Missing Monevator alert: For some sinister reason, Monevator email subscribers didn’t get my article on this week’s Budget. It was a spirited old ramble followed by some good comments from readers, so go check it out if you missed it!

People have been fretting about the stock market being too frothy all year (and for long before that…) But it’s worth remembering the majority of pundits are American.

I’d agree, for what it’s worth, that the US market is looking dear, especially the small to mid-sized companies.

But personally I think that the UK and Europe still look fair-to-good value. And some emerging countries like China and Russia are now in a bear market.

Supporting my feeling about the UK market is this interesting graph from John Kingham, posted on his UK Value Investor blog:

The graph suggests the FTSE 100 is still in the green ‘safety’ zone, when comparing its longer-run earnings to valuation.

John writes:

While a slightly cheap market isn’t particularly exciting, it does imply slightly better future returns than normal.

If we have 2% inflation and 2% real growth from the underlying companies, plus 3.5% or so from the dividend and a little bit more if the market mean reverts upwards towards fair value, then over the next 7 years we may get something like a 10% annualised return over that time.

At the end of that period in 2021, the FTSE 100 would be at 10,700.

Note the sensible use of the word “imply”. There’s nothing in this sort of valuation work that guarantees anything, and indeed the market could halve this year – or double.

But as an antidote to doom brought on by a few good years of decent returns, I think it is reassuring.

Keep on keeping on

Of course, passive investors know better than to try to time markets. Keeping your allocations, rebalancing, and ideally adding new money every month or year is how that strategy wins.

Barron’s has a short and interesting post on how those who save steadily over time can afford to ignore valuation:

For three decades, two investors put an annual $1,000 into Vanguard 500 Index starting in 1983.

One of them is Disciplined Dave. Dave invests his money on the last trading day of each year. He doesn’t try to time the market.

The second investor is Hapless Harry. Harry wants to time his annual contribution, but he has “the worst timing in modern Wall Street history.” He invests his $1,000 at the market peak every single year.

The result from 1983 to 2013?

• Dave’s $31,000 grew to $177,176. That’s 9.9% a year.

• The same money from Harry hit $169,153, for 9.5% a year.

There wasn’t too much difference between picking the worst days to invest and picking a regular day – just $8,000 or so.

It was time in the market that counted.

Of course you could argue that Harry would have done better to sit out the bear markets, if he’d somehow been able to see them coming in advance.

But The Brooklyn Investor warned this week that even the great value investors owe very little of their success – if any – to trying to time the market:

All of this is not to say that valuations don’t matter. They matter a lot. We are “value” investors, so of course “valuations” matter.

When we say don’t worry about warnings about overvalued stocks, bears will call us perma-bulls; that we bulls think markets always go up.

Well, they don’t. They will go up and down as they always have.

My argument is that it’s going to be hard to predict the market based on it. Higher valuations will mean lower prospective returns but higher valuations don’t necessarily lead to an imminent bear market or correction.

A bear market or correction will always be inevitable, but it’s hard to say when it will happen. And if you don’t know when it’s going to happen, it’s going to be very hard to capitalize on it

A lot of stupid comments that people leave on websites annoy me – I’m sensitive soul, in truth.

But the most annoying of all are glib comments about the market being obviously expensive and certain to crash, and so me or anyone else being muppets to write about shares.

The worse thing isn’t that these people are misleading everyone who reads their comments by giving some specious illusion of prescience – though that’s annoying and potentially costly enough.

But it’s that some tiny percentage of them will be right, by luck, every few years when the market does crash, as all long-term investors know it will now and then.

By all means follow valuation and have a sense of whether you think it’s time to add more of your funds to cash, bonds, or shares.

But run screaming from anyone who claims to know what’s going to happen.

They don’t. Nobody knows.
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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 55 ¹, 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!

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