guarantees a certain level of income in retirement risk-free, provided the scheme doesn’t go bust.

Worse, for a significant minority a transfer could present crooks with a great opportunity to defraud them out of a large portion of their pension savings.

So let’s be careful out there!

Yet despite these risks, I decided to transfer my sole small-sized defined benefits pension pot into my primary SIPP.

As things turned out, making this difficult decision was the easy bit. Actually getting the transfer done was the real challenge!

I thought I would share the logic behind my decision and my experience in case others find themselves in a similar situation.

One pension pot to rule them all

Some years ago I decided to consolidate the money from all of my previous defined contributions schemes into my employer’s scheme.

However I had hitherto left my defined benefits scheme alone.

Received wisdom was that these schemes were valuable, increasingly rare and the gold standard for pensions that shouldn’t be messed with.

But as time passed I became increasingly curious about the possibility of cashing in this defined benefits scheme and transferring it into my SIPP.

As I mentioned, I knew making such a move would be very much counter to the standard advice.

Why then did I do it?

Here are the main reasons I decided that transferring my defined benefits scheme into my SIPP was a sensible course of action for me:

• I am not convinced that defined benefits schemes benefit ‘deferred’ members with short periods of employment.

• My defined benefits scheme was a very small percentage of my overall pension provision (around 10%).

• I plan to retire early.

• I plan to take a tax-free lump sum.

• I plan to use flexible drawdown rather than to purchase an annuity.

• My wife’s primary pension is a defined benefits scheme, so between us we would still be covering the bases.

• I like the idea of having visibility of all my pension funds in one place. (Sad I know!)

Decision defined

I ought to explain my thought process behind the first bullet point above.

Final salary schemes benefit most those members whose salaries increase over their careers.

This is because a member’s final salary at retirement can be far higher than their average salary.

Thus being frequently promoted has the effect of inflating benefits without increasing previous contributions, which means high flyers can receive a Managing Director’s pension on a Post Boy’s contribution.

However as a deferred member, my salary is permanently fixed and I therefore have no opportunity to increase my benefits in this way. Hence the relative lack of appeal to me.

In an attempt to sanity check my logic, I approached an IFA I’d previously used to review some financial plans for some informal advice.

I explained my situation, and why I believed that a transfer was the best course of action for me.

Off the record, his response was ‘that sounds reasonable’, so I set the wheels in motion.

Computer says no

After waiting for ages, my defined benefits scheme administrator provided me with a binding Cash Equivalent Transfer Value (CETV).

I looked over the figures. To me it seemed a fair price for the guaranteed future entitlement I was giving up, so I approached my SIPP provider to initiate the transfer.

First problem!

My SIPP provider said that as the transfer was to come from a defined benefits scheme, they could only process my transfer if I had received advice from an IFA.

Then things got rather Kafkaesque. My SIPP provider added that they could accept the funds even if the advice from the IFA was that the transfer was not the right thing to do!

This struck me as an insane position to take.

Do not pass Go

Second problem – I went back to my IFA who told me he could run the numbers for me, but that it would probably cost around 10 per cent of the fund’s value!

I politely declined his offer; I am a firm believer that minimising professional fees for advice or management is one of the best ways to maximise investment returns.

I mused on the possibility of finding an accommodating IFA who would say ‘don’t do it’ for a nominal fee of £50. I could then present this negative advice to my SIPP provider, and they would presumably initiate the transfer.

After all, if the IFA said ‘don’t do it’ and I did it anyway, surely I couldn’t sue them? What would they have to fear?

Equally, the SIPP provider presumably felt that as long as there was a tick in the ‘client has received advice from an IFA’ box, they couldn’t be held liable if the transfer turned out to be a poor decision?

To be honest I was slightly offended that my SIPP provider would not accept my decision, despite the fact that I had thought the issue through quite thoroughly and decided it was the best course of action for me.

It was as if I was not qualified to make my own choices and accept the consequences.

Instead I had to pay some professional to tell me what I should do and to accept legal liability for that advice.

I did approach a couple of IFA’s and cheekily suggested my £50 for an immediate ‘Don’t do it’ report, but they weren’t keen for some reason. Presumably because it was more profitable for them to ‘run the numbers’.

A roundabout solution

Having seemingly exhausted my options, it looked like I wouldn’t be able to affect a transfer – even though I genuinely wanted to.

Clutching at straws I approached my company pension provider.

It transpired they were far less squeamish about accepting money from a defined benefits scheme.

All I had to do was answer some questions over the phone about my understanding of the risk, which was presumably recorded and filed under ‘in case he tries to sue us later’.

Hey presto! The money was transferred into my company scheme for a few months while I finalised the timing of my resignation.

Then, once I had left, I simply transferred the whole lot – final salary part and all – into my primary SIPP.

Job done. Hurrah!

Have you transferred (or given up on transferring) a defined benefits scheme? Did you go through a similar rigmarole? Or perhaps you think it’s never right to trade in a final salary pension? Please share your (polite, constructive) thoughts in the comments below.