An index-linked gilt ladder is oft touted as solving two big problems for investors:

• Hedge against unexpected inflation – something that by contrast inflation-linked bond funds have conspicuously failed to do recently. 

• Ensure a predictable supply of real income to meet living expenses in retirement. 

And it’s true! A ladder of individual linkers1 can deliver on both these scores…

…but you have to watch your step.

Linker ladders solve some risks while introducing others.

So let’s run through the two main use cases, examining the pitfalls and potential remedies as we go.

‘Safe’ retirement income

In principle, an index-linked gilt ladder is a much safer way of generating a retirement income compared to a volatile portfolio of equities and bonds.

Buying a series of linkers enables you to secure a reliable cashflow of government-backed, inflation-protected income.

Hey Presto! No more sequence of returns risk.

• See our member’s article on how to build an index-linked gilt ladder for further details.

A linker ladder has two big problems however:

• The danger you outlive your ladder. You build a ladder to deliver 40 years of income but then you have the temerity to last for 41. This is longevity risk incarnate. 

• Relying 100% on ladder-generated income requires you to predict your after-tax living costs far into the future. Get it wrong – with insufficient alternative sources of income – and you land on the liquidity risk square. “Do not pass go, do not collect £200…”

Unexpected bills are as inevitable as their more infamous ‘death and taxes’ counterparts of gloom. Your financial firepower may have to deal with waves of such baddies in the future. Think divorce, chronic health expenses, family members in need of support, and social care – to name just a few end-of-level bosses. 

Moreover, your personal inflation rate may outstrip official measures. Which means RPI2 increases in purchasing power from linkers may not cover your needs.

Please sir, I need some more

Twenty years ago a laptop, a broadband Internet connection, and a mobile phone were not an essential part of life, never mind retirement.

Nowadays pensioners without these items find themselves sidelined by society. 

Who knows what’s coming next? Personally, I’m factoring in a neural uplink plus bionic exoskeleton maintenance plan.

Meanwhile, higher taxes in the future could leave you with a lower net income than you anticipated. The country isn’t getting any younger, after all. The national fairy godmother isn’t waving her wand over the raggedy NHS. The military aren’t sure about that nice Mr Putin and there’s an energy transition to pay for. 

True, you could sell an individual linker ahead of time to cover an emergency. But do so and then what happens when you arrive in the year 2049 and the gilt that was meant to fund that year is already spent? 

It seems the twin threats of longevity risk and liquidity risk must be met by more than a ladder. 

The floor and upside strategy

A floor and upside strategy can provide a middle ground between going all-in on a linker ladder, and depending entirely on the favours of the stock market gods. 

Here your floor can be built from any blend of linkers, escalating annuities, the State Pension, and defined benefit pensions. Anything inflation-linked that provides ‘guaranteed’ income is ideal.

At the bare minimum, your income floor should cover your essential spending requirements. (That is, your non-discretionary expenses.)

Beyond that the upside is handled by a portfolio of investment assets. Fully 100% equities is often prescribed because the floor element effectively counts as your bond allocation. 

The upside portfolio’s job is to grow and provide for the fun stuff. That is, it pays for the discretionary ‘nice-to-have’ part of your lifestyle. 

You can dip into the upside portfolio to fund unexpected expenses, too. It can also extend your linker ladder if that nears exhaustion while you’re still going like the Duracell bunny. 

Safety first

Your precise floor and upside formula depends on your personal circumstances. If your entire income (discretionary and non-discretionary) is amply funded by defined benefit pensions then you can afford to be more aggressive with your upside portfolio. 

On the other hand you’ll need to be careful if operating on a super-lean essentials budget that’s barely covered by your ladder and an ‘It’ll be alright on the night’ personal philosophy. 

Cutting it fine is not recommended.

Annuities are the right tool to combat longevity risk

Annuities come in for a bad rap. But index-linked (or escalating) annuities solve the longevity problem by providing inflation-adjusted income for so long as ye shall live. 

If an escalating annuity funds the same income as your linker ladder – but for similar or lower cost – then it’s by far the better choice. 

The older you are, the more likely it is that an insurer will offer an annuity product that makes it worth your while. (Though it’s interesting/alarming to note index-linked annuities are no longer available in the US.)

The key point is that an annuity income lasts as long as you do. In contrast, a linker ladder’s lifespan is finite (unless you can keep extending it using cash drawn from other resources). 

You can quickly check the going rate on annuities with Money Helper’s excellent comparison tool. 

Make sure you choose an annuity that’s linked to RPI and not one of the lesser ‘increasing income’ options. 

At the time of writing I was quoted the equivalent of a 4.1% sustainable withdrawal rate (SWR) for a 65-year-old on an escalating annuity.

That compares well with a 3.9% withdrawal rate for a 30-year linker ladder. It also sidesteps the gymnastics needed to wring a similar SWR from a volatile equity-heavy portfolio. 

No surrender

People tend to shun annuities because they don’t like handing over a big bag of swag to an insurance company.

Perhaps those people have not heard of a floor and upside strategy? 

Moreover, they probably don’t realise that mortality credits make annuities the cheapest way to beat longevity risk. 

Mortality credits are like the bonus balls in the lottery of life. 

In annuity land, the spoils go to the long-lived. 

Supercentenarians make annuity managers weep as they win their personal bet with the insurance firm.

One can almost imagine shady annuity goons trying to drop pianos on sweet old ladies in the street as the insurers desperately try to stem their losses.

But there’s no need, because they collect on those who fall at the early fences. 

The house always wins. But so do you if you last long enough – and durability is precisely the risk you’re insuring against with an annuity. 

Of course, linkers are backed by the UK government. But annuities are backed 100% by the FSCS protection scheme. During a crisis that may well amount to the same thing. 

Juggling linkers, annuities, and the state pension

If you retire too early to make an annuity cost-effective then building a linker ladder to carry you to state pension age is a viable strategy. 

The state pension will then help with the heavy-lifting from age 67, 68, 106 – or whatever your qualifying age is. (Unlucky, Generation Alpha!)

At that point, you can also decide whether to fund the rest of your income requirement from your upside portfolio, an annuity, a linker ladder, or a patchwork of them all. 

Laddered couple

Monevator reader @ZXSpectrum48k has sketched out a helpful example of how this might work.

Picture a couple of early retirees, age 55. Their vital statistics are: 

• Essential income: £21,000
• Discretionary: £7,000
• Portfolio: £700,000

A linker ladder funds £28,000 of income for 12 years until the State Pension arrives. 

The linker ladder costs £320,000, leaving £380,000 for the upside portfolio.

The upside portfolio can then be left alone for 12 years, so long as the linker ladder is supporting expenses. 

Alternatively, if a bombshell bill hits you could sell the portfolio down a bit to meet the payment. This will likely be fine provided you’re not systematically plundering it. 

Then from age 67 the state pension (x2 in this case) takes over from the linker ladder to bankroll essential income. 

Even if the Upside portfolio only stands still for the next 12 years, it could fund the remaining £7,000 of discretionary income at a mere 1.8% withdrawal rate. That’s pretty safe. 

Let’s say the portfolio actually caved in by 50%, in real terms. It could finance discretionary income thereafter at a near 3.7% SWR. 

That’s a reasonable SWR too, but especially so after a 50% decline. That’s because stock market valuations will have contracted. And the evidence generally shows that lower valuations support higher SWRs. 

(Of course the 3.7% SWR is higher risk than the 1.8% SWR. And you’d leave a smaller pot behind for your heirs if withdrawing at a higher rate.)

Something for the weekend

Alternatively, from your late sixties onwards you could periodically check index-linked annuity rates. At some point your age and health are likely to make annuities a good deal for delivering the remainder of your income. Even more so if you don’t want the burden of managing a portfolio in your dotage. 

Personally I’d still leave something in my ‘Upside pot’, regardless of whether or when I bought an annuity.

In later life this allocation could come to represent one last spin on the wheel of fortune.

Will it defray unwished for emergencies? Fund round-the-world trips, grandchildren, or a legacy? Or just fizzle away in an almighty stock market crash? (In which case, thank goodness you built your income floor first).

Much depends on the cards you’re dealt. 

How long should an index-linked gilt ladder last? 

Our example demonstrated that the length of an index-gilt ladder depends on what you’re using it for. 

The doubt creeps in if you want it to last the rest of your life – so long as your date with destiny remains a tantalising mystery. 

For context, according to the ONS’s UK life expectancy calculator, a female has a 6.8% chance of blowing out the candles on her 100th birthday cake. 

Your income, health, and family history may indicate your chances are better. 

I think longevity risk is easier to handle than liquidity risk. So I’d be inclined to overcook the length of my ladder.

Our post on life expectancy will help you think through the issues.

Take a butcher’s at our piece on life expectancy for couples too if you really like your other half. The odds are surprisingly high that at least one of you will last a very long time. 

Meanwhile, if you’re using a linker ladder to meet a future expense (but without spending income en-route) then see our post on duration matching. Reinvest those coupons!

Upside portfolio management

Sustainable withdrawal rate research typically shows that 100% equity portfolios entail more boom or bust scenarios than more diversified allocations. 

The unpredictability of equity returns can result in anything from you dying very rich to watching your portfolio drain inside a decade. 

The lower your SWR, the more probable it is that a 100% equity bet pays off.

Conversely, SWRs much north of 3% from a global equity portfolio are edging into the danger zone. 

Consider diversifying beyond global equities if your SWR is above 3% when you retire and the global CAPE valuation metric is well above its historical median. 

A 90/10 split between equities and conventional bonds or an 80/10/10 division between equities, bonds, and commodities give you more options to fall back on when the stock market hits the skids. 

In reality, your overall position should be more stable than implied by these equity-skewed allocations. That’s because your guaranteed income products and pensions all count as fixed income. 

Using a rolling linker ladder to hedge unexpected inflation 

You may not want to buy a linker ladder for the rest of your life, but maybe you’re still interested in protecting a wedge of your wealth from being withered by inflation. 

Equities will probably do that over the long-term. But in the short-term, individual index-linked gilts held to maturity better fit the bill.

By holding each linker to maturity you avoid the price risk that has hammered inflation-linked bond funds over the past couple of years. 

Bond managers typically sell their securities before maturity in order to maintain their fund’s duration.

As interest rates took off in 2022, managers were therefore booking capital losses as prices fell in response to rising bond yields. 

Those capital losses were severe enough to swamp the inflation-adjusted component of linker returns. 

Hold!

The bottom line is you can avoid price risk by acting as your own bond manager and holding your index-linked gilts to maturity. 

To hedge unexpected inflation with index-linked gilts:

• Follow our How to build an index-linked gilt ladder guide. 
• Construct a shorter rolling ladder instead of the long, non-rolling ladder discussed in the guide. 
• Hold 0-3 or 0-5 years worth of index-linked gilts – just as a short-term bond fund would. 
• When a linker matures, reinvest the proceeds into a new linker at the long end of your ladder. 

Now you have an investment that directly responds to UK inflation.

You can reinvest your coupons into the ladder whenever you have enough piled up to make it worth your while. Or you can spend them, or reinvest them into another asset.

However you must reinvest the coupons if you want to achieve – approximately – the yield-to-maturity on offer when you first buy each bond. (This involves duration matching and is difficult to do perfectly.) 

Remember, your linkers’ pricing will still bounce around as market conditions change. So you’ll still feel the volatility if you track your gilt’s fortunes from month to month. Moreover, you’ll crystallise any loss (or gain) if you sell early.  

However, all told the volatility should be relatively tame on short-term linkers. And, as mentioned, you can ignore it entirely if you hold your gilts to maturity. 

We’ll write a post soon on how to buy individual index-linked gilts.

But in truth – providing your platform offers them – it’s not much harder than buying a fund or share.

Granted you may have to buy over the phone instead of online, but it’s completely doable.  

Stepping up

After many years of negative yields, individual index-linked gilts are affordable and worth buying again.

The window may not stay open forever. We might well fall back into negative real yield territory.

But for now, in an uncertain world, linkers offer something few other investments do. Just so long as you know how to make the most of them.

Take it steady,

The Accumulator

1. Linkers being the colloquial term for index-linked gilts. [↩]
2. CPIH after 2030 [↩]

What caught my eye this week.

The online brokers keep sending me pointers to cash and cash-like investing opportunities – from the interest rates they pay in SIPPs to ideas for money market funds and cash-like ETFs that track short-term bonds.

Indeed one low-cost share dealing platform has emailed me the same variation for three weeks in a row. Clearly it’s working for them, which tells us the appetite for cash among retail investors is ravenous.

And to be sure, explaining how to hold cash – and ‘nearly-cash’ – with an easily-traded ETF is giving the customers information that they want.

But it will also be aimed at discouraging those customers from moving their money off-platform instead, to traditional savings account or similar.

It’s a battle for attention, just like Netflix versus Sky.

What probably won’t have gotten so much consideration though is what’s the likeliest best long-run return for the typical retail investor.

Because the reality is that over time periods of more than just a few years, cash and very short-term government bonds have typically delivered lower returns than longer-term bonds, while equities have historically left cash in the dust.

Moving to cash in 2021 would have been a market-timing move for the ages.

But the odds of that being the case in late 2023 – even after the strong recovery we’ve seen in US markets this year – seems to me much lower.

Cash-ing

Don’t get me wrong – I love cash.

I consider it the king of the asset classes in all market environments, even when it’s badly lagging. The security just can’t be beaten.

But the fact is holding a lot of cash is a luxury that few of us can afford.

Back in 2010 as we continued to climb out of the wreckage of the financial crisis, I warned:

I think it’s currently sensible to prefer shares to cash or bonds. For now, the yield situation looks good for equities.

Also, financial insiders are still reporting there is a lot of cash on the sidelines after people stopped investing in equities and other risky assets during the bear market.

So even now, cash is king in a lot of investors’ minds.

Usually there’s very little cash around at the top of a market. In fact, people often start borrowing to invest – a classic sign of a toppy market!

Again, cash is trash doesn’t hold right now on that score.

Unfortunately, some shell-shocked investors who took too much comfort in cash after the financial crisis never got back into shares.

They then missed out on one of the greatest stock market bull runs of all time.

Cashing in

It’s hard to argue that shares are exactly cheap right now – at least not the US shares that make up the bulk of global market funds.

And most people should always have some cash for diversification, even beyond their emergency fund.

Also, cash is typically a better deal for switched-on private investors who can chase the best rates than it is for institutions, so I’d even agree with holding much more cash than their model portfolios might suggest. At least until you’re knocking up against the savings allowance.

Finally, there’s a craze at the moment for holding low-coupon gilts as a cash substitute outside of tax shelters. Gains on gilts are capital gains tax-free, so this is better than paying tax on interest from savings. It’s interesting stuff to explore and one can happily get lost in the weeds.

Nonetheless, I’d urge readers not to lose sight of the prize if you’re a typical investor with decades ahead of saving for the long-term.

Unless you’re a mega-earner, cash(-like) returns won’t get you where you need to be.

Have a great weekend!

[continue reading…]

I was surprised to hear my landline ring. The number is only known to The Accumulator, my accountant, and my girlfriend.

And none of them ever wants to speak to me.

Sure enough, when I found the handset – hidden beneath a throw thrown over several months’ of FTs – their abstinent track record was maintained.

“Hello? Am I speaking to The Investor?” enquired a chirpy American voice down the line, as if this was still the 1990s.

I confirmed that I was he.

“Bob Leigar has heard about your website Motivator and he thinks you guys are just the talent to come up with a spiritual sequel to The Big Short – which is still the best movie ever made about finance, and not only because I’m a simp for Christian Bale even with his hair cut like a pudding bowl. Bob will be in London on Wednesday. Can you have your pitch ready by then?”

It seemed rather presumptuous. I hadn’t even had my porridge.

But you know… Americans.

“Why not,” I assented in my jauntiest English accent. “See you then!”

The stage is set

We were to meet Leigar in the bar of The Langham five days later, and when the day came Team Monevator was there early. Me in the suit I’d bought in 2015 when I thought we might win Investing Blog of the Year at the British Banker awards. The Accumulator in one of his trademark boiler suits – thankfully a lightweight autumnal number.

Still, he didn’t exactly look up-and-at-em.

“Is that the best you can manage when Tinseltown comes calling?” I hissed, even as Bob Leigar and his entourage entered the room and filed towards us.

“No compromise!” shrieked TA, raising his fist like Wolfie from Citizen Smith.

Leigar clocked the gesture, and paused. Then a big toothy smile engulfed us all. It was as if somebody had turned on a second set of lights.

“Colin Kaepernick fan, eh?” the famous Hollywood producer grinned. (I had of course googled Leigar and checked his bona fides). “Cool cool. We’ve kind of moved on stateside, but hey, that’s why we love you chaps in the old country. You won’t be hurried, right?”

On that note, he sent off one of his apparatchiks to find out “what the heck” had happened to the matcha latte he’d ordered 74 seconds ago.

Then we settled down to business.

“Okay, so I assume Cindy, Chad, Miguel, Barb, and Ming Tan have got you up-to-speed on why we think it’s time to make a sequel to The Big Short,” said Leiger, after Cindy, Chad, Miguel, Barb, and Ming Tan had taken their seats around him, leaving me and TA to perch uncomfortably – and without touching – on the remaining footstool.

“Not rea–” I began.

“Great!” interrupted Leigar, and everyone nodded and congratulated each other on a job well done.

“To recap…” Leigar continued, “…Bitcoin is back above $40,000. The bull market is on again, and nobody even went bust in the bear. Well apart from my bank in California but I hated those bastards anyway. Seriously, who doesn’t go bankrupt a couple of times making movies? It’s practically a Hollywood tradition. But still those creeps wanted their money back. Screw them!”

He was quietly mashing one hand made into a fist into the open palm of his other hand.

“What was I saying?” he wondered.

“The movie!” chipped in Cindy or Barb.

“The movie, that’s right! Well we’re not here just for the warm tea and the rain, and definitely not for the matcha latte,” he said, looking around before continuing, “We’re here to make the best investing movie since The Big Short and we think you dudes are the guys to help us.”

“Actually I preferred Margin Call,” mused The Accumulator. “Very underrated.”

Nobody said anything.

Chad and Ming Tan exchanged worried glances.

This is what happens when you bring The Accumulator to the big city. He lacks the necessary social lubricants. He looked ridiculous in his blue boiler suit and I wondered if it would scupper our chances. He came across like some 1970s Chinese peasant smuggling a lot of dead eels and mandarins home from the farm under the plush fabric and it had given him bumps in all the wrong places.

Fortunately at that exact moment Leigar’s drink arrived.

“Hallelujah!” the big shot exclaimed, literally. “Okay, enough chitchat about that arthouse stuff. It’s time for the main event. What you got for us?”

The pitch

It was showtime and I was ready for it. After 17 years of blogging this was our chance to bring passive investing to the big screen. Turning the rest of the world onto indexing with a blockbuster movie would make nearly everyone richer.

Including us, at last.

We’d fly on Virgin Atlantic to Los Angeles. In California even TA wouldn’t be able to wear a thermally-padded boiler suit. Meanwhile I could walk the streets where they’d filmed Beverley Hills 90210.

“So we’ve given it a lot of thought and we think we can tell an exciting story in the style of The Big Short,” I said. “You know, we’ll have several key personalities who go against mainstream thinking and yet prevail. They’ll be our countercultural rebels. They’ll get rich by turning their back on Wall Street and The City.”

Everyone nodded and said “yes!” and Chad fist bumped Ming Tan.

But TA prodded me in the ribs.

“Oh and maybe my – ahem – co-conspirator could appear in the movie as an Easter egg,” I mumbled.

“What’s that?” said Leiger. “This guy wants to play the Easter bunny?”

“No no, an Easter egg! A cameo appearance for those in the know? Like how Richard Thaler appeared in The Big Short to explain synthetic CDOs.”

Ming Tan’s hand shot up.

“Ming Tan!” staccatoed Leiger. “Hit me!”

“Well, with the cameo, aren’t these two MoneyRater guys anonymous?” she said.

She turned to look at us.

“Isn’t that why you’re both wearing dark glasses indoors? And isn’t it why that guy is dressed in a romper suit with a big red pirate’s beard?”

“It’s a good point,” said Leiger thoughtfully.

He leaned in and looked at me and I imagined his tanned and chiselled face reflected back in my jet black knock-off shades.

“Have you guys really done your research?” Leiger said. He sounded peeved.

Now Miguel’s hand was raised.

“Miguel!”

“Yes, and who is this guys’ people to reach out to?” he asked. He had his mobile in hand and was ready to take a number. “If we’re going to book him for a cameo then I want to get that ball rolling ASAP IYKYK?”

“Sorry?” I said. “Eye why kay why kay? Is that an agency?”

“FORGETABOUTIT!” thundered Leiger. “Tell me about the heroes! Tell me why we should make this goddamn movie!”

Putting on the Rizz

“Okay, okay,” I said, soothing the air like I was caressing an invisible pony.

I admit I was flustered. I knew we were missing the moment.

So I powered-up and went for it.

“Okay, the chief protagonist is this guy Toby Smith. We first meet Toby in 2002 when a financial advisor is trying to sign him up to an expensive active fund. The IFA tells him he is sure to get rich, and coughs and suggests golf when Toby asks why he’s also paying an upfront fee of 5%. Or maybe tennis, says the advisor. But Toby sees through him, and instead he invests in a range of tracker funds via a cheap online platform. Over the next 21 years Toby achieves market returns that beat 90% of active funds, and as a result he is able to retire early. And maybe we could show how his IFA had to become a caddie, too.”

Bob showed no sign of emotion and his team looked riveted, so I continued.

Action!

“Next, we get a burst of excitement,” I said. “In fact one of our heroes overcomes a big gap!”

“Now that’s what I’m talking about!” shouted Chad, fist bumping Ming Tan again and causing the other people in the bar to look over. “The Big Short meets Mission Impossible 5! Woo-hoo!”

“Exactly!” I lied. “Only this is more about a concept known as The Behaviour Gap–”

“Hey I think I’ve been there,” said Cindy. “It’s near Death Valley, right?”

“Er, well anyway our second hero, Jane Jones, she sees all her friends getting into online investing forums, and later social media and Reddit, and they trade in and out of the market and chase all the hot funds. But Jane just ploughs her money into a global index fund, month in, month out, year after year.”

“And…?” said Leigar. He didn’t sound exactly giddy.

Then again, I wasn’t sure if he should? This was his place of business, after all. I wouldn’t be tap-dancing if I were at the office.

“And – Jane beats the average annualised returns of all her friends by 2% a year just by doing nothing!” I concluded with some satisfaction.

Nobody said anything.

“Whereas all her friends’ activity comes to naught!” I added. “Well, 2% less than nought, really.”

I chuckled and TA snorted.

Adult content

“And… that’s it?” asked Leigar after what seemed like several hours. “That’s your pitch for The Big Short 2?”

“Actually, on that…” I said, “… we were thinking we could call it The Big Shrug. Kind of ironic, yeah?”

Barb didn’t seem convinced, which was better than Leigar who was trembling.

“Guys,” Barb chimed in, “I think where Bob is disconnecting is that it’s 2023 and audiences are finally getting hyped about going to the theatre again after all the China flu et cetera and well this pitch doesn’t really seem like a movie. More like a kind of blog post full of in-jokes.”

Leigar raised his eyebrows.

“Haven’t you got anything more dramatic?” Cindy added, between blowing big pink bubblegum balloons.

“For flub’s sake,” muttered TA at my side. “Go on! Tell them about March 2020. The climax!”

Hmm. We’d argued about this.

The Accumulator had wanted me to shoehorn in a mention of his blog article about how passive investors shouldn’t sell in a panic. The one he’d posted at the depths of the Covid crash of March 2020.

I agreed that staying the course through thick-and-thin was passive investing 101. But his admittedly legendary post just didn’t seem very cinematic to me.

Nonetheless I outlined the scenario to Leigar and co.

“And all this happens on the Internet?” the famous Hollywood producer deadpanned after I’d finished.

“Well, in his spare bedroom in reality,” I said. “But we can cut between him sweating and taking his dog to the vet while urging me over the mobile to publish the piece. Artistic license, you know?”

Roll credits

Leigar sighed and stood up. As if they were attached by strings it pulled the others up with him.

“Don’t call us,” the movie man said. “We’ll call you. But really – don’t call us.”

They all turned and began to file out of the room.

“Hang on!” I pleaded. I sensed we’d fluffed somewhere. “Did I mention how in the article he swears?”