Good reads from around the Web.

I could make every post of the week in my regular weekend reading slot one from Mr Money Mustache. The guy drops more bombs than Wile E. Coyote.

Besides being wise and funny, his blog is also stuffed with swearing, shouting, and uncompromising stances. It’s what my blog might be if my prosencephalon didn’t insist on compromises, caveats, and complicated clauses (not to mention ad hoc alliteration).

Some people think they hate Mr Money Mustache. I point them towards it, only to hear how they’re annoyed by the cursing and his made-up words like ‘complainypants’ and ‘Mustachianism’. 

They’re still telling me how annoying it is two months later, when they’re clearly still reading it.

A couple more months more, and it wasn’t them who ever said a word against Mustachianism, oh no guvnor. They’re his biggest fans!

Like this, Mr Money Mustache is taking over the U.S. blogosphere. He’s going to end up bigger than Dave Ramsey, Suzie Orman, and all those other people we’ve never heard of.

And when he does, it will be because beneath the love-him-or-love-him-a-bit-later fireworks, he’s got a rare talent for writing.

Here he was this week writing about a piece of junk mail. Just some junk mail!

I sometimes try to deny it, circulating in my privileged life of bicycles, library books and You the Mustachians.

I pretend that the shopping malls have closed and the former customers are all out there chipping up the asphalt to plant great community gardens. The Escalades are all gliding slowly along their Final Conveyor Belt, about to hit the carbide blades of the grinder which will shred them for reprocessing into wind turbines and solar panels.

But yesterday, someone had the nerve to stuff the mailbox at the Mustache residence full of colorful flyers advertising a huge array of Absolute Crap. And these flyers reminded me that that our work here is far from done. And they enraged me sufficiently that I was forced to grab a pair of scissors and some school glue in order to make the following Infographic for you. Study it, and try to keep a handle on your pulse rate, for it is horrifying indeed.

Beneath the pen, paper, and glue infographic, he asks:

Are people out there still buying scaryass white-bread fast food and jugs of “soft drinks”, a substance only barely less toxic than drain cleaner?

The food is sold with big closeups of deep-fried batter, when instead the image should be of the decaying 720-pound corpse of a man who died in his mid 40s of diabetes and obesity complications.

Read the full post, and find your mind being tweaked and re-tuned by his deceptively spectacular prose.

[continue reading…]

I don’t know why any investor would worry when a financial regulator predicts lower future returns.

The regulators have no notable skill in making long-term market calls. And nor should they – it’s not their job.

So I’m not particularly saying it’s incompetent of the regulators to lower the pension forecasts that financial firms are allowed to use to illustrate what you might get by investing in their products.

No, if I wanted to question that, I’d point to:

• The enormous financial crash we have just lived through, which happened on their watch.

• The boom and bust in most property markets, which happened on their watch.

• The fact that they permitted provincial High Street banks to gear up to an extraordinary degree and spend money on commercial property like it was going out of fashion – just as it was about to.

• The PPI insurance scam that they allowed for over a decade with nary a care – where the bill for cleaning up the mess is on track to hit £12 billion.

• Their genius at forcing pension funds to load up on bonds at record low yields.

• The 50% of mortgages in London and the South East that are interest-only. (Though they can be a useful tool for a few, they have blatantly been misused by many to chase soaring house prices, with no plan to repay them).

I could go on, but happily CityWire has already done so with its 10 scandals the regulator could have prevented.

The point is that financial regulators seem adept at rolling up to the scene of a horse absconding and nailing the stable door shut, even though the nag has been headbutting the walls and braying like a wildebeest on heat for years.

Which brings us neatly to the lowering of pension returns.

What goes down can go up

It takes a special kind of rocket scientist to be employed in the financial services industry – to be steeped in the investing world, and to have unique access to clever market participants at the highest level – and to somehow have missed the most fundamental truth about markets.

Which is that they go up and down.

So here we have the regulator rolling up to the scene of the crime not long after the worst decade for equities relative to bonds (the worst two decades, even) to warn us – wait for it – to temper our expectations.

As far as useful advice goes, this is a bit like Eva Braun showing up in London in the middle of the Blitz to warn Churchill that her boyfriend seems a bit obsessed with guns.

What was the regulator doing in 1999, when the UK stock market peaked at nearly 7,000 and shares traded on a P/E of around 30?

Evidently not tempering expectations, given that the sanctioned projections are only now being lowered, 12 years and two bear markets later.

The long-term means the long-term

Go and look at the historical returns for UK and US assets, and you’ll see there’s little historical basis for radically chopping your expectations down to a smaller size.

Stock market crashes are nothing new. Low yields on cash and bonds aren’t either, although they have been five or six decades coming. Somehow we coped before.

It’s true that the returns from bonds are probably depressed from here, and I can’t really fault anyone who warns to that effect. The 30-year bull market in bonds is surely bumping along the bottom at best – there’s only so far a yield can fall.

But the corollary in my view is equity returns will likely be at least average, if not higher, from here. That’s what studies like the Barclays’ Equity Gilt Survey reveal.

True, we’ve already had some saucy returns from shares since the low point in March 2009.

And I’ve had a couple of years of occasionally being called an idiot for writing on this blog that readers should consider sticking with shares for better long-term returns since then, too.

Never mind. I’d far rather be right, laughed at, and richer, then to stand with the consensus in the corner and lose my money in company.

Sure, latecomers to the post-crisis rally probably shouldn’t expect the 20%-plus returns that looked likely for the following decade back in 2009.

The major markets have moved pretty far already. Nobody knew when those returns would come, and they came a lot sooner than anyone predicted.

But in my view there’s no reason to panic. I think that over appropriate timescales, returns are likely to continue to be healthy from here.

It’s worth pointing out, incidentally, that the job of projecting the new forecast returns was delegated to accountants PricewaterhouseCoopers. The regulator hasn’t just conjured up these new figures in the pub one day.

What’s more, the PwC research is extremely detailed, and well worth reading if you’re an investing nerd like me.

So please note I’m not having a shot at the mathematics, or the endeavor.

It’s the timing – at the end of a very bad period for investors and a near-catastrophic one for financial services, and in the middle of a grinding stop-start recovery – and the recency bias that I suspect informs both the motivations and the conclusions of this report. That’s what I’m questioning.

The new normal (it’s nothing new)

What about that big picture, I hear you ask? The mountains of debt, the inevitable low-growth future, the terrible demographics, peak oil, China taking all the proper jobs, the aversion to shares that will last for generations, and all that?

And do I hear somebody muttering about Japan at the back?

Where do I begin?

I’ve dealt with Japan before, so as far as I’m concerned I’ll scratch it off the list.

As for peak oil, notice you don’t hear anybody talking about it much anymore?

That’s because exactly as skeptics like myself predicted, capitalism responded to higher energy prices by finding new sources of energy.

In the few years since peak oil talk peaked, America has found so much natural gas that it’s now being touted by some (maniacs) as the Saudi Arabia of the 21st Century.

True, fracking is environmentally questionable, and burning fossil fuels could well contribute to environmental collapse (something you should worry about).

But that’s never stopped Americans filling up their SUV before.

The point is, those supposedly nailed-on energy shortages have now been punted – again – decades down the road by new discoveries. And that’s just one example. Go and investigate the rate at which solar technology is improving, or the advancing fuel efficiency of cars and airplanes.

I doubt we’ll ever run out of oil. We just won’t need it one day.

That’s a good cue to write-off most of the rest of the concerns of the fearful masses. Whether it’s their love of ‘real work’ sweatshops or their concern that the West is not making PCs and cars anymore – abandoned handily ahead of PCs becoming commodities and the margins on brute force car-making collapsing – low-growth Luddites suffer from an enormous failure of the imagination.

Their worldview (and I appreciate this includes some of you) is stuck in the past and looking further backwards.

Imagine it’s 1910. Would these visionaries be anticipating mass air travel, nuclear power, television, nylon, the pill, and Facebook?

No, they’d be bemoaning the loss of some rubber plantation in India.

Would I have predicted Starbucks and Twitter? Like heck. But I have the humility (just!) to know that the future is inherently unknowable.

And unknowable doesn’t mean automatically doomed.

I see plenty of reasons to be optimistic about the potential for humanity and Western companies in the years ahead.

Huge new markets stuffed with consumers have replaced closed countries building tractors nobody needs. When not making stuff we want at unbelievably low prices, these young nations are now innovating, too – all good, it keeps us on our toes – while the Internet is spreading knowledge that once took decades to leave academia in milliseconds.

Masses of promising technology stands ready to remake our world again, from bio-pharma to 3D printing.  Most of this research is led and owned by Western companies, who also own by far the biggest brands on the global stage – in a world where emerging markets have proven even more gaga for brands than us.

But apparently we’re doomed because the Chinese make our dishwashers.

Right.

The bear case always sounds smarter

I am not some happy-clappy Panglossian optimist. (Again, go read my post on environmental degradation for a touch of the Apocalyptic).

I do think though that if you are gloomy about our society and our economic system, then you need to realise optimists like me don’t have to prove anything is different this time.

Whereas you do.

The FTSE 100 is on a P/E of about 11, and yields nearly 4%, far more than cash and bonds. I doubt there’s any historical precedent for UK shares doing badly from these levels over the long-term.

As for globalisation, financial panic, deleveraging, and all the rest – none of this is anything new.

Trade between nations has been making us richer for hundreds of years. Financial crisis come along like clockwork.

As for deleveraging and the suffocating mountains of debt:

• The early 1990s saw a massive property crash in the UK that led to hundreds of thousands of homes being repossessed. Just a few years later, London was booming again.

• The $1 trillion US budget deficit that dooms the world’s biggest economy to endless grinding misery? Even leaving aside whether the US really needs to address its budget deficit1, as recently as 2000 the US budget was in surplus.

• The mountains of debt that will take US wage slaves generations to repay? The graph below, from February 2012, shows how far the US has delevered already, in the midst of falling house prices and the lousiest recovery anyone can remember.

You can see from the graph that much of the work was done by the end of 2011, and that’s without the benefit of rising house prices (which painlessly reduces debt-to-asset ratios). A similar argument can be made for the UK.

There’s further to go, the overhang will likely continue to curb the recovery, and as I’ve written before, income inequality must be addressed if the middle-classes are to get back to their feet to drive Western economies forward without the crutch of excessive borrowing.

But beware tidings of doom from every corner from people who were silent (or more likely oblivious) on the economy and its debt issues when they really were a mounting problem – five or six years ago.2

The only way is up! (And down and up and down)

I agree every instance is different. History doesn’t repeat itself, it rhymes, and with a lisp at that.

But the point is Western capitalism has dealt with all this and more – total global war, seemingly imminent nuclear destruction, the influx of half the human race into the workplace as the jostling of men and women refashioned the basic tenets of our economic way of life – and yet we’ve motored on.

Could the worst predictions come true? Unlikely, but anything is possible.

In particular, I absolutely guarantee that at some point over the next 30 years you’ll be able to pick the price of shares, gold, property, bonds, or anything else in one instance, compare it to another instance some number of decades away, and make the returns look bad.

But that’s a long way from saying that a 30-year old who begins regularly investing into a pension now is doomed to expect less than his or her parents did. They have many years of ups and downs ahead of them.

I strongly believe that – to simplify – as long as you keep the equity dial turned to full for the first half of your 40-year investing horizon, and then de-risk and rebalance over the years that follow in case you’re hit by a crash, you’ll do fine.

Be prepared, but not downbeat

None of this is to take anything away from The Accumulator’s advice to stress test your retirement plans.

And I’m not just happy he highlighted the latest pension forecast figures on Monevator – I’m proud he did.

It’s by taking control and being informed of these developments that you have the best shot of reaching your financial goals.

Hope for the best but plan for the worst will always be the best advice.

I don’t even mind the regulator dialing down those projections, as it happens, even if I won’t be losing any sleep over them.

While I don’t think investors should panic, that doesn’t mean the changes are harmless for everyone.

On the contrary, if it means that financial firms are less able to bamboozle us, and to hide their bloated fees inside flabby projected returns, then cutting them back is all to the good.

I don’t even have anything against the regulatory profession. Rather like the much-maligned ratings agencies, they have no incentive to do anything other than what the masses and their political masters ask of them – which is to step out of the way and let the money-making merry-go-around continue until something goes wrong, and then to be seen to do something.

It would be an absolute tragedy, though, if a young would-be investor plugged the lowest of the new projections into a calculator, and was so daunted by the prospects that they threw in the towel before they even started.

It’s rational to be optimistic about stock market returns

Nobody ever got rich by being pessimistic. But if you’re going to be gloomy, you’ll do better to get that way when everyone else is optimistic.

As Warren Buffett says, you pay a very high price in the stock market for a cheery consensus.

Buying at cheap to fair value is what drives good long-term returns. Not waving your hands above a darkening crystal ball.

Think long-term, live well within your means, and save and invest all you can. Unless you’re already a millionaire, learn to cope with volatility and equities, rather than trying to stretch a 2% return into a viable pension fund.

Oh, and if you do all that and this site is still around in 30 years time, then please come and tell me how you fared.

I’m confident I’ll have no reason to nail shut the flapping barn doors.

1. Ten-year Treasuries yield less than 2 per cent, which implies borrowing is bargain basement cheap for America and so might be perfectly rational. [↩]
2. As a quick litmus test, when they cite some seemingly insurmountable debt figure, ask them what the size of the US economy is. Few will get within $5 trillion of the real figure. US GDP was $15 trillion in 2011. Many latter-day prophets of doom are suffering a severe dose of sticker shock. [↩]

A happy retirement cruising the world for new tea and cake experiences rests to a critical degree on the growth rate your investments enjoy in the meantime.

So it was with a nervous shudder that I greeted news that the Financial Services Authority (FSA) is cutting the projected growth rates used for pension forecasts and other investments.

The new annual growth rates are:

• The nightmare scenario: 2%
• The new normal scenario: 5%
• The dream scenario: 8%

That’s a drastic downgrade in comparison to the previous middle and low-end projections of 7% and 5%. The upper end was previously 9%.

If you’ve used a UK-based retirement calculator to create your own personal pension forecast, then its growth assumptions are probably based on the FSA’s projected returns.

Which makes previous plans as over-optimistic as your mum on exam day.

A dose of realism

Numerous commentators and academics have warned that the damage inflicted by the Credit Crunch has created a new, low-growth world.

They estimate that future expected returns are unlikely to live up to the long-term historical averages when developed economies must grapple with:

• The debt hangover
• An aging population
• Permanent damage to productive capacity
• Tighter credit conditions

Sluggish equity returns and abnormally low bond yields may afflict portfolios for the next 10-15 years according to the research commissioned by the FSA.

True, these stunted growth rates are only projections. They are not destiny. But failure to review a plan before a sunny forecast turns to rain is a classic financial mistake.

So let’s break out the ol’ retirement calculator to find out what adjustments may be required now – rather than storing up the shocks for later, endowment mortgage style.

I’m the operator of a retirement calculator

I’m going to use Dinky Town’s retirement income calculator because it gives me complete freedom to adjust the growth rates1.

This particular pension forecast will be made on behalf of jobbing illustrative anyman, Dangerous Dave.

Dave is:

• 40-years old
• Retires at 65
• Invests £400 per month (including employer match)
• Wants £20,000 annual income in retirement (after tax, and in today’s money)
• Has £60,000 already in the pot

We’ll use an inflation rate of 2.5% in line with the FSA’s forecast.

I’m assuming that the new growth rates hold true for the remaining 25 years of Dave’s pension accumulation phase.

7% growth rate – The good old days

 

In the glory days of 7% returns, Dave’s predicted retirement income would have been just over £20,000 after tax and inflation.

Now let’s see what happens as the global gears grind and growth slows to 5%.

5% growth rate – Life in the slow lane

 

5% growth only delivers an annual income of £14,687 after tax, with all other assumptions remaining the same.

That’s a cut of over 25%.

I think it’s safe to predict that 2% growth is going to be horrible…

2% growth rate – NO! NOOO!

 

The £20,000 a year dream has been smashed. In this reality, Dangerous Dave can only scrape up £9,420 a year. His income will be less than half of what he hoped for.

The good news: Dave won’t pay tax on that.

Pay now, buy later

Evasive action is required. Assuming the FSA’s new projections come to pass, how much extra does Dave need to invest in order to hit his £20,000 target by age 65?

At 5% growth – Dave needs to up his contributions from £400 to £700 a month. That’s an increase of 75% and stiff medicine.

Alternatively Dave could plan to retire later or shave a little off his target retirement income.

At 2% growth – Dave must put away £1,220 a month to hit £20,000 in 25 years. That’s an increase of 300% and just not possible as Dave’s income is squeezed from all directions.

Assuming £700 a month is the best Dave can manage, then he will eventually retire on a little over £16,000 a year if he delays retirement to age 70.

Here’s hoping that prolonged 2% growth proves to be no more than a bad dream.

What a state

I haven’t included the state pension allowance in any of Dave’s sums, and that could brighten the picture considerably.

I think of the state pension as a fallback position if the plan goes awry:

• If growth is even lower than I’m allowing for.

• I can’t work for as long as I hoped.

• I’m not able to contribute as much as I wanted to.

• Retirement expenses are higher than I’ve estimated.

• The tax position is worse than expected.

• I live for a very long time.

That’s a lot of reasons to keep something in reserve when doing your projections.

Dave won’t even qualify for the state pension until he’s 67. Moreover it’s a brave pundit who forecasts what it will be worth in 2039.

Taking stock

Another option I haven’t explored is throwing Dave’s asset allocation into equity overdrive. Afterall, much of the reduction in the pension forecast rates is due to low bond yields.

However the research is based on a standard issue portfolio that already devotes a fair wedge to equity (including property):

• 57% equity
• 10% property
• 23% government bonds
• 10% corporate bonds

The report actually forecasts a return of 6% for this portfolio, though it makes no mention of fees.

Most investors should probably round down to 5% to account for the finance industry’s nibble. Careful passive investors should get away with losing only 0.5% to fees.

Upping your equity allocation is therefore a potential solution but one that courts disaster if you’re ignoring the limits of your personal risk tolerance. Will you be able to control your flight reaction when the market crashes and your future is staked on nose-diving equities?

Increasing your equity allocation also increases the risk of a rare but terrible outcome – you can get a sense of this by stress testing your retirement plan with a Monte Carlo simulator.

Steady as she goes

It’s impossible to contain all the variables in play and also I’m glossing over the fact that, in my personal circumstances, inflation has outstripped my stagnant salary and pension contributions over the past three years.

The best you can do is to keep running your own pension forecast numbers every year and correct course as you go.

You can always ease off the gas later, should it turn out that you’ve over-compensated, or the dire forecasts failed to predict the invention of cars that run on bullshit.

At least any pain taken now will be partly anaesthetised by increased feelings of security, and visions of your future-self sending you a congratulatory telegram back through the time-post.

Take it steady,

The Accumulator

1. The new FSA growth rate projections do not have to be implemented by financial firms until April 2014. [↩]