I don’t know if Bank of England governor Mark Carney is a Monevator reader (perhaps he’s the guy signed up as FoolsGold65) but whether or not he read my Brexit articles he seems to have reached a similar conclusion to me.

Some said I was a doom-monger when I suggested it was prudent to prepare for a probable recession in the face of the decision to leave the EU.

One Brexiteer told me to “Can it!”

But for his part Mark Carney hasn’t yet had enough of experts, which is just as well because he actually is one.

And he and his expert monetary policy committee have looked at deteriorating data such as the fastest drop on record in the PMI survey numbers, and they’ve seen enough.

They’ve just announced the biggest cut to the BOE’s economic growth forecasts since it began making projections in 1993.

True, the BOE doesn’t quite see a recession – but it does see likely GDP growth in 2017 of 0.8% as opposed to the 2.3% it forecast as recently as May.

Here’s the latest projection in graphic form:

Source: BOE

Of course one reason the BOE thinks we might escape a recession – as indicated by the dark green line in this graph skirting above the 0% level – is because it has just implemented a bunch of measures to try to ward one off.

Carney to the rescue

In response to the plunge in business activity and the crunch in GDP projections, the Bank of England has:

• Cut Bank Rate to 0.25%.

• Created a so-called Term Funding Scheme to try to ensure banks pass the cut through to customers.

• Announced a new move to buy up to £10 billion of corporate bonds issued by companies the Bank believes most directly impact the UK economy.

• Expanded the asset purchase scheme for UK government bonds (i.e. QE) by £60 billion, to take the total stock to £435 billion.

These moves are no panacea. The Bank still projects unemployment will rise over the next 12 months, for example, and that GDP growth will plummet.

And personally, given the uncertainty – as well as the probable subliminal pressure on BOE forecasters not to assume a worst case scenario, which the BOE said in its press conference it had avoided – I would not be surprised if things turn out even worse than that.

But time will tell, and I certainly hope we do better.

What’s most striking for our purposes today though is the outlook for savers.

A real headache

As most of you will know, the biggest visible impact of Brexit so far has been the fall in the pound versus other major currencies.

The pound had fallen by about 9% since the EU Referendum when Carney began making his announcements. It dropped another 1.5% afterwards.

For globally diversified UK investors, this six-week slide in Sterling has helped cushion any impact of the Brexit decision on our finances to-date.

In fact, as you will have noticed if you’ve peaked at your portfolio in the post-Brexit kerfuffle, most assets are up for UK investors.

Our Slow & Steady Passive Portfolio has bounded ahead, for instance.

One reason assets are up is because equities and bonds alike have risen as investors have correctly anticipated lower-for-longer interest rates will follow the shock of Brexit.

But our portfolios are also higher because our overseas holdings have risen in value as the pound has fallen, lifting their value in pound terms.

Note: We haven’t magicked real money out of nowhere like this.

The pound is down around 10% – and so we are actually 10% poorer than the Trumps, the Merkels, the Hollandes, and the Paul Hogans in the country next door as a consequence of Brexit.

That may or may not be a price worth paying, depending on your own views – but it IS a real price that we’ve paid.

Now cash savers are set to pay an even higher price.

Inflated expectations

We may not yet be in negative rates territory in terms of the official Bank Rate, what with it hanging on to 0.25% like a cinematic damsel in distress clinging on by her fingertips to a cliff edge.

But in real terms (that is inflation-adjusted) we’re headed down, down, down.

Interest rates on cash savings are already very low. The best one-year interest rate I can find right now comes from IKEA-owned ¹ Ikano Bank, which pays a pitiful 1.6%.

That’s puny, but CPI inflation is depressed at the moment also. It was just 0.5% in June, according to the Office for National Statistics ( ONS).

You can see just how low in a 10-year graph:

Source: ONS

Why exactly inflation has been running so low – well below the BOE’s 2% target – is a subject for another long day.

But the relevant point here is that with CPI inflation at, say, 0.5%, even a wretched 1.6% savings bond is delivering a better-than 1% real return. Hence it is slowly making you wealthier.

However two things are now likely to happen.

Firstly, it’s likely savings rates of even 1.6% will soon be gone, because the Bank Rate cut will pull down yields across the money markets.

Soon you may only get say 1.5% or lower for locking your money away for a year.

The other thing that will likely happen is CPI inflation will rise. The weak pound that has so far been such a salvation for our perceived wealth will push up the cost of imports, and hence the prices we pay in the shops.

The BOE said as much today, and conceded its latest measures will make things worse. It sees too-high inflation as – probably rightly – the lesser of two evils.

The other option would be to take no action, and allow GDP growth to fall further than otherwise, for unemployment to head higher, and for us to perhaps be left with an even more precarious economic outlook in a year or two.

Whether or not you think such ‘economic cleansing’ would be valuable, it’s not in the BOE’s remit.

So CPI inflation is likely going up. A lot.

Here’s the bank of England’s latest forecast for inflation, taken from the August Inflation Report:

Source: BOE

The BOE now projects that under the new 0.25% Bank Rate regime, CPI inflation will probably be running at 2% by early 2017, and that it could well be approaching 3%.

In terms of the BOE’s official mandate, 3% or more is no worse than inflation at or below 1% – but it does present a bigger headache for everyday savers.

Let’s assume – optimistically perhaps – that you can still get 1.5% on your locked-away cash in such a climate.

At 2% CPI inflation, a 1.5% interest rate is not good enough to deliver a real return.

Instead, your cash will be becoming less valuable every year, because:

1.5% minus 2% = minus 0.5%.

And obviously if we were to see CPI inflation at 3% you’d be losing even more money in real terms.

The curve ball

I don’t believe the BOE mandarins are high five-ing each other at the prospect of pensioners getting poorer via a negative return on their cash savings.

True, the bank warned this kind of thing was likely if we voted to Brexit. And the pensioners voted for it anyway.

Which is fair enough – there’s more to life and the EU decision than money – but I will be pretty pee-d off when the inevitable sob story articles start to appear featuring income-starved Brexit-voting OAPs.

Own your decision, Brexiteers!

But while punishing savers isn’t the direct goal, making cash less desirable to hold in general is very much part of the rationale for the sort of QE operations the BOE extended today.

As a result of the likely move into negative real returns on cash, more cash savers will move into UK government bonds (gilts), more gilt owners will swap them for corporate bonds, some more will move into equities, and a sliver of risk-takers will use cheaper financing to start businesses or take out loans to build property.

And hopefully all that will help blunt the worst economic impacts of the decision to Brexit, by bolstering economic growth.

But make no mistake – by moving more of us out of super-safe cash and gilts and into riskier assets like peer-to-peer savings, corporate and retail bonds and equities, the stakes are being raised for everyone.

1. And FCA-regulated.[↩]

There’s not a lot to jump up and down about as a passive investor, which is why we tend to get over-excited around here whenever a new index tracker enables us to trim our costs by another 0.1%.

It’s rather like a retired detective deducing who ate all the cake at their kid’s birthday party. Our methods may seem extreme, but they help us to feel useful again.

The question is are we using a sledgehammer to crack a nut when we race to inform you that some tracker or another is now a smidgeon cheaper than last week?

Just how much do a fund’s costs need to fall before it’s worth selling out of the old and buying into the new and ever so slightly more efficient?

And should we bother to update the Slow & Steady Portfolio on account of cheaper funds? (Some readers think not).

Before we go on, investors who are new to the simple life of passive investing should avert their gaze now. You definitely do not have to go to these lengths to fine-tune your portfolio.

In fact, this piece is probably the most anal thing I’ve ever written.

It is strictly for hardcore investing life-hackers who are magnetically attracted to every infinitesimal advantage that crosses their path.

Numbers game

What we need to know is whether a new cut-price fund will make a worthwhile difference to our long-term investment prospects.

The numbers that matter:

• The cost of holding the fund – Take into account the Ongoing Charge Figure (OCF), any initial charges, capital gains tax consequences ¹ and differences in dealing costs and platform fees.

• Fund worth – The bigger your holding, the more you gain from OCF clipping.

• Future contributions – See above.

• Investment time horizon – The more years you hold, the more cost reductions compound to your advantage.

• Return on investment – The bigger your pile, the more percentage fees like the OCF will cost you.

You can quickly use these factors to work out your savings with a fund cost comparison calculator. Let’s now use that calculator to rustle up a few illuminating examples of the impact of price pruning.

I’ll keep the numbers moderate so that it might represent the situation of a fairly typical small investor, rather than use a 40-year time horizon or similar to hammer home my point.

Example 1: Seeing the light

You get the biggest boost when the fee drop is pronounced, such as with a switch from active funds to passive funds.

Old fund OCF 1.5% 
New fund OCF 0.5%

Fund worth £10,000
Future contributions £100 a month
Investment horizon 20 years
Annual return 6%

Fund worth after 20 years cost savings:

Old fund = £62,676
New fund = £72,255

You gain £9,579 or 15.28%

That’s a lot of money that might as well be in your pocket rather than a fund manager’s. Especially when you scale that saving up across four or five funds in a portfolio.

Example 2: The Gillette switch

Now let’s look at a closer shave. The type you might make as a seasoned passive investor benefiting from tighter price competition in the tracker market.

Old fund OCF 0.5%
New fund OCF 0.25%

Fund worth £10,000
Future contributions £100 a month
Investment horizon 20 years
Annual return 6%

Fund worth after 20 years cost savings:

Old fund = £72,255
New fund = £74,892

You gain £2,637 or 3.65%

I’ll take that. It’s still a fair wedge, even though it may be 20 years off.

Example 3: The salami slicer

What about the kind of 0.1% finessing that prompted the wholesale switching of our Slow & Steady passive portfolio back in 2012?

Old fund OCF 0.3% 
New fund OCF 0.2%

Fund worth £10,000
Future contributions £100 a month
Investment horizon 20 years
Annual return 6%

Fund worth after 20 years cost savings:

Old fund = £74,357
New fund = £75,432

You gain £1,075 or 1.45%

£1,000 eh? Well, I’d definitely snatch your hand off if you gave that to me now. But that’s actually the gain you’ll make in 20 years time.

Just how much is that worth now?

The present value of money

The time value of money is a concept that helps explain our natural intuition that money gained in the future is less valuable than cash in the hand right now.

We can estimate how much the future £1,075 gain from the last example is worth to us now by using a present value of money calculator.

If I assume the same 6% interest rate and 20-year stretch, then the calculator tells me the present value of £1,075 is £335.

Whether you’re prepared to get out of bed for that kind of money is a personal choice. I am.

Let’s say it takes five hours to research the new fund, take a decision, make the trades and track the changes. And let’s say I charge out my free time at £20 an hour. That means that any switch that delivers more than £100 today is worth my time.

Using a future value of money calculator it turns out that £100 today is worth £321 in 20 years time. So any switch that saves me over £321 in 20 years is worth the faff (given my assumptions above).

Sorry, I told you this was beardy. And I must repeat that none of this is compulsory!

Previously I’ve always compared funds using the fund cost comparison calculator to decide whether a switch was worth the hassle. But there’s something about blogging that forces you to don your white coat and make matters more scientific.

Just one last thing

Sadly there is another factor you need to think about before you go a-switching, which is the risk of being out of the market while the transaction takes place.

If you invest in index funds then you can be sitting in cash for a few days, after selling the old fund and while you’re waiting for your broker to stop playing on Facebook and buy your new fund.

If shares surge in the meantime then the transaction will cost you more than you bargained for, because your cash in limbo will not be invested and so will not track the gains.

How much might it set you back? Needless to say, that’s complicated, but the short answer is – if you’re very unlucky – it might actually do more damage than paying slightly higher ongoing fees.

It’s potentially worth considering ETFs over index funds from an instant trading perspective if the risk of being out of the market feels like a biggie to you.

Take it steady,

The Accumulator

1. See ivanopinion’s excellent comment 41 below[↩]

Good reads from around the Web.

I have found a new website and it’s right up our street. Called Portfolio Charts, it’s dedicated to exploring asset allocation visually – and assuming all the maths is correct and the resultant graphs are accurate – it appears to be brilliant.

Now don’t get me wrong. I still think most people are best off not immersing themselves in the minutia of a dozen different asset allocations and wondering for six months whether the Coward’s Portfolio, the Merriman Ultimate, or the Golden Butterfly is the best allocation for them (or indeed whether they’re really finishing moves from Street Fighter III).

In truth, The Accumulator’s back of a blackboard graphs are about as spuriously precise as is required to overcome inertia and keep new investors focused on what matters.

But if you’ve been coming here for a while, there’s a good chance you’re not most people. And that while you know you should know better, you’ll also have plenty of fun clicking around the site looking at how adding 10% more Treasuries dampened volatility if you were power-shouldered 1980s New York executive buying stocks to fund a place in the Hamptons.

(Yes, it’s American of course. Perhaps that’s an advantage if it means we focus on the gist rather than the detail?)

Less risky but more rewarding

The latest post exploring whether an investor should go 100% equities is a good place to get started.

The author writes:

In investing, the concept of efficiency is most commonly discussed in terms of risk-adjusted returns. Basically, it’s all about trade-offs.

What are you willing to risk for your potential higher gain?

Sure you can invest in a portfolio with a higher average return, but with the trade-off that your odds of actually achieving that return with any certainty are much lower.

Portfolios that work towards good returns while minimizing downside risk tend to do quite well compared to pedal-to-the-metal portfolios.

Now that sounds great, but how is one to identify these magical portfolio unicorns with superior risk-adjusted returns to the stock market?

Surely they are quite rare, so why waste our time chasing the unattainable?

Here’s the thing — they’re not rare at all.

Then follows this graph, which goes straight into the Monevator Hall of Money Shots.

Source: PortfolioCharts.com

The square red box on the far left represents the performance of an all-stocks portfolio. The other symbols mark the same for a variety of lazy portfolios.

What this graphic shows is that over the period, adding other assets to your 100% stocks portfolio typically resulted in a less-steep worst year loss ¹ while also tending to increase the minimum long-term annual compound returns your portfolio earned.

It doesn’t mean you won’t do better with 100% stocks – it doesn’t prove anything will happen in the future, because it is only a study of the past – but it does indicate very clearly that for long-term investors, diversifying assets has historically done the business on the basis of risk versus reward.

There’s plenty more where that came from over at Portfolio Charts.

[continue reading…]

1. i.e. Maximum drawdown – the fall in the value of your portfolio from peak to trough.[↩]