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.

The investing industry hides charges like FIFA execs hide bank accounts. Even relatively transparent vehicles like index trackers are not squeaky clean – the annual fee you see printed on the factsheet as the OCF or TER does not tell the whole story.

This is true for every fund, but at least for index trackers these extra costs are discharged like a telltale smoky belch that’s detectable using tracking difference.

Tracking difference shows you how far a tracker fund (that costs money) falls short of the performance of its index (that costs nothing).

For example, if the FTSE All-Share index returns 10% in a year and a particular index tracker only manages 9.5% then the tracking difference is 0.5%.

That 0.5% is the true cost of owning the fund, regardless of what the factsheet might claim.

How do I uncover tracking difference?

Until now, tracking difference has been a devil to calculate and compare across funds.

I’ve previously explored a bunch of ways. None of them has been the answer.

But now one of the investment data providers, Trustnet, has taken a very good stab at tracking difference in its new passive funds section.

Hit one of the asset class categories (e.g. UK equities) and you can compare the tracking difference performance of a decent range of index funds and ETFs. (Go to the performance tab.)

Here’s an example to show you the tracking difference, um, difference, between several funds.

First we use the tool to find the low OCF leaders:

FTSE All-Share top five trackers by OCF 

Index tracker	OCF (%)
Fidelity Index UK P	0.06
HSBC FTSE All Share Index C Acc	0.07
Vanguard FTSE UK All Share Index	0.08
L&G UK Index I	0.1
Royal London UK All Share Tracker Z	0.15

Press the [+] button to reveal more fund versions on Trustnet’s site.

Now let’s see what happens to the line-up when we rank by tracking difference:

FTSE All-Share top five trackers by 3-year tracking difference (TD)

Index tracker	3-year TD	TD average p.a.
L&G UK Index I	0.15	0.o5
Vanguard FTSE UK All Share Index	-0.28	-0.09
HSBC FTSE All Share Index C Acc	-0.32	-0.11
Lyxor FTSE All Share GBP ETF	-0.47	-0.16
Old Mutual UK Index A Acc	– 0.61	-0.2

Positive figure shows fund beat the index.

Holding tracker funds up to the righteous light of tracking difference substantially alters the top five line-up. Every position in the ranking changes. And two of the funds have changed – previous table-topper Fidelity Index UK P drops out of the rankings altogether, when ranked by tracking difference.

The Fidelity fund’s three-year tracking difference (not listed above) of 0.7% amounts to a true cost per year of 0.23%.

That’s nearly 400% bigger than the advertised fee of 0.06% (which you can only get if you invest in the fund by tying yourself into Fidelity’s platform).

In contrast the Vanguard fund’s tracking difference reveals a real cost per year of 0.09%, which is as near as dammit to the quoted OCF of 0.08%.

Vanguard’s initial charge – levied every time you invest, and put towards stamp duty – is probably the reason why it is able to sail so close to the coast.

HSBC’s All-Share fund does not impose an initial charge but there’s no avoiding stamp duty. This means investors cop it through lower net returns that are illuminated by the tracking difference score.

Most eye-catching of all is L&G Index I, which actually beat the return of the index by 0.05% per year and effectively paid you for owning it. Very nice of them.

However L&G isn’t providing its services for free, so how did it do it and can it keep it up?

Cost begone

There are various techniques for enhancing performance – the major one being securities lending.

In this scenario, a fund manager lends out individual securities (e.g. shares) to short-sellers in exchange for a fee.

The risk is the short-seller’s dark arts blow up in their face, they go bust and your security doesn’t come back.

Imagine Hertz rents out your car to someone in town for the day and it splits the fee with you – only for your car to accidentally get totaled in a Destruction Derby and to come back to you in a bucket.

I’m exaggerating for effect, of course, but securities lending is a risk and not every tracker provider does it.

So if you’re attracted to a fund because it’s outperformed its benchmark, it’s worth checking the provider’s securities lending policy and deciding if you’re comfortable with that.

Another reason why L&G may have outperformed is because it samples the FTSE All-Share to create its fund – it doesn’t fully replicate it.

In other words, the L&G fund buys enough shares to do a passable impression of the index but it doesn’t match it firm for firm.

It could be that its particular selection just happened to have a gold run that won’t be repeated over the next few years.

Tracking difference can fluctuate over time and that’s why many commentators recommend plumping for a tracker that hugs its index tightly as evidence of good management practices – regardless of whether the difference is positive or negative.

On that basis, the L&G UK Index I fund still wins with a 0.15 performance versus Vanguard’s -0.28.

Lookout below

You will find some funds with incredible figures like Chariguard UK Equities‘ 7.77% three-year outperformance of the FTSE All-Share.

There’s usually a snag and with this fund it appears to be uninvestable on the platforms available to the likes of you and I. (Anything this deviant is also no tracker.)

Meanwhile, the SSgA UK Equity Tracker has a positive 0.35% tracking difference, but I can only find this fund on Youinvest where it seemingly comes with a murderous 10% initial charge.

Another tip – don’t pay any attention to one-year tracking difference figures.

Results over short periods can be royally skewed by something as basic as the date the fund was measured, so use the longer term figure. Hopefully Trustnet will expand the service to a five-year view, too.

When making your comparison, be sure you are comparing like with like when it comes to the indexes (Trustnet refers to them as benchmarks).

For example, FTSE All-Share funds are very different beasts to FTSE 250 funds. Filter to ensure your comparison is relevant.

In contrast there’s little meaningful difference between the FTSE Emerging Markets and MSCI Emerging Markets indices. You can safely take your pick from trackers that play for either team.

You can find out more about an index by Googling it or by comparing funds using the Funds Library fund comparison tool and spotting the difference between holdings.

Be your own kingmaker

Trustnet has also thrown in a classic one to five stars rating system (except the stars look like crowns).

Rating systems are time-saving catnip but personally I think it’s important to develop a decent understanding of what an investment can do for you.

Trustnet’s methodology includes a weighting to tracking error and fund size, which I believe are much less important to buy and hold investors.

Personally, I’d rather be guided by tracking difference and a review of the most important features of the factsheet. It needn’t take long if you have a good underlying grasp of what you’re looking for.

A big difference

The main improvement I’d like to see from the tool is a global tracker section but hopefully that will come. In the meantime, here’s a few tips on divining tracking difference yourself. ¹

Quibbles aside, by creating a simple tracking difference reference tool, I think Trustnet has done passive investors a great service that will help us in our mission to crush costs and to navigate the investing hall of smoke and mirrors.

Take it steady,

The Accumulator

1. Note, this article refers to tracking error rather than tracking difference. The terms are often used interchangeably but this article is referring to tracking difference as Trustnet means it.[↩]

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 inventory ¹ 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 China ² – 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.[↩]