My regular weekend ramble, then it’s on to a list of great reads.

Every morning seems to bring a new personal finance headline these days.

Last week it was high-earning sole breadwinner families and those on excessive benefits who saw their handouts cutback. This week it was the turn of super high-earners, who now face a cap on their pension contributions:

Tax relief on pensions will be limited to contributions of £50,000 a year, down sharply from the current ceiling, which is five times that. However, there had been suggestions that the limit would be nearer £30,000 a year, which would have hit many on relatively modest incomes who had many years of service with their employer.

Higher-rate taxpayers will also be allowed to keep tax relief at their highest rate on pension contributions up to the £50,000 limit. There had been fears that the Government would restrict tax relief to 20pc for everyone.

I think on balance the move is perfectly sensible, even if it is odd coming from a Conservative-dominated Coalition. Liberal Democrat voters should stop bleating and be proud of the difference their party is making to the deficit-reduction balancing act.

As for the £50,000 cap, well the idea of tax relief for pensions is to stop people being a burden on the State in their old age, NOT to enable Fat Cats and Cityboys to stash away absolutely enormous amounts of money free from the tax man’s grasp. The move doesn’t cap the ultra-rich person’s ability to invest for their future, just the tax rebate the State gives them for doing so.

But it would be unwise to be too smug. Only 100,000 high-fliers are estimated to be affected by this new rule (and the FT is already pointing out ways around it) but you don’t have to wait for long for something else to come along to clobber you in the current climate.

I had feared ISA limits might no longer go up with inflation, but the Treasury has clearly decided it’s a cheap middle-class perk, and thanks to runaway CPI inflation it will raise the limit to £10,680 next year.

That’s good news if you aspire to be one of the emerging band of ISA millionaires. This week’s pension cap move does introduce a niggle into the idea of using ISAs to fuel a pension, however.

Currently you can transfer ISA savings into a pension pot at a later date if the rules or your circumstances make it sensible, and pick up 20% or 40% tax relief on the way. But the new £50,000 cap will limit that traffic.

New investors might smirk at the idea of a £50,000 a year transfer being ‘limited’, but money invested in equities can grow like Topsy over time – whatever our recent history indicates!

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I believe the simplest way to start investing is with a cheap and easy mix of cash and an index tracker.

Banks and financial advisers prefer to sell more exotic products, such as Guaranteed Equity Bonds.

You’ll have seen the adverts:

Invest in the Filchet and Philander Guaranteed Equity Bond Issue Mark 4! Your capital is not at risk (unless the stock market drops by 32.5% between August 13th 2012 and January 22nd 2014) and after five years you’ll get 33% of the gain in the FTSE 100 index (unless it’s up over 75%, in which case you’ll get the 2/3 of any gain over 21% plus half the number you first thought of). You can cash in your bond-thingie at any time, provided it’s a third Friday of either April or October on every odd year from the day you bought the bond.

I exaggerate, but you get the picture. I don’t like these guaranteed equity bonds (GEBs) for many reasons:

• They’re opaque – The average person doesn’t know how they work, or why.

• They’re a lie – ‘Guaranteed’, ‘equity’, and ‘bond’: Words chosen to reassure widows and the guardians of orphans, but these products are actually constructed out of derivatives and options! Hence the weird hurdles like ‘the FTSE must be over 5223 on such a day’, as well as extra counter-party risks.

• They’re confusing – While some of these so-called bonds may offer a good balance of risk versus reward, they’re invariably sold to people who couldn’t tell. In fact, I’ve never met a guaranteed equity bond owner who can explain to me what they’ll get under what circumstances.

• They’re expensive – Not just in terms of the gains you give up for potential security of capital (which may be fair enough) but also the hidden fees rolled into their arcane structure.

• They’re inherently flawed – Most give you a return based on the value of the stock market on some particular day, or if you’re lucky over the average of a few months. But stock markets are volatile, so ill-suited to this. Buying a product where the return is dependent on the level of the index over a few days in five years time is like choosing a spouse based on what you think you’ll get for Valentine’s Day in 2017. You might have five good years followed by a week long crash, yet still be forced to cash out.

People are drawn to these bonds, though, and it’d be arrogant of me to dismiss that. The urge for capital protection is strong, rightly or wrongly.

And when it’s money someone may get just once in his or her lifetime – perhaps an inheritance, or a redundancy payout – who am I to tell them they should be braver with the stock market?

Instead, I’ll tell you a neat way to get capital protection, while still getting the chance to make money from a rising stock market.

How to roll your own Guaranteed Equity Bond

What I’m going to suggest isn’t rocket science.

Guaranteed equity bonds promise to return the sum of money you put into them (ignoring inflation). But you can use cash savings and a stock market tracker fund – plus a calculator – to create the equivalent of a guaranteed equity bond, provided you’re not investing vast amounts of money. ¹

Your DIY guaranteed equity bond consists of two parts:

Part A: Sufficient cash in a fixed rate savings ISA

This is the component that guarantees you get your capital back. Out of your lump sum investment, you put enough cash into the ISA so that when the compound interest is rolled up you’re left with the same lump sum that you started with.

Part B: Invest the rest in an index fund

The money left over goes into a stock market index fund. Whatever the stock market does over the period, that’s your return on your lump sum.

A worked example

Let’s say you have £5,000 to invest for five years. The two steps are:

• Part A – Work out how much of the £5,000 to save as cash
• Part B – Invest whatever is leftover from that in the stock market

Part A: The cash component

Suppose the best five-year fixed ISA savings rate you can find pays 5%.

You can either use maths to work out how much you’ll need to put aside in cash to ensure you have £5,000 left at the end, or you can do what I’d do and simply play with the Monevator compound interest calculator to find the right amount by guesswork:

In this example, the number of years is “5”, the amount added each year is “0”, and the interest rate is “5”. Put your guesses into ‘Initial Amount’ until the Result is £5,000. (If Result is more than £5K, lower the initial amount, and if it’s less than £5K, raise it until it’s as close as can be).

Through trial and error you should soon find that an initial sum of £3,918 saved at 5% will give you £5,000 (and 14p) in five years time.

That is your part A. You put £3,918 into the ISA and let it compound for five years, and get your £5,000 back in five years time.

Part B: Investing the rest in a tracker fund

The leftover money that you don’t need to save as cash – £1,082 in this example – goes into part B, a stock market index fund.

You want to choose the cheapest index fund you can find to keep costs ultra-low. Your best bet as I write would probably be the HSBC All-Share Index Fund, which has no initial fee and charges just 0.27% a year.

Choose the accumulation option so you automatically reinvest the 3% or so in dividends you’re due back into the fund each year.

Returns from the DIY pseudo-GEB

Here’s a few examples of how your returns could pan out, depending on how the stock market performs over the five-year period.

Market return* after five years:	-30%	0%	30%	50%	100%
Cash component after five years	£5,000	£5,000	£5,000	£5,000	£5,000
Equity component after five years	£757	£1,082	£1,407	£1,623	£2,164
Your returns:
Total value of your DIY ‘bond’	£5,757	£6,082	£6,407	£6,623	£7,164
Gain** on your initial £5,000	15%	21.5%	28.5%	32.5%	43.5%

* The index rise or fall plus your reinvested annual dividends. **Return to the nearest 0.5%

• From looking at the table, you can see in my worst case scenario, where the market is 30% down after five years, you still make a gain on your lump sum.

• In fact, if the market was completely wiped out and your index fund went to zero, you’d still get your £5,000 back (assuming banks were still standing!)

• On the other hand, when the stock market (plus dividends) doubles, you make less than half that rise with a 43.5% gain. The cash is a drag on your returns.

This latter point illustrates the price of security. In fact, you need your index fund to make at least 30% over five years for your returns to be better than leaving all your money in cash. ²

But at least this way you do get exposure to potential big gains in the stock market, without risking a nominal loss.

Benefits of this ‘DIY’ Guaranteed Equity Bond

I’m not claiming this cash-and-index combo will deliver better returns than every GEB going. That’s not why I’m suggesting it here.

Rather, I’m putting it forward for the following advantages:

• Simple to understand – Everyone knows what a cash savings account is, and an index tracker fund is as simple as stock market investing gets.

• Cheap – Savings accounts are free, and tracker funds are the cheapest way to invest in a diversified basket of shares.

• Transparent – You can see exactly how much money you’ve got at any time. There’s no hurdles or precipices – if the market drops your fund will go down, and vice-versa.

• You’re in control – You don’t have to sell out of your tracker fund after exactly five years if the market is in a slump. You can wait for a better opportunity. Equally, if the market goes up very quickly in the first year or two then you can take some money off the table if you choose. You get nothing like this hands-on choice with a standard GEB.

I’ll have more thoughts on this DIY guaranteed equity bond in part two, such as how you can modify it to take slightly more risk for more reward. I’ve closed comments for this article, so we can have all the discussion about the pros and cons in one place when the piece is concluded.

1. The size limit comes about because we need tax-free returns from the cash to make the maths work, so the cash component must be under the £5,100 cash ISA limit.[↩]
2. £5,000 in cash at 5% for five years would be worth £6,381.[↩]

My weekly musings rant, plus some great reads from around the web.

Anyone who doubted the benefits system in the UK must be rolled back pronto should have got a slap around the face this week.

But sadly, I except many feel vindicated.

The truth is we must beat this monster back before it devours everything we think we stand for.

I’m not just talking about the £120 million in interest per day we’re spending to finance the deficit we ran up by living beyond our income.

I mean, too, the sentiment reflected in the reaction to the first two cuts announced by Chancellor George Osborne in Manchester this week.

What about the workers?

Firstly, Osborne’s proposed household benefits cap, which aims to limit total State benefits to non-disabled households to what an average family earns from knuckling down and going to work.

I’m not going to argue the cap is not a good thing. Clearly, it is a good thing.

What is incredible is that there weren’t riots in the street when people realized this wasn’t already in the statute books. What is flabbergasting is that it’s taken a financial meltdown for somebody in Government to think a cap might be rather a good idea, wot?

Think about the opposite for a moment – a benefit system where a household can claim more money from their fellow citizens than they’d get from working by doing absolutely nothing all week.

Madness – yet that’s the system we’ve got.

Proud workers who banded together to found the Labour movement a century ago did not seek social justice to this end – to actively incentivise people to loaf about laughing at the poor saps who trundle to the office every day.

They certainly didn’t strive and strike so privileged Labour politicians could bung bungs every which way to buy votes like a ghetto dealer bandying dirty money about the hood.

The idea of a State safety net – which I subscribe to – is to help people through temporary bad times, or to help those who genuinely can’t help themselves. It is not for the State to play Tamagotchi with some underclass of the spectacularly unproductive.

It always amazes me how muddled-headed left-wing politicians are about incentives. They paid kids to stay in school and argued it improves attendance, yet they think it’s morally reprehensible to suggest paying young girls who have kids or 30-something adults to smoke spliffs from 9-midnight might also have a distorting impact.

The thought that my father slogged even one extra day towards the retirement he so desperately needed and had saved all his life for just to keep some State-sponsored scrounger in tracksuits is too sad to contemplate.

Worst of all is the genuine trap this system creates for the many would-be working citizens currently on benefits. It’s one thing to give layabouts money, but it’s another to tell someone with some gumption that they’re better off staying at home.

This is why the aim of removing lower-earners from income tax is so laudable, and preferable to benefits and means-tested slap-downs. Work must pay.

Childish thinking

The wailing that’s met the cutting of child benefit for certain middle-class families is even more galling.

I’ll say up-front that I know £44,000 a year is hardly the riches of Croesus, especially in the South East.

I also appreciate the precipice nature of losing the benefit the moment you or your partner goes into the higher-rate tax bracket is simple for the Treasury, but a nightmare if you’re on the borderline.

Obligatory finance tip: If you’re on say £46,000 and you have kids, ask your employer to lower your salary to below the higher-rate threshold, and to top-up up your pension instead, or simply pay more in yourself. You’ll qualify for child benefit without losing out in income, albeit you’ll have to wait until you retire to enjoy the postponed fruits of your shenanigans.

Now, the fact I’ve told you a way to work around the move doesn’t mean I support middle-class moaning about losing this benefit. It’s just that it’s in my job description as a money blogger to suggest these moves. It’s all part of the service.

I’m not sure I really want any of my money going to fund people’s pastime of having children, but I can be persuaded the health of truly poor kids can be improved by what for low-income families is a sizeable tax-free sum.

But paying for the average kids’ weekly Xbox game or for an extra pair of Agent Provocateur undies to keep middle-class mum and dad busy on a Friday night? Not with my money, thanks.

As ermine wrote on his blog this week, citing one excessive whiner:

4 kids? Depending upon a State handout to make her personal finances work? This lady has got a PhD FFS – she should have seen how unwise that is.

And the throwaway reference to keeping the older children in their school, well, if it’s a question of paying Tarquin and Jemima’s school fees with my taxes, steady on there…

I’m happy enough for my taxes to put Brussel sprouts and mash on Jack and Shanice’s plate, but school fees? What’s up with that? What’s with the absence of savings, too? This little princess has got to get used to making some decisions about her priorities and values in life.

Unfortunately, certain elements of the middle-class – women, as a generalization I’m looking at you – have become just as addicted to State handouts as the Great Unwashed they cross the street to avoid.

As Stephanie Flanders writes on the BBC:

Voters, particularly middle class voters, have strong and often mutually inconsistent views on the subject of women, children and work, and different views about what constitutes a “family-friendly” tax and benefit system.

For some, it means subsidised childcare to make it easier for mums who work; for others it means extra incentives and payments for mothers who chose to stay at home.

Often, voters will believe both of these things. The government should somehow be giving women incentives to work, and incentives not to work.

Modern woman confused, Stephanie? Luckily for her, she can say these things without getting lynched.

Things can only get worse/better

The whole spectacle is completely depressing, and reminds me of why I invested a huge percentage of my net worth into VCTs a few years ago when the rebate rates were 40% in an effort to claw back as much income tax as I could.

Quick recap on my high-rolling lifestyle: I am currently renting a flat in London, earning nicely (though not excessively) above both the median and mean average full-time male worker’s salary.

• Yet technically, on my salary I cannot afford to buy even a grotty two-bed flat within zones 1-4 of London. (In reality I can thanks to adventures on the high seas of investing, but that’s another story).

• I save between 20-30% of my salary for my long-term provision, and I sometimes wonder if even that’s enough.

• I read about civil servants retiring on unfunded gold-plated pensions, yummy mummies of three getting £2,000 from the State just for making their Mamas and Papas dreams come true, and never-working mothers-of-five (though not their notably absent fathers) being hurled cash by the State to no obvious end except to perpetuate the cycle, and I find myself yearning for a nice right-wing politician to come take charge like, oh, Attila the Hun.

Okay, I don’t really – I don’t want to be a right-wing nutter. I went through my profile on Facebook after the General Election and realized I could only identify barely half-a-dozen of my friends who could conceivably have voted for the Conservatives. I’m well aware that people get different breaks in life, and I’m not against some redistribution to even out the genetic lottery.

But enough is enough. This ‘sweets for all, especially the naughtiest’ attitude isn’t just bad because it’s landed us in a hole deep enough to frighten a Chilean miner.

It’s pernicious because we’ve gone from a great idea – closing down workhouses, and getting Tiny Tim into long trousers and the classroom – and sleepwalked into a cross between Hungry Hippos and Animal Farm.

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