Good reads from around the Web.

This week saw North America finally bite down on the stock market rout that has roiled most of the rest of the world for the past year or so:

• The UK’s FTSE 100 index is now down nearly 18% from its peak on 27 April 2015.

• The German Dax index is down 23% since 13 April.

• Emerging markets such as Brazil are down far more again since their peaks a few years ago.

These are bear market declines – or near as damn it in the case of London.

Armed with these numbers, it is somewhat amusing to hear U.S. commentators explain why a bear market in the US isn’t possible due to the state of the global economy or low interest rates across the developed world.

If it’s clearly already happened elsewhere, why not there?

Indeed in reality most of the US market is already in bear market territory, in terms of peak-to-trough declines.

In the past year only a handful of stocks such as Facebook and Amazon held up the US indices. Now they’ve rolled over and the indices have come down.

That’s the bad news.

But there are plenty of reasons why it’s not really so bad.

It is happening again

First and foremost is that if you’re a sensible passive investor, you know this sort of thing is going to happen and you’ve built your portfolio around it.

For example, our Slow & Steady model portfolio will keep trucking on, despite having plenty of exposure to global equities.

Sure, if this continues then 2016 isn’t likely to be a banner year for passive portfolios.

So what? It happens.

One of the most amusing things I’ve heard in the past few days is otherwise sensible investors such as the veteran Leon Cooperman of Omega Advisers blame some of the US volatility on the post-financial crisis regulatory landscape that has restricted the ability (or incentive) of intermediaries such as investment banks and dealer-brokers to hold inventory1 and so reduce volatility.

These old-timers usually also point at robot traders for good measure.

Now, I happen to agree liquidity has been reduced by financial regulation, and I don’t doubt momentum-based traders are influencing the markets.

But crashes have happened pretty regularly ever since we’ve had markets, and long before quant funds or the shrinking of bank trading desks.

Indeed recent years have been marked by relatively low volatility in America – despite the prevalence of these factors.

You can hardly have it both ways!

Therefore, we can safely bin these theories as poppycock.

Things fall apart

Of course people always want explanations.

My best one is that the US market has looked expensive for years, and traders finally found some excuses – the US rate rise before Christmas, the otherwise irrelevant volatility in China2 – to shed some of their pricey-looking exposure.

But really, who knows?

As Robert Seawright explains on his blog:

Wildfires, fragile power grids, mismanaged telecommunication systems, global terrorist movements, migrating viruses, volatile markets and the weather are all self-organizing, complex systems that evolve to states of criticality.

Upon reaching a critical state, these systems then become subject to cascades, rapid down-turns in complexity from which they may recover but which will be experienced again repeatedly.

This phenomenon was discovered largely on account of the analysis of sandpiles.

Scientists began examining sandpiles and discovered that each tiny grain of sand added to the pile increased the overall risk of avalanche.

But which grain of sand would make the difference and when the big avalanches would occur remained unknown and unknowable.

For passive investors, the best way to combat the unpredictable is to control what you can – your exposure – by rebalancing your portfolio from time to time.

This way you’ll trim more expensive (and perhaps more vulnerable) asset classes over time and top-up cheaper ones, without having to try to make potentially ruinous market calls.

The other thing to remember is that volatility is great for long-term savers. You’re buying more shares cheaply, and the benefit of that bargain price will compound for the rest of your investing lifetime.

You might even treat the next round of market falls with a smile.

You’re here for the long-term

What is not advisable is panic.

To this end, The Reformed Broker Josh Brown has delivered a good one-two-er on the psychology of investing through volatility.

His comments on the wisdom (or otherwise) of passive saver-investors trying to turn themselves into market timing geniuses when stock markets fall is on-point for everyone saving for their retirement:

…accept the fact that risk is a given no matter what.

But you have a choice: You can decide when to take the risk, today or in the future.

Rational investors would prefer to take investment risk today, accumulating assets while coping with drawdowns and fluctuations in value.

Only an insane person would choose to take their risk at the back end of their life – being short of money in old age when it is nearly impossible to earn more money.

You can risk the volatility today or the chance of being broke later, your choice, but you must choose.

Sitting in cash may temporarily feel better because there is a sense of security that comes over us when the value of our account ceases to fluctuate.

But you’re not safe, you’re merely gaining the stability of a unit of currency in exchange for the risk of losing future purchasing power.

Even presuming there is a bigger crash coming that it would be profitable to sidestep, once you decide to sell up your portfolio on the hunches of analysts, you’re going to have to be right at least once more if you’re going to stay invested.

Or, as Brown put it in pictorial form:

This is going to hurt… a bit

The obviousness of all this on a sunny Saturday morning doesn’t mean that it is easy in practice.

Usually quite the opposite.

Once you get past the superfluous complication some try to foist on it, constructing a passive portfolio is easy – so easy a child could do it.

However actually investing regularly, rebalancing, and having the discipline to adjust your allocations based on your stage of life, not on scary newspaper headlines – that can be hard.

So while it might be offensive to some of the Monevator faithful, I do have some sympathy for Brown when he says:

The fact is, most investors cannot tolerate the full brunt of a bear market psychologically, and will end up doing the perfectly wrong thing at the most inopportune time.

You will see how many newly-minted Vanguardians and robo-clients vomit up their equity portfolios toward the end of whatever this market episode becomes.

And so I would say that if you believe yourself to be susceptible to this sort of thing – and there is no shame in being emotional about money, we all are – now would be a good time to make sure you are getting good guidance from an advisor who you trust and who understands what’s happening.

Those of us who have had a lot of contact with investors – whether we are investing bloggers or Wall Street denizens – have seen the foibles of the typical investor more than most people.

And I’ve seen we’re all pretty foible-d.

Is it 2008 all over again?

For example, I’m a believer in passive investing who thinks it’s what you should do, too, but who himself runs his own active portfolio like he’s a wannabe George Soros with a Napoleon complex.

Hard to get much more conflicted than that!

So when stock markets fall fast – and I do even worse than the benchmarks, as has happened so far in 2016 – I get the double pleasure of seeing my net worth dwindle and feeling I should have done something clever to prevent it.

Fun!

Not really – and yet another reason why it’s better you invest passively and to get on with the rest of your life.

/spurious speculation begins/

For what it’s worth though I do not think this is 2008. The US market could and perhaps should come off another 10%-20% given the extent of its overvaluation, but I personally do not see the systemic risks, the economic slowdown, any euphoria, or a global overvaluation in equities that might precipitate a worldwide slump from here.

Still, it could happen. As I said earlier, crashes are normal. If anything it’s weird the US went so long without one.

But understand they don’t all end in capitalism-threatening heart attacks.

To be sure, there are ominous signs. I keep hearing US commentators claiming their economy is safe because unemployment is still falling, for example, but jobs are a lagging indicator.

Low US unemployment actually makes me nervous!

The yield curve still looks okay – which is to say it still slopes upwards. But it has been flattening, and this will only get worse if the Federal Reserve does hike US interest rates four times this year, as was expected. (I think it won’t).

What about commodities?

The prevailing view now is that low commodity prices may be signalling something ominous.

But personally I doubt it.

To me commodities remain a story of oversupply. In the case of oil and some metals, we even know who is deliberately oversupplying the market and why. Add in years of widespread expansion, and it is abundantly clear there’s too much digging and drilling going on.

But I do not see the collapse in demand.

On the contrary I would not be surprised to see low energy and material prices eventually spark a boom in places like India and even China.

One thing that is a bit more worrying is the state of the high-yield market in the US, as I think we’ve discussed before.

Essentially too much money was lent too freely to too many shale drillers at ridiculously cheap rates.

That is now about to come home to roost. However I think the big banks are generally more than capable of taking it.

Another thing I’d note is I’m seeing a bit of strange pricing in some parts of the market. It’s not riddled with strange anomalies like in late 2008, but I believe there is some rapid de-correlation going on.

Such divergence could indicate a market falling apart – or just maybe it’s a sign of capitulation.

Finally, the rolling nature of this market rout has given active investors plenty of opportunity to take cover in cheaper stocks.

Just don’t expect them to feel comfortable!

Since late 2015 for instance I have had more natural resource exposure than ever before in my investing career. True, it’s held on a short leash and I trade it often, but I do think it’s likely to prove a better investment on a five-year view than the supposedly safe household goods giants on high P/Es.

We’ll see!

/end of spurious speculation/

Nothing has changed

So this is a bit of a brain dump on the state of the market in 2016.

I won’t be doing it every week – even if the market keeps falling – you’ll be pleased to hear.

If you do want more comment in a month or three, perhaps just come back and read this post again. I doubt anything much will have changed except the prices.

Overall, my suggestion to most would definitely be to keep investing passively, be glad that shares are on sale, follow my co-blogger’s excellent passive investing posts, and just keep on keeping on.

This is not the time to panic, not least because it’s probably a bit too late to panic for the typical UK investor who will have a home-biased portfolio.

If you’re more actively inclined, there may still be time to react to what I suspect is an ongoing regime change in market leadership. Personally, I suspect the era of large cap growth dominance may well have run its course for now.

But to be frank, even for active investors the odds suggest you’re best off buying and holding quality companies for the long-term – or at least for as long as they’re still doing good business – rather than trying to dance around too much.

[continue reading…]

1. That is, shares and other securities. [↩]
2. I’m not saying the Chinese economy isn’t significant, but its market has boomed and crashed out of sync with ours many times. The volatility it causes seems to be short-term. Also, it’s not even clear the Chinese market is a particularly good indicator on the direction of Chinese economic travel, let alone global stock markets. [↩]

The Christmas mail brought a pensions update from a former employer, a FTSE 100 engineering company.

In four years’ time, it proposes to pay me around £5,500 each year.

Not bad going for a job that I was in for just five years, and which I left in 1983.

What was especially interesting, though, was the half-page of information devoted to warning people about the various pension scams going the rounds, with murky companies apparently offering dubious ways to ‘liberate’ pensions and provide early access to funds.

So avoid cold-callers or website pop-ups offering ‘a free pension review’ or ‘legal loophole’, it advised – and be especially cautious of overseas money transfers or paperwork delivered to your door by courier, requiring an immediate signature.

Even when outright theft isn’t the objective, it added, so-called pension liberation can still see retirement savers hit by usurious fees and commissions, sometimes amounting to a third of their pension savings.

These are, indeed, shark-filled times.

Take care out there.

Freedom versus responsibility

But is Chancellor George Osborne one of the biggest sharks? Or, if not an actual shark, at least helping to encourage the feeding frenzy?

Because data crossing my desk certainly points me in that direction.

Yes, the 2015 pension freedoms have done much to put retirees in the driving seat, giving them more control over how they access their pension savings.

But control isn’t always exercised responsibly. And to borrow an analogy from former Lib Dem pensions minister Steve Webb, if you put just-qualified 17-year old drivers behind the steering wheel of one of Webb’s famous Lamborghinis, you’re going to get a certain number of car crashes.

Now, call me old-fashioned, but as a (hopefully) responsible parent, I can’t help but think that while the 17-year old deserves a lot of the blame, the person who handed over the keys should not be beyond reproach, either.

Spend, spend, spend

There’s a popular perception that George Osborne’s pension reforms arrived fully-formed, rather as with Moses and the tablets.

In fact, they have their roots in similar freedoms granted to retirees in a number of overseas countries.

And a report from the (admittedly left-leaning) Social Market Foundation has examined how those freedoms have worked in practice.

It makes for sobering reading.

In Australia, for instance, four out of ten Australians with pension savings had spent them all by the age of 75.

Americans, meanwhile, typically withdrew at an unsustainable rate of 8% a year – double the 4% many observers recommend.

To the Foundation, this is a warning that the same thing could happen here, throwing destitute retirees onto the mercies of state benefits – although, as I’ve pointed out, those mercies can’t be guaranteed.

At last: hard facts

So how are Britain’s retirees handling their now-found pension freedom?

In the weeks following last April, a number of financial providers and commentators issued bulletins on the proportion of new retirees cashing-in their pensions, often incurring a hefty tax charge in the process.

Nor were these withdrawn funds necessarily reinvested elsewhere. Anecdotally, a proportion of pension savings seem to have been spent on paying off debt, holidays, and new cars and kitchens.

But hard facts, drawn from across the market, have been missing.

No longer.

On 7 January, the Financial Conduct Authority (FCA) – the successor body to the old Financial Services Authority – published its latest Retirement Income Market Data survey, covering the second three-month period that the new freedoms have been in place.

Adding a further 178,990 retiree data points to the 204,581 retirees who accessed their pension pots in the April-June quarter, we can now see how almost 400,000 real-life pension savers have made use of Mr Osborne’s freedoms.

Why the especial significance of this second quarter of data? Because it’s likely to be cleaner data than the first quarter, given that the first quarter’s data is anomalous, combining:

• Pent-up demand from savers determined to withdraw everything and consequently delaying their pension decision until the freedoms came in;

• Under-informed pension savers who lacked the education that has since started to emerge from more informed advisers, more (and better) media exposure, and the government’s new Pension Wise service; and

• A number of known data collection errors in the first quarter’s data.

What we’re all doing

So what do these hard facts add up to? Let’s take a look:

• Overall just 13% of retirees elected for the annuity route – a very sharp reversal of the annuity industry’s past fortunes. But the proportion of annuity purchasers shopping around for an annuity actually fell, which is both disturbing and odd.

• Instead, the greater proportion of retirees (34%) chose to access their pension savings through the new Uncrystallised Funds Pension Lump Sum (UFPLS) route to taking pension benefits. Of the options on offer, that’s probably the smartest, and the one that’s probably of the greatest appeal to Monevator readers.

• A further 23% of pension savers fell into the £30,000 ‘small pot’ bracket, and so took the lot as cash. This group accounted for 88% of the total number of full withdrawals, with a massive 57% of full withdrawals being pension pots of less than £10,000 in size. Even so, many of those individuals with £10,000+ pension pots will likely have been hit by a thumping tax charge, assuming average earnings.

• 30% of pension savers opted for income drawdown, the traditional alternative to annuities.

• In terms of income withdrawal, including both UFPLS and income drawdown retirees, almost three-quarters (71%) of those accessing their pension pot took an annual income of less than 2% of their fund. A further 13% took an income of 2-3.99% of their fund.

• 12% of those individuals making full withdrawals had pension pots valued at above £30,000. Somewhat incredibly, roughly 1,200 people fully cashed-out pension pots of £100,000-£149,999 in value, suffering a significant tax hit in the process. (Did these people take Steve Webb literally?)

Mine, all mine

On the face of things, then, in the vast majority of case, Australia this isn’t.

Except that for the fact that while most retirees appear to be sensible, a significant minority buck the trend.

• Over the quarter, one in ten of those accessing their pension pots (10%) took a rate of income withdrawal of 10% or more of the value of their pot. That isn’t a sustainable rate of annual income withdrawal, for sure – unless such retirees are in their eighties.

• Which seems unlikely, because it was individuals aged 55‑59 who took the highest rate of income withdrawal, with 27% of those individuals aged 55‑59 taking an income of 10% or more of their pot after any tax free cash was deducted. Again, this isn’t sustainable, and these individuals’ retirement prospects look set to hit the buffers. Perversely, the higher the individuals’ age, the more prudent their income withdrawal rates.

• The proportion of individuals making full withdrawals (and taking a likely tax hit, to boot) is worryingly high. 31% of those making full withdrawals had pension pots valued at between £10,000 and £30,000, and 12% of those individuals making full withdrawals had pension pots valued at above £30,000. And £100,000+ withdrawals are not a fantasy: it is happening.

What to make of it all?

Clearly, the FCA has further work to do in refining its data collection methods. At several points in the report there are evident data collection ambiguities, which the FCA acknowledges.

It’s also — frankly — not the clearest-written of reports, which again doesn’t help.

So if anyone from the FCA is reading this, I can be contacted via the comments box below, and my rates are reasonable.

Overall, though, the picture is moderately encouraging.

Most people are being sensible, and most people are doing something other than a) withdraw the lot, or b) hand it over to an annuity provider.

But the fact remains that a significant minority of people are heading for what appears to be a penurious old age.

And while some of you reading those words might not mind this too much, a central plank of past government pension policy has always been to protect people from themselves.

Now we are seeing why.

• Read more of The Greybeard’s articles on pensions and deaccumulation.

I spend so little time on my investments that it feels wrong. How can I expect to succeed without any effort?

You get back what you put in, right?

Wrong.

Investing is one of the most counter-intuitive of activities going, because we can only meaningfully judge the results over several decades, not the hours or days our human brains are wired for.

Just how counter-intuitive is it? In investing:

• You don’t succeed by trying harder.

• You don’t get what you pay for.

• Doing nothing is generally better than doing something.

• The herd usually gets fleeced as they stampede from gold to Russia to pig trotters in search of the jackpot.

As legendary investing strategist Charles D Ellis said:

The saddest chapters in the long history of investing are tales about investors who suffered serious losses they brought on themselves by trying too hard or by succumbing to greed.

Don’t be a postscript to the next sad chapter.

Ignorance is bliss

Because I’m into investing, friends will often ask me what the FTSE 100 is doing or whether yak futures are hot or not.

Embarrassingly, I don’t know.

I just don’t worry about it, because knowing how many points the FTSE moved last week doesn’t help me achieve my goals.

If anything knowing that sort of stuff is counter-productive. It’s akin to being afraid to go out at night because you’ve watched too many episodes of Crimewatch.

Instead, my passive investing operation works like this:

Here’s how it fits together:

• The direct debit automatically deducts money from my account.

• My online broker silently funnels that cash into the funds I’ve preset as regular investments.

• The funds reinvest the dividends.

• My asset allocation already contains all the mutually supporting investments I need to grow my nest egg and hopefully weather any storms that come along.

It all ticks along famously without bothering me.

The passive investing revolution will not be televised

It takes me just 30 minutes a month to double-check that everything has gone according to plan between bank and broker. Nothing is ever amiss, but I’m a paranoid soul.

I also tune in every now and then to update my portfolio tracker. And I rebalance my holdings annually.

Rebalancing and reassessing my contributions once a year takes a few hours in total.

The rest of the time, I’m really not needed. It’s like a clockwork machine that just needs a bit of oil and a service now and then.

Sounds too easy? Well, we already know that passive investors will beat active investors on average.

If you think that you can pay someone to help you top the investment hi-score tables – and for some reason you think you need to top the tables to succeed (you don’t) – then there are plenty of people who are willing to charge you a massive fee for believing in fairy tales.

A crash course

The effort you need to put into investing is front-loaded. It’s worth understanding how the basics work at the start, so you don’t get ripped off or self-sabotage later.

Think of it like the time you put into buying a house. Doing some legwork is the best investment you can make in yourself because it’s incredibly important to make the right choice. Your future happiness depends upon it.

Here are some pointers.

• For the quickest summary of the basics, read William Bernstein’s If You Can. It’s 40 pages short and it is free on Kindle.

• For a fuller but amazingly easy to understand picture of what you need to do, read John Bogle’s Common Sense on Mutual Funds.

You’ll now understand why passive investing is the best way for you to go.

To turn that underlying philosophy into a concrete plan of action then UK investors just need to pick one book from the following:

• Investing Demystified by Lars Kroijer.

• Or Smarter Investing by Tim Hale.

Finally, if there’s anything you’re not sure about or want more practical help with, then not even modesty can prevent me from admitting that there’s no better place to go in the UK than our own passive investing HQ.

Get rich slowly

That’s it. Read two books – one easy, the second more comprehensive – then reinforce your understanding with our series of key passive investing posts.

You’ll be better informed than the vast majority of investors out there. You should easily know enough to manage your own investments with minimal impact on your time1.

There’s always more to learn, of course, especially for investing nerds like yours truly.

But if you haven’t got the time or the interest then at least you can move on in the knowledge that once you’re set up, the hard work is already done.

Whatever you do, just don’t end up writing a blog about it.

Take it steady,

The Accumulator

1. Note you may need professional assistance if you’re trying to do something fancy, to do with taxes for example. If you need financial advice, look for a flat fee adviser with a good reputation who charges by the hour. [↩]