I started Monevator seven years ago, writing about the rewards that would shower upon the righteous who followed the virtuous path of spending less than they earned, saving the difference, and aiming for financial freedom.

As for taking the opposite path – that of a feckless borrower, say, or a risk-taking punter – then woe be upon you.

What lousy timing I had!

Within 12 months the financial crisis struck. The world was turned upside down, and so were the basic principles of personal finance.

Far from coming a-cropper, borrowers with vast mortgages acquired at the top of a housing bubble were bailed out by the lowest interest rates for 300 years.

Far from being rewarded for saving, interest rates on cash deposits plunged below inflation, again favouring borrowers over savers.

The stock market pretty much halved from peak to trough, shares in blue chip banks were decimated, hitherto safe-looking stuff like PIBS went loco, and crazy-eyed gold bugs made out like bandits.

Forget prudence. The luckiest person to be was someone who’d over-borrowed in the bubble years to buy the biggest house they could – perhaps using an inflated self-cert loan, preferably signing up for PPI in the process – who didn’t bother with savings or pensions or any of that old rubbish.

Mortgage rates slashed, seven years of inflation, and a bit of PPI compensation to boot. Result!

So much for personal finance 101.

How savers were screwed

Many people have suffered in the downturn. They’ve seen their real incomes curbed, their benefits cut, their bedrooms declared surplus to their requirements.

Some of this was warranted. Some not.

But there’s no disputing that the most ironic misery was that inflicted on savers who’d done the right thing during the borrowing binge that led up to the crash.

Their poster child – or perhaps pop-up OAP – was someone who retired during the turmoil, was forced to buy a rubbish annuity touting a woeful income using their depleted pension funds, and saw any other spare cash languish at pitiful rates of interest.

This person won’t get the natural sympathy we have for say the young and unemployed, or the genuine victims of welfare restraint.

The relatively flush private pensioner still gets a pension. They are not on the streets.

True, but there is a bigger picture here.

When someone comes to draw their pension, they’re drawing down on consumption they personally postponed for many decades. A whole lot of foregone pleasure when they could have lived for the day – only to be hit by a dodgy decade at the end.

What kind of society do we want to live in? One where making some sacrifices so you can comfortably take care of yourself in the future is encouraged and rewarded, or a bailout compensation culture where you borrow to the hilt and blame someone else if it all goes wrong, and then fall on the State at the end?

Most people inhabit shady streets of grey, of course, not Benefit Street, Reckless Row, or Horrid Banker Heights for that matter.

But I think it’s inarguable that when it comes to the middle classes, recent years punished the prudent and patted the clueless on the back.

And that’s a terrible lesson that turns moral hazard into a personal finance nightmare.

A nicer ISA

Hence why the 2014 Budget was so encouraging.

Out of the blue we finally got a Budget that encourages and rewards our efforts at saving and investing.

Nobody expected the annual ISA allowance – currently £11,520 – to be raised to £15,000 a year from 1 July 2014.

In fact, the usual suspects in financial services were warning ISAs could be cut down in size – no doubt to try to get more last minute ISA money through their doors from the jaded public.

Junior ISA annual limits rose too, to £4,000. Together, these higher allowances mean a nuclear family of two adults and two kids can shelter £38,000 a year of their savings free from tax.

Another excellent development – cash and stocks and shares ISA allowances are being merged into one New ISA (or NISA) that you can split between cash and shares as you see fit. In fact you’ll be able to swap from cash to shares and vice versa.

This move treats investors as grown-ups, and at the same time it gets rid of a pointless split that has confused and turned off so many over the years.

Some will now churn their asset allocation like a hedge fund manager on commission, but that’s a choice they take. It can only be good news for the rest of us that we’ll now have the flexibility to turn some of our equities to cash if we want to – and also for some of that cash to find its way back into the stock market at opportune times.

Given today’s low yields on bonds, even ardent passive investors could benefit from moving some of their fixed income allocation into tax-protected cash, too.

And being allowed to buy short-term bonds in ISAs will also be useful one day, even if today’s micro-light yields make it seem pretty irrelevant currently.

The bottom line on these ISA changes is most people will be able to shield the vast bulk of their savings from tax if they start young enough, and with less of the restrictions that they faced before.

Meanwhile those of us who have substantial investments outside of ISAs (perhaps because we were slow learners!) can now look forward to getting more of our money sheltered than we thought possible.

Pensions fit for purpose

In any normal year the powering-up of ISAs would be the big news, as well as another nail in the coffin of pensions – a coffin that already looks more like a porcupine.

But in a pinch-me-I’m-dreaming moment, Chancellor George Osborne then went on to do a Gok Wan job on pensions, too.

Instead of the usual silly fiddling, these look like sensible yet radical changes that Actually Make Pensions More Attractive. (Gasp!)

The biggest change is still to be fully confirmed – that you will be allowed to take your entire pension pot as a lump sum in your mid-fifties. The first 25% lump sum would still be tax-free, but the rest would only be taxed at your marginal rate, instead of at today’s punitive 55% rate.

If that gets through consultation, it’s a game changer.

No more being forced to buy a crappy annuity. Infinitely more flexibility about how you use your money.

No more having to convince a 25-year old that she should save for her retirement in 40 or 50 years time. Instead, there’s an escape clause at 551, at which point she could spend all the money she’s saved on a mini super yacht if she wants to.

Of course she won’t actually want to blow her whole retirement pot when she gets there – not usually.

But she might want to downsize and move to Spain, or invest some of her money in her son’s business, or use a sensible portion to take the trip of a lifetime before her lifetime is over.

Given such freedom, pensions can better stand toe-to-toe with buy-to-lets in the flexibility stakes, as well as two holidays a year in the Y.O.L.O. department.

And that’s important if pensions are to be made attractive to everyone.

More modest treats from Budget 2014

Osborne had more tricks up his sleeve, including:

• Higher drawdown limits for those already taking an income from their pension, starting 27 March.

• A lower qualification limit that will allow more people to take flexible drawdown.

• More small pension pots will be qualify to be taken as a lump sum, with a £30,000 limit.

• Scrapping the 10% starting rate for savings from April, and the new 0% starter rate band extended to £5,000.

• New “pensioner bonds” from National Savings & Investments that should deliver markedly higher interest on savings for those over 65 than they can get today in the market.

• Premium bond limits rising from £30,000 to £40,000 and then to £50,000 over the next two years.

• The personal allowance for income tax rising from £10,000 to £10,500 in 2015/2016, and the higher rate threshold finally going up, from £41,865 next year to £42, 285 in 15/16. (These had already been announced).

Not all of this is earth shattering, admittedly.

Scrapping the 10% is a welcome simplification, but it won’t add up to much given current interest rates. Premium bonds are poor investments right now. As for the higher rate tax threshold, it should be rising further, faster, after its freezing has dragged millions more into the higher-rate tax band in recent years.

But it seems churlish to complain.

Savers can’t be trusted?

Some people will say that higher ISA limits are only good for the wealthy, and that ultra-flexible pensions can’t be trusted on the British public.

But that’s to misunderstand the mindset of those who save and invest.

It’s not only high earners who will enjoy the higher ISA limits. They will help all kinds of people get their finances into a more tax-efficient place, from those who were tardy about getting started with ISAs to those who receive lump sums, and also normal middle-class earners who want to retire early by saving far more than ordinary mortals.

As for pensions, few people save and invest for 30 years then blow it all in a moment of madness.

We who do save and invest know that doing so changes how you think about money. The very act of getting more people on-board with that mindset could reduce the financial self-immolation going off every day across the country.

Besides, if this is a giveaway then at least it’s one where the recipient has to give something up today to get something better tomorrow, as opposed to spending it all today and then whining about not having enough to get by when tomorrow inevitably comes.

Encouraging more people to save more into more flexible schemes doesn’t solve all the problems of everyone, especially those poorer workers who may have the motivation but don’t have much cash to spare.2

But the Budget is clearly a big step towards rewarding aspiration and self-reliance for many of us. And I’m all for that.

Making something out of nothing

Of course the cynic in me whispers the government is doing all this because it has to. That this is the carrot, and the stick of a steadily diminishing State pension is to come. That the territory is being prepared in advance.

And perhaps it is – though it must be said State pensioners have been virtually a protected species under this government.

But let’s worry about that another day.

The good news is we have a Budget for once that lives up to its name. It will help those with the means and desire to take greater control over their finances to help themselves, from their first pay slip to the grave.

You say this is just a Budget to win votes?

Fine. It gets mine.

Note: At GOV.UK you can download and read all the Budget 2014 documents.

1. Potentially this will be 57 by 2028. [↩]
2. To help them I think the State should match contributions for the first £500 a year into a NEST pension, say. [↩]

Good reads from around the Web.

Some readers have asked why I’m not sharing many active investing ideas at the moment.

One reader even wrote on his blog about it!

It’s true I’ve given passive investing mantra the run of the pitch recently. I even joined in with a post about Warren Buffett’s tracker-philia.

Yet away from Monevator I’m as much in thrall to the dark forces of active investing as ever.

What gives?

Actively resisting

First, I’m ever more convinced that most people are genetically terrible investors who should automate their savings and asset allocation and then stand well back.

I don’t want to dilute that passive message at present. (I’m capricious and this is a personal blog, not Pravda, so it won’t stop me forever.)

Secondly, the ongoing platform price war is The Big News of the moment – our equivalent of Prince Harry getting married on an aircraft carrier to a pregnant girlfriend en route to the Falkland Islands.

The Accumulator was even on Radio 4!

Thirdly, while I probably still have more in equities than I should – and a mongrel lot at that – my exposure is no longer dialed to Spinal Tap’s 11. As I’ve mentioned previously, I’ve been selling down, on and off, for months.

Fourthly, and related, there aren’t the blatantly great opportunities to invest cheap in mainstream markets like there were.

It’s now five years since I (accidentally!) urged buying on the day of the bottom of the bear market. Prices are well up. It’s a long time since strange anomalies suggested the market was seemingly breaking down, since equity income trusts traded at double-digit discounts, or since commercial property and the housebuilders were priced at levels implying either bubonic plague or that future generations were going to live like nomads in tents.

I’m a cheapskate value investor, and I like to buy bargains. So there’s less to buy.

Finally, I have have written once or twice when (for what it’s worth) I’ve seen value. I wrote last summer about the potential in gold miners, for example, and also in emerging markets.

Both ideas were too early and the first was really just a punt for fun money (which I’ve put on via the iShares gold mining ETF with the ticker SPGP).

Emerging markets do look like a proper grown-up opportunity, however.

Everyone is a genius in a bull market

I’m not saying UK equities are clearly too expensive or anything like that.

True, there’s lots of froth in the smaller caps, but the FTSE 100 looks alright. Europe seems okay to me, too. The US does look downright dear, but it usually does in bull markets.

I digress. The bottom line is I saw many cheap things over the past five years, but you didn’t have to be George Soros to do that – the wind was at our backs.

The FTSE 250 is up 170% over the past five years, and that’s not including dividends. Picking winning ideas has been like shooting fish in a barrel – that’s the humble truth.

It hasn’t stopped legions of overpaid hedge fund managers shooting themselves in the foot and doing much worse, of course!

[continue reading…]

One of the unusual opportunities thrown up by the financial crisis were the stricken preference shares of certain High Street banks.

These once solid income-paying securities – or their descendants – from Lloyds and Natwest were hit for six in the turmoil.

Brave dumpster divers bought shares at stonking yields of 20% or more, that would theoretically payout forever!

Of course the fear was that those yields would not be sustainable – perhaps because the banks would be fully nationalised.

Note: This is not a recommendation to buy or sell any of the shares I mention. Please see my disclaimer and do you own research. Also, I will sometimes use the term ‘preference shares’ as shorthand to cover the whole gamut of prefs, PIBS, and certain retail bonds. There are important legal and financial differences, so again do your research. This is all just my opinion.

A preference for income

A few years on and things look far rosier, in the main.

Certain Lloyds prefs – tickers LLPC and LLPD – were barred by the European legislator from paying their dividend for a couple of years, as a result of that bank being bailed out by the State. But they’ve since resumed payments and prices have recovered strongly, as have the preference shares of Natwest – ticker NWBD – which never stopped paying, despite its parent RBS’ woes.

True, there was a reminder last summer of the earlier uncertainty. Owners of various Co-Op high yield securities got pulled pillar to post as the scale of under-funding at the run-by-mates Co-Op Bank was revealed. An impressive grassroots campaign eventually secured them a pretty decent deal though, and the wider fixed income universe bounced back.

And I noticed this week more bouncing in some of the preference shares and bonds I still hold.

Alas not the floating rate ones I wrote about in January, which are doomed to look like awful investments until the fateful day the bank rate soars to 2%. (Then they’ll look brilliant! Really!)

Rather there’s strength in the likes of the Lloyds preference shares, and the Bank of Ireland subordinated bond with the ticker BOI.

My first thought on spotting this was that the wider markets were selling off on the Crimean ruckus, and a few nervous investors were buying bank preferences shares instead.

These shares are very illiquid, so this idea isn’t as fanciful as it seems. While they shouldn’t be thought of in the same breath as government bonds – they are far, far riskier and in a true meltdown will sell-off much like equities – as the financial crisis recedes they will be governed more by interest rates.

I’m now pretty sure though that the real reason is Lloyds’ recent tender offer to buy back its Enhanced Capital Notes (ECNs).

Tender is the plight

Lloyds’ ECNs were created in 2009 as the bank scrabbled about for capital in the midst of the banking crisis.

Regulators have seemingly had a change of heart since then, and there is talk the notes may not count as core capital if the bank gets into trouble, or even in a stress test.

The upshot is Lloyds apparently doesn’t want them hanging around on its books. It’d rather buy them up now and replace them with something more pleasing to the regulator.

I’m being deliberately colourful in my description here because I’m not any sort of expert on these ECNs and I don’t want to mislead you with spurious precision.

In fact, I’d suggest holders have a read of the relevant thread on the clued-up Motley Fool banking board. Or, if you find that’s too confusing – and I wouldn’t blame you – then there are write-ups at ThisIsMoney and Reuters, among others.

The latter articles outline the thinking of Mr Mark Taber, who has become the unpaid champion of the Little Guy in these situations. (He’s also in that Fool thread, posting under the name OldBoyReturns). He reckons Lloyds is behaving unfairly to retail investors1.

I didn’t really agree until I read more deeply into the Fool discussion. The tender offer is optional, for starters, so my first thought was how coercive can it really be? But on reflection there does seem to be a reasonable argument that the bank has handled things clumsily (some allege worse) and that private investors are being asked to make a decision that they aren’t well-equipped to make.

There’s an estimated 120,000 retail investors holding these ECNs. How many of them are reading the latest newspaper articles, let alone in-depth discussions like the one on the Motley Fool?

A fraction of a fraction I’d have thought.

You might save caveat emptor – except the roots of these notes can stretch back to PIBS first issued when Lloyds-owned Halifax was a building society and I was in short trousers.

PIBS were a class of investment that was often touted as ideal for widows and orphans, as opposed to being touted at City slickers. Yet these unsophisticated holders are now being asked to decide whether to tender.

Retail investors not wanted?

Interestingly, Taber also believes the powers-that-be have decided everyday investors like you and me shouldn’t hold these sorts of bank securities at all.

Apparently that’s why the Lloyds tender doesn’t enable retail investors to swap their ECNs for new bond-like securities, only cash.

On the one hand, a glance at the tender announcement for the ECNs seems reason enough to agree that Joe Public shouldn’t be going anywhere near them. Their potentially confusing nature when things get sticky is implicit in most critics’ objections to the tender, after all.

Also, it’s clearly not in the authorities’ interest to have supposedly loss-absorbing capital that turns into a PR disaster whenever old people or photogenic mothers-of-three are the ones taking the loss. Better such cannon fodder is in the hands of banks and institutions who are unlikely to get much sympathy in a crisis.

Yet on the other hand, we are allowed to own ordinary shares in banks. And it’s often forgotten that equities are the riskiest tranche of capital of all.

So there does seem to be potentially something odd going on, if it’s true that we’re being quietly steered away from non-equity investments in banks.

Falling yields: Consol yourself

Anyhow, the point for bank preference shares is that I suspect people are buying them as a result of this brouhaha.

They may be buying them as a replacement for the income stream they’re selling with the ECNs, or they may be buying because the perpetual nature of these bank preference shares suddenly looks a lot more attractive. Or they may be buying because they think those things will occur to others soon enough!

Whatever the reason, it could present preference share holders with a difficult decision if prices keep rising.

Really, preference shares should be priced off a spread over their yield versus perpetual government bonds – gilts – such as Consols or War Loan2. This spread should reflect their much greater riskiness, compared to gilts.

And sure enough the spread has been narrowing as people have gotten happier that the issuing banks are more secure. But it’s still not quite as tight as before the financial crisis.

War Loan is yielding about 4.2% at the moment, while the Lloyds preference share LLPC is yielding around 6.7%. The spread is thus around 2.5%. From memory it was as narrow as 1.5% before the crisis3.

Now, I’d argue the big banks are a much safer bet than pre-2008, although as a shareholder in Lloyds I’m possibly biased. And while there is certainly more regulatory risk than before, this is more of an issue for owners of the common shares than the preference shares.

Tougher rules make the banks less lucrative in terms of return on capital, say, but they are a positive for the preference shares, since preference share dividends must be paid before the common shareholders get a penny. So they don’t need such strong earnings to see their income streams maintained.

Slim pickings?

For these reasons, exactly what’s a sensible spread over a perpetual gilt is hard to judge. If it got much below 2% though, I suspect I’d let others have mine.

It’s worth making your mind up as to what level of spread, if any, would be a sell for you if you own these preference shares. And then to watch them carefully!

If even a fairly small number of those 120,000 ECN owners start throwing money at bank preference shares, the spread could narrow sooner than we’d think. But equally, their impact on prices might not last.

A perfect set-up for us active investors to tie ourselves in knots over.

Note: I own holdings of several of the preference shares cited in this article.

1. Retail investors are ordinary people like you and me, as opposed to institutional investors. [↩]
2. Note: These issues could theoretically be called by a government, and hence are not truly perpetual. But they never have been, and the market treats them as if they won’t be. [↩]
3. Or rather that was the spread on the old Halifax issues that these preference shares descend from. [↩]