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

Good reads from around the Web.

This week saw the media, the pundits, and even the politicians come alive to the fact that the 300-year old United Kingdom might imminently be torn asunder by what seems to be a chess gambit gone wrong.

Even more amusing/tragic is that this fight is being waged by leaders who boast all the gravitas of the Mr Men in a pillow fight.

I’m not going to get into the politics or even the economics of the situation. There are plenty doing a better job than I could, including what it might mean for investors.

Personally, I started considering the impact of Scottish independence years ago.

And so did the market.

Odd behaviour

As a whole, the market is clever enough to have spotted this referendum was coming, even if most of us seemingly forgot about it.

The moves we saw earlier this week in the pound and in some UK shares – especially on Monday – reflected the market adjusting to a surprisingly tight poll, not a sudden awareness of the possibility of Scottish independence. That’s long been priced in.

I’ve noticed some people struggle with the idea that something can be ‘priced in’ and yet there’s still volatility and uncertainty.

For a colourful analogy, you might think of a horse race – only one where hidden somewhere in the stands is a sniper with a grudge against horses.

As the race begins, the odds are whatever was determined by the betting at the bookies. They reflect the sum total of the best guesses of everyone who has put their money where their mouth is.

Once the race begins and horses begin to drop, the odds of winning change. Some victims are out of the running. Other horses now look better placed. Eventually some gamblers might even spot – or think they spot – a pattern as to which horse the sniper will turn on next. This could give them an edge.

If a 33-1 outsider gallops over and away from its competitors to victory, it doesn’t mean such a victory wasn’t priced in.

It was priced in – at 33-1.

The initial odds priced in what was known, to the best of everyone’s conflicting interpretation.

But things change. It’s not about black or white, but rather lightening and darkening shades of grey.

We’ll see

Luckily, horse racing isn’t a blood sport and nor – as much as both sides might deserve a custard pie in the face – is the Scottish Independence campaign.

Besides, despite all the media narratives and panicking politicians, the FTSE 100 index doesn’t seem very much more bothered by the prospect of Scottish independence than whatever was priced in last week.

I just watched a CNBC presenter wrap up a piece on the ‘mayhem’ in UK share prices with a cut to the closing figures for the UK, French, German and Italian markets for the week. She was shocked – the UK was the best performer.

Now admittedly that’s probably partly because the coincident weaker pound is so good for so many UK companies.

But still, if you think what we saw this week in share prices was panic then you’ve forgotten what it was like in 2008.

For what it’s worth I strongly suspect “No” will carry the day, and I think the market does too.

But that doesn’t mean it’s complacent. It means it’s handicapping the odds, and those are the way they stand right now.

Odds are not certainties. That’s what the vote is for.

[continue reading…]

Most Monevator readers know high costs are the major reason to avoid active funds, and that low costs are the biggest draw for index trackers.

However paying high fees to managers – as well as all the trading and other expenses racked up by an active fund – wouldn’t matter if they soundly beat the market.

Around here we tend to think of passive investing and index tracker funds as a ménage à deux, but there are plenty of people who invest in active funds who would describe themselves as ‘passive’ investors, too.

They simply put their money into a variety of actively managed funds, and then leave them to get on with trying to beat the market.

But sadly, the reality is few active funds do beat the market after costs, as explained in this Sensible Investing video:

It’s the failure of nearly all active funds to beat index trackers over the long-term that makes active versus passive such an unfair fight.

Imagine an alternate reality where, say, 40% of active funds beat the market.

Or maybe where 50% of funds beat the market – but with more volatility, or with fatter ‘tails’ that meant some active funds lost most of your money, but a good proportion spanked trackers.

Then we’d have a really interesting debate on our hands.

But as Jack Bogle, the father of index funds, says:

“The intellectual basis for indexing is is gross return minus cost equals net return. Period. What is the intellectual basis for active management? I’ve never heard one.

“Probably about 1% of managers can beat the market over the very long term.”

I wouldn’t call 1/100 anything but exceptionally long odds. Would you?

Are there any good reasons to invest in an active fund?

So as it is, there’s not really any reason to invest in active funds unless:

1) Your sister is a fund manager.

2) Your brother-in-law is a fund manager.

3) You like the romance and colour of active fund management, and you’re happy to pay for it and do worse overall.

4) You want to beat the market and you don’t care that the odds are hugely against you, and you don’t want to pick shares for yourself.

I paraphrase, but that’s the gist.

Now, occasionally a reader will voice a comment saying “it doesn’t have to be either/or”.

And I agree. (Heck, I pick shares for my sins so I can’t be precious).

However you have to be really clear about why you’re investing in active as well as tracker funds.

• If you want to juice up your returns, then investing passively in value and other so-called return premiums might do the trick.

• If you’re doing it to reduce volatility, then it’d almost certainly be safer and cheaper just to hold fewer equities and more cash and bonds.

• If you’re doing it to get overseas exposure, well, you can easily do that through ETFs and trackers.

• Some people claim they own active funds for the diversification, which makes little sense given the huge diversification offered by trackers – except to add the few hard-to-reach areas of the market like UK small caps.

Holding 10 active fund managers who invest in UK, US and European large caps is to my mind simply an expensive way of getting tracker-like performance at best, but doing worse after costs.

It doesn’t help that a growing share of active funds are closet trackers to start with.

How I’d invest in active funds

I believe the only reasons for investing in most active funds1 is either because you’ve a sentimental attachment to them (I’m not being facetious – many managers write great narratives about their ultimately fruitless decisions) or because you want to try to beat the market despite the poor chances.

If it’s the latter – and you don’t want to pick shares yourself, and return premiums don’t do it for you – then be smart about how attempt it.

How I’d probably try to go about it is to decide on my one or two very highest conviction active fund ideas (no mean feat, given academics have shown past performance is no clue to future performance) and then invest only in those one or two funds for my active allocation.

I’d then make up the bulk (say 80%) of my equity portfolio with tracker funds.

This way you get a little bit of active fund management colour if you want it, and if they beat the market then you will.

But most of your portfolio will remain pretty cheap, thanks to the trackers, and they’ll likely keep your returns in the same ballpark as the market, too.

Think of your modest allocation to active funds as an indulgence or a folly, like having a pot-bellied pig as a pet.

A bit of fun perhaps, but completely unnecessary, and probably more expensive than you think.

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

1. As opposed to active stockpicking, which is challenging and fun and my own foible. [↩]