Good reads from around the Web.

Every now and then a reader asks me to update one of the older articles on property and house prices here on Monevator.

I usually say I plan to — and usually I do plan to.

But whenever I knuckle down to it, the whole subject is too depressing.

Obviously a bubble?

Quite often I meet young value-minded investors for whom London property in particular is clearly in a crazy bubble.

They are appalled that I don’t agree that an imminent crash is a slam dunk certainty.

I say that I might if I was standing in their shoes. My problem is London house prices first looked to me like a crazy bubble in 2004.

Besides, far more often I meet people who say “you can’t go wrong with London property”, including members of my own friends and family.

One is weighing up leaving London, or else using the six-figure deposit she’s saved hard over her ten years in work — together with the highest mortgage she can get with her (latterly) £70,000 a year job — to buy a two-bed flat in Zone 3 in the East End.

Madness.

But will it ever end?

Everything in me that’s a value investor says yes — including my awareness that my reticence to voice that London property is in bubble territory, after being wrong for (most of) the past ten years, is probably in itself a sign of a bubble.

But the animal in me is fearful. It sniffs the air, sulks, and returns to its den.

Numbers of the beast

Some useful stats on all this in The Telegraph today, in an article that asks if the average working life is no longer enough to pay for a house:

Official figures suggest there are about 400,000 over-65s still with mortgages, a figure that is growing by about 10% per year. And as Telegraph Money reported recently, European figures show that one in five of British 65 to 69-year-olds is still working, a far higher proportion than in Germany, France, Ireland, Italy or Spain.

Why? To pay off their mortgage, of course, or scrape a bit more towards a pension, or both.

The article is a rarity, in that it combines the plight of older home almost-owners with that of the young.

It also gives lie to the nonsense that it has always been this hard for the latter:

The ratio between property prices and wages has shifted so enormously that house buying today is as difficult for buyers with two wages as it was 35 years ago for a single borrower on just their own income.

Today’s first-time buyer – putting down an average £30,000 – would need to borrow 3.4 times a single wage, compared with a borrower 35 years ago needing 1.4 times his wage, to purchase the equivalent property.

As for London:

Say you’re a hugely lucky buyer with a 20% deposit (£100,000) to put down.

Assume the average rate you’ll pay over 25 years is 5% – a generous assumption, given rates over the past 25 years have averaged higher.

You’d still pay around £2,340 per month and just over £700,000 in total.

It’s generally said mortgage costs shouldn’t exceed half of a household’s after-tax income. But for £2,340 to equate to less than one half of post-tax income, an individual would have to earn £87,000 in today’s tax regime (£4,800 per month after tax).

And that’s the average property in the capital – not the comfortable family home that an averagely paid accountant or doctor might have afforded in London in the Eighties, but which today would cost £2m or £3m.

Generation wars revisited

The most depressing takeaway from all this?

The suggestion that 60-somethings with mortgages should use the new pension freedoms to release cash to pay off their debts.

It’s probably good advice, as no doubt the poorer among them will eventually be able to pass means-tests for pension top-ups or similar, which I’d bet will look at incomes and investments, but not at personal places of residence.1

But as a sustainable solution for the nation, I think this is ridiculous.

The correct thing for older people living in big houses they haven’t paid off to do is to sell-up, move somewhere smaller, and put anything leftover into their pension.

And to free up a house for a young family at the same time.

I once had a bitter, bitter argument in an online forum that I eventually had to leave about this sort of thing, when I said I had no sympathy for 65-year olds rattling around in 5-bed houses who were struggling to meet their heating and council tax bills.

Sell! Move!

Apparently I was utterly uncaring and heartless. Because I saw a bigger picture of need, not a micro-hardship.

Well that was a decade ago, and things have only gotten more crazy.

I’ve discovered in unrelated discussions that even most Monevator readers disagree with me that inheritance tax should be, say, 95% over the first £100,000.2

So I suspect that equally few among the phew-we-made-it middle-classes will be on my side when it comes to my call for mass-downsizing.

An Englishman or woman’s home is a castle. And once they’re in it, they’re jolly well entitled to pull up the drawbridge, right?

Even if they can’t afford it, and even if it is turning the next generation into peasants.

I so wish the whole caboodle would crash, before it gets even uglier.

[continue reading…]

1. I am speculating about the future here, not talking about the specifics now or yesterday. [↩]
2. Whereas incomes I’d tax at a flat rate of perhaps 25%, after raising the personal allowance for lower earners. Earn more while you work, contribute, start businesses or invest. Get much much less because dad died. [↩]

Many people have been won over to index funds and passive investing because index trackers are cheap, and it’s not worth paying more for active managers who overwhelmingly fail to beat the market.

But have you ever wondered why index trackers are able to do just as well as tens of thousands of the world’s best paid professionals?

After all, you would be unwise to trust your brain surgery to whoever offers to chop your skull up most cheaply.

And while the relationship is far from perfect (Beats headphones, anyone?) the phrase “you get what you pay for” usually holds true with everything from cars and computers to education and ice cream.

No surprise then that passive investing still feels wrong to so many people.

But as the following video from Sensible Investing explains, when it comes to investing it’s really quite simple.

Share prices at any time reflect the best guess of all those thousands of highly-informed market participants. In theory, the market is literally the most educated estimate of a company’s valuation that humanity can come up with.

Any new information is quickly reflected in the price, too.

Therefore only those with inside (that is, non-public) information will theoretically be able to beat the market, except through luck.

And there’s more.

Even if somebody has some exceedingly rare ability to better predict what all that available information means for the future of share prices – and so outperform – they can only gain at the expense of somebody else.

Any winner must be matched by a loser, and so the overall expectation of active stock pickers must be zero.

The French connection

Something else that’s highlighted in the video is the role of 19th Century French PhD student Louis Bachelier in the evolution of what we now know as the Efficient Market Hypothesis:

At age of 22 Bachelier came here to Paris to study at the Sorbonne. Among the eminent mathematicians whose lectures he attended was the world-renowned Henri Poincaré. It was also in Paris that Bachelier developed an interest in the workings of the financial markets.

After graduating, Bachelier stayed at the Sorbonne to study for a PhD. His specific focus was how stock prices moved. Detailed study of the data led him to conclude that:

• all the available information is already included in the price of a stock

• prices react to new information which is, by nature, random

• therefore, price movements are also random (or, as he rather colourfully put it, no more predictable than the steps of a drunkard).

In conclusion, Bachelier said, “the expectation of the speculator is zero”.

We tend to hear a lot more about the US academics like Eugene Fama and Paul Samuelson who brought Bachelier’s theories to wider acceptance, as well as Jack Bogle who put theory into practice by devising index funds.

Trust a French intellectual to think the unthinkable first!

Check out the rest of the videos in this series so far.

Fairly obviously, the era of final salary pension schemes has gone for good. But what is much less obvious is how individuals should now go about replacing that assurance of a reliable and adequate post-retirement income.

As a new member of the team here at Monevator, it’s my job to help you figure out your own approach to this seismic change in our collective prospects for retirement.

And precisely who am I? Am I — gasp — a pensions pundit, fresh from yet another soundbite in the Daily Telegraph? A guilty-feeling IFA, perhaps? Or an employee of a pension firm, forced to moonlight as a blogger as would-be retirees stay away from annuities in droves?

Er, no. I’m none of those things. I’m an investor, as it happens, and probably little different from you.

But — and I recognize that this may be my most relevant qualification for the role — this month I turn 60.

Gulp.

So I have a keen interest in finding not just easy answers to the retirement conundrum that faces us all, but the best answers. Answers of direct relevance to your circumstances, as well as mine.

Together, we’re going to navigate this brave new world of deaccumulation, SIPPS, annuities, flexible drawdown, and all the rest of it.

A different landscape

When many of us entered the workforce, final salary schemes were the norm. You’d work until you were 65 – 60 for women — and then retire on a pension that was calculated as a fraction of your salaried pay.

No longer. The vast majority of private sector employers have ditched their final salary schemes, transferring employees to ‘money purchase’ schemes, which leaves employees — and not the employer — carrying the risk of any investment downside.

Retirement ages, meanwhile, have been jacked sharply upwards.

My own state pensionable age is now 66, not 65. My wife thought she was going to retire at 60; now, as a public sector employee, she’s expected to work to 62.

And a close friend in her late 40s — also a public sector employee — now finds herself due to retire at 67, thanks to the way that public sector pensions calculate pensionable service.

More miserable years

Plus, as a nation, we’re also living longer. And those increased retirement ages are partly a response to that, of course.

But more particularly, our increased average longevity is regularly cited as one of the reasons behind tumbling annuity rates — which is another aspect of the changing retirement landscape, of course.

It’s the scale of that increase in longevity that is frightening. According to Office for National Statistics population projections and life expectancy estimates, nearly one in five of us will live to see our 100th birthday.

Good news, surely?

Well, not if you’ve cocked-up your retirement strategy, that’s for sure. Someone I know, in their late fifties, has this week just stuffed another £40,000 in their pension. Just as they did last year, and the year before.

Someone else I know, of a similar age, perhaps has total pension savings of that same amount.

Yes — £40,000.

A retirement composed of 30 or so years of baked beans and homebrew? No thanks.

You’re on your own

What to do? Roll it all together, and the picture that emerges isn’t comforting. It certainly isn’t a view of retirement that your father would have recognised.

Simply put, compared to our parents’ generation, each of us can expect to:

• Retire later

• Rely on our own savings for a greater part of our post-retirement income

• Require those savings to support us for longer

It’s the last of those that is giving me pause for thought. Because there’s a very real risk that my retirement savings will have to sustain me 25, 30, or even 35 years.

Which, put another way, is scarily close to the timescale over which the bulk of those savings were built up.

I certainly don’t want to join the beans and homebrew brigade.

Running on empty

There are no silver bullets. Despite the hype since the Budget, I don’t think that the changes to pensions and annuities announced on March 19th particularly help.

Giving pensioners more freedom to use their pension savings as they like — instead of being made to buy an annuity — doesn’t magically increase the size of a pension pot, or make it stretch further.

Indeed, by increasing the drawdown limit from 120% of the equivalent annuity income to 150% of the equivalent annuity income, there’s a real danger that some people’s pension savings will expire before they do. Especially for people in their 90s, or reaching 100 — the very point they can ill-afford a cut in income.

So as retirement landscapes go, it’s not a pretty picture.

Nevertheless, in the months ahead, I’m going to begin weaving my way through it. With you, Dear Monevator Reader, as a traveling companion.

Let’s have fun — and hopefully, retire richer.

The Greybeard