What caught my eye this week.
Turns out Liz Truss really was useless – we don’t even need her to cause chaos in the UK mortgage market.
True, Britain’s Prime Minister for a day achieved in one Mini Budget what it’s taken nine more months of persistent inflation to deliver organically. But two-year swap rates have moved above where they peaked when Truss passed through office last September:
Source: Investing.com
As a result, banks have been hiking mortgage rates again – and even pulling their entire ranges for short periods. My recently secured five-year fix looked toppy in March. But it’s now cheaper than the best rate my bank offers today.
At least we’re not seeing a re-run of the LDI/pensions crisis of last Autumn. Unlike with that politically inspired drama, this time the markets are moving in an orderly fashion to reflect how core inflation is stubbornly sticking around, the Bank of England and the Federal Reserve will likely hike rates further, and that a subsequent slowdown will then see interest rates fall as soon as next year – though remaining at a higher level than was expected just a few weeks ago.
As best I can tell these changing expectations are being transmitted smoothly through the markets. Hence no more surprise blow-ups – at least not so far.
Rather we face all-too predictable pain for UK mortgage borrowers.
I do it for you
Long-time readers will remember I warned we should stress test our borrowing against coming higher rates a year ago.
Well, those higher rates are here and it’s a bit too late to do much about it.
According to the Resolution Foundation, the pain to come for individual borrowers who paid high prices for their homes when they remortgage could be worse than that felt in the 1980s:
The speed of rate rises today means that – for the households that have a mortgage – the income hit from higher rates this year is worse than anything seen in previous decades.
Although Bank Rate isn’t expected to reach the highs of the late 1980s and early 1990s, mortgaged households today are more leveraged than their historic counterparts. That means that, for a typical mortgagor, the rise in rates in 2023 alone is expected to increase repayments by 3 per cent of household income – or around £2,000. This is a bigger annual hit than at any time in almost five decades.
When repayments surged in 1989, as the Bank of England raised rates to nearly 15 per cent, the increase in repayments was only about £1,200 in today’s money for the typical mortgagor, or 2.4 per cent of household income.
The good news – for the government and the economy generally – is many more people now own their homes outright, as the graph in this week’s links below shows. I suspect that swapping out younger buyers for buy-to-let landlords will also limit the extent of the agony this crunch causes, too.
Don’t get me wrong – it could clearly go very Pete Tong, as we used to say in the years following Britain’s last big housing downturn in the early 1990s. I’m just looking for a ray of sunshine here.
Obviously it would help if mortgage rate rises leveled off soon. Their rate of increase on a graph looks like the ‘vert’ of a particularly gnarly skateboard ramp:
Source: Resolution Foundation
As someone who did time in their youth executing face-plants on such ramps trying to pull off a ‘180’, I’m acutely aware of the potential downsides.
The Shoop Shoop song
Naturally, these yield moves have consequences extending far beyond the mortgage market.
Bonds are back in the dumpster, for instance. The day you’ll be happy you own bonds again has been pushed out even further.
On the flipside, that’s good news if you’re a buyer today. You can get positive real yields on UK index-linked gilts again. With a bit of faff, you could protect the spending power of your wealth for decades to come and earn a little more on top by buying a linker ladder – all taking no risk, except for the opportunity cost of course.
More simplistically, annuity offers will get even more attractive. And savings rates on cash will continue to rise.
While I must confess to being a bit wrong-footed by this second coming of spiky interest rates, we shouldn’t be surprised that returning to economic normality has come with turbulence.
My metaphor for the consequences of the stop-start economic disruption of the pandemic and lockdown years was always a juddering machine that vibrates madly when you turn it off and on.
I’ve long had a particular image in mind – the ‘collating’ machine we used at my student newspaper to stitch together our weekly rag.
For a while I was the ‘collater whisperer’. One of only a handful who could get it to run smoothly.
But the process still took loads of misfired staples and mutant newspapers with three front pages stuck together before we got it dialed in.
Dizzy
Real life – stuff – is messy. Expectations in mathematically-inclined minds that you could suspend and then reboot the economy like pressing refresh on an Excel model were always wide of the mark.
As best I can tell, distortions caused by factories going offline and distribution networks getting snarled up produced momentous supply shocks. Concurrently, we saw (understandable at the time) huge infusions of State Aid and a surge in money supply.
Everything then reversing – stuff getting made, more money lying around to spend on that limited supply – ignited inflation. Putin put the boot in with his invasion of Ukraine. And central banks finally moved to try to put out the fire:
Blaming the BOE for high rates and the inflation shock is like berating a plumber who is fixing your boiler.
We’re here because of the pandemic, an excessive monetary response (in hindsight), the supply chain shock, and Ukraine.
We’ll stay here longer in part because Brexit.
— Monevator (@Monevator) June 14, 2023
Some of that inflation now appears to have gotten ‘sticky’. Put prices up in the supermarket by 20% in a year, and people are going to want more money to pay for the shop. The Bank of England was pilloried for urging pay restraint; perhaps it was futile but this was what it feared.
I don’t think we’re in wage spiral territory yet. But we’re possibly in the foothills, with the directions starting to appear on the signposts. And while this is definitely not a UK-only problem, I believe Brexit has made it worse for us, introducing more frictional trading costs and crimping the flow of workers.
For the Blimps who voted for that benighted and benefit-free project, perhaps things won’t feel too bad. They own their own homes. Cash in the bank will pay a lot more. Mortgage rates will remain well below the near-legendary 1990 peak, enabling them to tell the struggling young that they don’t know their born while ignoring the total costs of purchase.
The pension triple-lock continues, too, protecting the elderly from the sharpest end of inflation.
It all seems like another boot in the face for Britons under 45 though.
Any dream will do
Some might say a big housing crash would be great for young people. But I don’t think the UK economy could endure a 30-50% fall in house prices to approach mid-1990s price-to-earnings ratios without suffering a near-depression. Which wouldn’t be anyone’s idea of fun.
Ho hum. Hopefully we’ll muddle through.
Indeed I wish it were otherwise but I’ve a feeling we’re going to be trudging through the aftermath of the pandemic, the lockdowns, ‘Brexit getting done’, and these inflation and rate shocks – and follow-on tax rises – for many years. The finally-proven liar and disgraced Boris Johnson along with gift card experience prime minister Liz Truss appearing like memento mori at annual events such as Remembrance Sunday to – well – remind of us when and where it all went wrong.
But we can only play the cards we’re dealt. There will be opportunities – there already are – both for our professional lives and for our portfolios.
Just don’t expect the powers-that-be to make it easy for you. They haven’t got the money and they’ve run out of wriggle-room.
Have a great weekend.
p.s. Gosh but 1991 was a terrible year for music until Nevermind arrived. Still miss you Kurt.
From Monevator
When is it okay for a passive investor to time the market? [Member post] – Monevator
Investing for 100-year olds – Monevator
From the archive-ator: Why are we surprised when FIRE-ees have second thoughts? – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
UK mortgage turmoil continues as lenders pull products… – Housing Today
…and average two-year fix inches towards 6%… – Guardian
…while Jeremy Hunt ‘privately’ rules out help for mortgage borrowers… – iNews
…probably rightly, given this recap of the unfair [IMHO] ‘help’ mooted – Guardian
US Fed pauses hikes, but sees two coming more before end of 2023 – Reuters
Molten Ventures cuts Revolut valuation by 40% – Vox
UK government extends deadline for state pension top-ups to 2025 – Which
BoE warns against reliance on reinsurers for corporate pension deals [Search result] – FT
UK staff in EU holiday jobs down 70% with Brexit, industry wants help – CityAM
Any housing crash will be slow due to owner-dominated market – Bond Vigilantes via Twitter
Products and services
Savings account providers scramble for Best Buy top spot – This Is Money
Six ways to improve your chances of getting a mortgage – Which
Open a SIPP with Interactive Investor and pay no SIPP fee for six months. Terms apply – Interactive Investor
Victims speak out over the ‘tsunami’ of fraud on WhatsApp and Instagram – Guardian
Loyalty accounts offer big discounts, but it’s at the expense of privacy – This Is Money
Open an account with low-cost platform InvestEngine via our link and get £25 when you invest at least £100 (T&Cs apply. Capital at risk) – InvestEngine
Where to go in July – Which
Homes for sale with grand designs, in pictures – Guardian
Comment and opinion
Investing personality types – Portfolio Charts
Make a ‘clean break’ divorce deal, or risk costly future claims – This Is Money
How returns happen – Fortunes & Frictions
How long can the UK rental crisis last? [Search result] – FT
Toxic frugality and financial independence – Life Outside the Maze
Begging to differ – Humble Dollar
A Hobson’s choice: getting FIREd – Life After The Daily Grind
How to invest if you’re sitting on a big pile of cash – A Wealth of Common Sense
Average TIPS investor lost money over a decade [US but relevant] – Morningstar
You haven’t got enough time – A Teachable Moment
The tribulations of property, buried below an ISA transfer rant – S.L.I.S.
The difference between self-employment and ‘normal’ jobs – Young Money
Podcasts mini-special
A two-part interview with investment writer William Green [Podcast] – B.T.B.S.
Why stocks are good inflation hedges [Podcast] – Morningstar
Interview with Lord Lee, stock picker and the first ISA millionaire [Podcast] – FT
Oblivious Investor Mike Piper [Podcast] – Clipping Chains [h/t Abnormal Returns]
Naughty corner: Active antics
How did a US-GDP weighted index perform? – CFA Institute
Hidden forces – Sapient Capital
The case for investing in recruiter Robert Walters – UK Dividend Stocks
Long-only value investing: size doesn’t matter – Alpha Architect
Can Japanese regulators really force up valuations? – Verdad
Kindle book bargains
A Man for All Markets by Edward O. Thorp – £0.99 on Kindle
The Tetris Effect: The Cold War Battle for the World’s Most Addictive Game by Dan Ackerman – £0.99 on Kindle
Liar’s Poker by Michael Lewis – £0.99 on Kindle
Love, Pain, and Money: The Making of a Billionaire by John Caudwell – £0.99 on Kindle
Environmental factors
UK lagging in the race to decarbonise, says TUC leader – Guardian
Carbon trading: a slow burn for investors [Search result] – FT
Finland’s plan to bury spent nuclear fuel for 100,000 years – BBC
The coolest library on Earth – Hakai
Be pretty mini-special
Lookism on the rampage – Marginal Revolution
Attractive women 16% more likely to secure start-up funding [Search result] – FT
Robot overlord roundup
OpenAI, DeepMind will open up models to UK government – Politico
Four different ways of understanding AI and its risks – Vox
Klarna CEO on how AI will make shopping “more emotional” – Semafor
Off our beat
Compounding optimism – Morgan Housel
Cool, sexy, and stinking of smoke: cigarettes make a comeback on TV – Guardian
The time traveling mistake we make when procrastinating – Behavioural Scientist
How to reform government finances – Klement on Investing
A review of Wes Anderson’s new movie Asteroid City – Vox
Are Tory MPs as deluded as Boris Johnson? It’s a tough act to follow – Marina Hyde
Hundreds of billions in US Covid relief was wasted or stolen – AP News
Correlation found between cosmic rays and future earthquakes – Science Direct
How to create a masterpiece – Uncharted Territories
And finally…
“We wear different masks and hide our reality from everyone, including ourselves. Our assumed identities becomes our whole lives, and we start to believe them – even more than others do.”
– Mo Gawdat, Solve for Happy
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It was always a major question to my peers so long ago (40 years) was as they rejoined in their houses magnificent unearned profits(potentially) how were their children then going afford their own dwellings ?-never got an answer!
A house is not easily realised as a financial asset-you can’t sell a bedroom when cash flow needed
Once I had bought my own small dwelling it was stocks and shares for me for that reason amongst others
There never seemed a practical scheme to enable your own dwellings profits to turn into to a financial resource-for whatever reason-housing the kids being the obvious linked requirement
Maybe I missed something?
xxd09
The state of the mortgage market or interest rates is starting to look disastrous for the UK sacred cow of house prices.
We are entering a new era and I for one don’t trust the predicted numbers – extrapolation won’t explain the way the world works.
On the bright side, higher interest rates will benefit those who have wealth – but woe betide the overstretched, overleveraged debtors out there – new mortgage borrowers can expect an extra few % points when they renew – making mortgages look as bad as rents (for the first time in a long time)
Can anyone explain why interest rate uses seem to be the only method to tame inflation? I read that 85% of people are on fixed rate mortgages and therefore unaffected (for now). Those with savings earn more in their cash. So, it seems that the burden of tackling inflation falls on around 15% if mortgage holders. Wouldn’t tax rises be a more equitable solution? Especially given that the extra revenue could be used for something useful and beneficial? It’s something I’ve wondered about ever since I helped the government of the day reduce inflation I the late 1980s via a barely affordable mortgage.
What nonsense from the TUC that the UK is ‘lagging’ in the global effort to decarbonise the economy.
Actually, the UK is a poster nation for decarbonisation, since our carbon emissions have already fallen below 50% of 1990 levels, and that is in spite of substantial rises in population over the last 30 years. There are very few other nations that have managed to halve their emissions over that timeframe – this is an achievement that we should celebrate rather than constantly browbeating the population.
Of course, much of the success to date has come from the way the UK has revolutionised its electricity generation by moving towards wind/solar power (and using gas as a transitional fuel), but there is much that other nations could learn from how that has been achieved, since by far the biggest gains for climate mitigation will come in the first two or three halvings of emissions.
The focus of the TUC would be better targeted on how we can globally export that policy knowledge and expertise to encourage gigantic carbon emitting countries like China and the US to follow the UK’s path, otherwise (at least in terms of climate mitigation) it will have been in vain.
@ Gizzard, The interest rate is the cost of money, inflation is how fast prices are going up. The cost of money affects us all, whether savers or debtors.
If the cost of money is lower than inflation, the rational thing to do is buy everything you might ever need today. & then borrow some money to buy more of it to sell at a profit in the future. So interest rates lower than inflation brings forward all demand and further ramps inflation.
Once the cost of money (the interest rate) goes above inflation, the picture flips. If you’re making say 10% guaranteed on your savings and inflation is less than that, it makes sense to put off buying things for as long as possible. If you’re having to borrow at that 10% it’s very painful – you’re skint and you’ll try hard to get rid of the loan (downsize the house, default on the car etc). So interest rates higher than inflation brings pushes back all demand and kills inflation.
Other approaches have been tried around the world over the years, but not successfully. AIUI, no inflationary episode has ever been brought under control without interest rates being pushed up higher than current and expected inflation. Hence the concern at our ‘sticky’ core inflation…
The Rational Reminder podcast with Prof Campbell made the point that long-term inflation-linked bond is the ideal risk-free asset for a long-term investor. That probably wasn’t the case through much of the last decade when linkers offered a guaranteed loss of purchasing power. (Which shows that even the staunchest “passive” investors can’t ignore valuations.)
Now with linkers paying real returns again, it would make sense to shift a part of the portfolio into linkers pre-retirement.
I’ve added an ETF recently, but I’m not quite sure if funds are right for this, as they keep a constant maturity and get priced for the inflation expectations in an ever-receding future.
Building a ladder is more complicated and I’d have to yet figure out how to do this, if the minimum amounts and transaction fees are reasonable and in which accounts this is possible (e.g. an old Monevator artice says “Only gilts with five or more years left to run when you buy can be held in an ISA”). Another can of worms as it seems.
@Gizzard. The tools to control inflaiton are either monetary or fiscal. The BoE controls monetary policy but has a limited number of tools. Essentially it can jack up short-end policy rates or it can drain liquidity via QT. They know they can do nothing about current inflation, but using those limited tools, can try to tame the rise in inflation expectations. It’s inflation expectations that will drive longer-term inflation since that drives wage inflation.
The other choice is fiscal policy which is within the remit of the government. They can reduce govt spending or tax more to drain money from the system. Perhaps try to cap wage rises. Realistically though that ain’t happening. It’s not exactly popular. So the BoE is basically on it’s own.
I don’t see why you think mortgage holders are suffering though. They had a decade of cheap money. Now rates are going back to more normal levels, they just need to hand back a small fraction of all that money they saved. They did save that money didn’t they?
@TI. Minor point. You might want to change these charts of your swap rates. You seem to still be using Libor based swaps when they are now just synthetic legacy rates. Everything going forward is SONIA based. The 2-year SONIA rate is about 5.40%.
They of course didn’t save the money ZX as house prices ran away so in many parts of the UK even modest houses will become unaffordable when the old normal becomes the new one. The point being made – that it’s only a small proportion (those on variable rates or renewing any time soon) of a third of the population (that have mortgages) that are bearing the brunt when many are likely already stretched, for lifestyle reasons or cost of living ones, is a fair one and shows just how blunt and likely ultimately unsuccessful a tool interest rate rises to tame the housing market will be. I get the theory behind it all but in my view most of the inflationary pressures are caused by a confluence of extraneous and unlikely to be repeated circumstances – Brexit, Covid, war in Europe – and their impacts on energy prices, food, labour supply and supply chains. We need to sort that out rather than forcing unforeseen pain on the young while the old coin it in again.
> rather than forcing unforeseen pain on the young while the old coin it in again.
I find it hard to see how house prices coming down to lower multiples of household income (and therefore deposits not being so off the scale too) is forcing pain on the young. But the slightly less young who bought in the last two years, encouraged by Government artificial deadlines, maybe.
I have personal experience of how that works from a former Millennium. Buying a house in 1989 still ranks as the worst financial mistake of my life, which took about 10 years to break even, and a lot of luck to survive (not losing my job, primarily). I still recall pouring 2/3 of my net income down the toilet of negative equity for a few years, with no’wt to show for it. Both neighbours were repossessed.
That’s the price extracted by the UK residential property market for the endless boom time. One in every couple of generations, it consumes a cohort of recent homebuyers dreams with pitiless fury. On the ashes of those dreams are built the joy of the property speculators of the interregnum between these offerings to Moloch.
@Sparschwein the rule that “Only gilts with five or more years left to run when you buy can be held in an ISA” is one from the era when Cash ISAs and Stocks&Shares ISAs had different allowances. To prevent savers using the larger S&S ISA allowance to hold pseudo-cash, some cash-like investments were prohibited in S&S ISAs. (For example, you previously couldn’t hold money market funds in an ISA.)
Now that the Cash and S&S ISA allowances have been unified, all gilts are OK in an ISA. (According to HMRC’s web pages, only gilts acquired before 1 July 2014 were subject to the maturity restriction.)
There’s a lot to unpack in this week’s article, none of it particularly rosy!! A few musings from me:
1. It strikes me that the BOE might be forced to “rip off the plaster” soon if inflation remains sticky. It will be very ugly, but it’s currently death by a thousand cuts
2. I never understood why the BOE got such grief for saying “Brits need to accept they’re poorer”. For many it’s true, this brief article and an inflation graph tells us so. We’re clearly a bit too sensitive as a society…
3. “They haven’t got the money and they’ve run out of wriggle-room” – I’ve long since thought this, although upcoming elections will temper the desire to raise taxes. So it makes me suspect they’ll come up with other ways to tax wealth (instead of income) in order to balance the books, under the guise of “it only impacts the rich”
4. 15 years of low interest rates has finally caught up with us, society has got used to cheap finance. Some generations don’t know any different! My social circle includes unnecessarily large houses, unnecessary renovations, endless high-end PCP cars, multiple annual holidays on credit etc. I genuinely worry some will lose their houses. It escapes me why it took 15 years to raise rates above 0.5%, but maybe this is hindsight bias
Gosh but 1991 was a terrible year for music until Nevermind arrived. Still miss you Kurt.
Well said @TI
I feel there are years of pain on the horizon. Our mortgage rate is going to treble and before the recent increases we were already looking at a monthly payment jumping from £800-£1150+ I thought we were vaguely sensible (owe less than 3 year’s wages) but it no longer feels that way!
E&G. House prices falling is hardly forcing pain on the young. The exact opposite. We need lower house prices. The only issue is that so much wealth is now tied up in stinking property crap that if they do fall, there is nothing else left.
Plus it’s not even vaguely true that only a few residential mortgage holders suffer. Anyone who is levered will pay more. That’s corporations when they roll over their bonds, it’s SMEs who want to roll over their loan. Commercial property companies and REITs. The government on their Gilts. The pain is far more widespread than you suggest. But again, these rates are nothing out of the ordinary. It’s the last decade plus that was the anomaly. All of these benefitted hugely in that environment. It couldn’t last forever.
I largely agree in general (and am biased here as I’m remortgaging a big debt in September) but I can’t see how prices will come down in our dysfunctional housing system – supply will dry up as less folk are willing to sell into a downturn, development will become unviable (particularly given rising construction costs and labour inflation) and those who can afford to buy will end up with the same or higher monthly outlays but it’ll just be going in interest rather than capital if costs come down, while those who can’t will have interest rate rises passed on by their landlords. We need a housing system that isn’t boom and bust – and one that’s not rigged in favour of the boomers.
@L
My lifetime tracker (IO) has gone from 1% to 5.4% – and hence 5.4x the old payments (was around £500 pcm). Having a think about selling BTL, releasing cash buffer, taking an ISA holiday etc. under 2 years for PCLS which will cover a third of the os balance .
But, I have had a very good 12 year run with basically a free mortgage.
It seems all these 2/3/5/7 year fixes have diluted the BoE’s ability to curb demand – still can’t understand why houses aren’t down 20%
>Gosh but 1991 was a terrible year for music until Nevermind arrived
Totally with you on the timing but Screamadelica was released the day before Nevermind, with Bandwagonesque and Loveless out soon after. Corporate pop and commercial hair rock forever banished by a beautiful fusion of melody, harmony and groove. Or so we hoped. But it never lasts. Kurt soon heard sense and covered The Vaselines into immortality.
I’m sure there is some decent analogy with a new wave of business doing something at the economy or something!
Glad to see “ From the archive-ator: Why are we surprised when FIRE-ees have second thoughts?” getting a reboot. Most of us, if we are honest, seek ‘drop dead’ money not retirement. If we have the energy, skills and luck to achieve financial independence, we probably need to continue to deploy those skills somehow.
For me, it has meant using my skills in the same way as I have throughout my career, just for an interestingly different set of industries. Others do it differently. A friend, who was HR director of a major multinational, became a successful fine cabinetmaker. A senior scientist from the same company took early retirement to become a garden designer. And a very successful property developer is now a professional portrait painter.
So when people look at me accusingly and say “I thought you’d retired!”, I just smile sweetly and get on with my life.
@londoninvestor – that’s good to know, thanks.
From a quick look through my accounts, most offer bonds trading albeit by phone only. IB are useless with their arbitrary trading restrictions.
I don’t get too excited by talk of 20% house price falls.
All that would do is take the average price back to what it was pre covid.
See for yourself: https://www.nationwidehousepriceindex.co.uk/reports
The market always self corrects as the major housebuilders just … stop building for a few years.
https://www.theguardian.com/society/2023/feb/26/england-new-housing-housebuilding-planning-policy
Then there is a shortage and house prices … go up again.
However it would be nice if a new government could do something about this, as it just fuels the uk’s obession with property.
@Boltt (#17):
Can you not pull you pension (and PCLS) forward, albeit possibly actuarially reduced?
@A1 Cam
I’m not yet 55 so current plan is: half of cash buffer, sell a BTL, 25% DC lump sum and some draw down (not keen on touching DB early).
I’ll probably do it in chunks to see if interest rates move favourably in the meantime . Getting 6% on prefs and paying 1% mortgage was great while it lasted!
I think it was TI who paid £50k off his mortgage to see how it felt – sounds like a good plan.
We all new 5% rates would return, it’s just the speed that pace that’s surprising. Hopefully other IO base rate trackers holders have a plan too.
Repayment mortgage holders seeing +~20% on monthly payments aren’t too hard done by (imho).
@Boltt:
Age 55 is the key!
For some reason I seemed to think you had a DB with revaluation fixed at 4% and indexation of RPI subject to a 5% cap – in which case under the current circumstances it may be better to take the DB sooner rather than later as the indexation is less bad (vs current rates of inflation) than the revaluation.
Just a thought – and apologies if I have got your DB totally wrong!
With linker ladders, the rates are already sufficient to get better payout rates than ‘safe’ withdrawal rates (SWR) – e.g. with the yields approaching 1%, the payout rate on a ladder is 3.8%, 3.4%, and 3.0% on ladders of 30, 35, and 40 years length (reasonable planning period for a 70yo, 65yo, and 60yo couple respectively), while the historical UK SWR for 60% stocks, 20% bonds, 20% cash (using the calculator at https://www.2020financial.co.uk/pension-drawdown-calculator/ as a guide) was 3.3%, 3.0%, and 2.8%, respectively.
You’re right constructing such a ladder would be a faff (e.g., the purchase of more than 30 different bonds – over the telephone for some platforms) although it is a one off faff. However, a ladder can be approximated by using two linker funds with different durations (there are various discussions, from a US perspective, at Bogleheads, https://www.bogleheads.org/forum/viewtopic.php?t=240325 may be a good place to start).
As you suggest, the alternative is an RPI annuity with rates for a single life (5 year guarantee period) at 70yo, 65yo, and 60yo of 5.5%, 4.5%, and 3.7% (https://www.hl.co.uk/retirement/annuities/best-buy-rates) or joint life with 50% survivor benefits of 4.5%, 3.7%, and 3.1% (from the moneyhelper tool). These have no guarantee period – adding a 10 year guarantee reduces the income for the 70yo couple by about 60 basis points (and a bit less for younger couples). My (limited) understanding is that an all of market IFA may be able to get better rates than these.
While for a single person, the annuity is a much better approach than the ladder, for a couple, the ladder is probably better at 60yo (since it has 100% survivor benefits), the annuity at 70 and much of a muchness at 65yo.
Both approaches provide more income than the SWR (with all the flaws in that method), but purchasing enough guaranteed income to supplement state pension and to cover essential spending (however you define that) allows the retiree a) use a dynamic withdrawal strategy (e.g., constant percentage, Bogleheads VPW, Vanguard dynamic spending approach, etc.) and b) have a higher stock allocation in their remaining portfolio. The ladder or annuity provides safety, while the portfolio provides upside potential together with discretionary spending.
Of course, all this ignores tax considerations.
Sorry that turned out a bit longer than I anticipated!
@Alan S (#25):
Also known as floor and upside (f&u).
IMO the trickiest part being enumerating your “essential spending”.
To quote the late great Dirk Cotton:
“The most important decision you will make in retirement planning is how much of your resources to allocate to the upside and floor portfolios” and “The correct balance [between the upside and floor portfolios] will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.”
Dirk’s website “The Retirement Cafe” still exists and IMO is packed full of good stuff. My go to text for f&u remains Retirement Portfolios, Theory, Construction, and Management by Michael Zwecher.
@A1
Good memory – 5% fixed, then 5% max. The actuarial reduction is 26% for 55 v 60, which would be very generous if inflation averages close to 5% for the next 6 years! Mind you in inflation looks that bad they may change the AR. I really hoping it’s not going to be that bad.
I really don’t want to be thinking about complex investment decisions when I’m 70+, so DB is preferred safety net (inflation permitting)
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Without our ongoing support, and as a smaller website, I fear that it could eventually disappear (see @TI’s rather downbeat post back on 17/12/2022).
So, if you haven’t subscribed, then at least consider the £30 p.a. to become a Maven.
Think of the value compared to forking out £500 p.a. for a basic Sky package; or for that matter spending 100s to 1000s £ p.a. in fees to overpriced platforms, to active managers who demonstrably underperform trackers, or to IFAs doing no more than cross selling.
To repeat and adopt @ermine’s comments from back on 4th November 2010, which appear at the top of the comments on the last article, “Investing for 100 year olds” (updated 15th June 2023): “I’ve learnt a lot of things from this blog”.
Re: Housing Today, Guardian, iNews & Bond Vigilantes links + many of the comments above (@ #2,3,4,5,7,9,10,12 15 17 & 21): we’re now at a quite crunchy time (this coming Wednesday’s data will reveal more) for whether (or not) the BoE has a grip on core inflation & on inflation expectations.
On one hand, outstanding residential mortgages = £1,675 billion, a record even adjusted for inflation & earnings changes.
On the other hand:
1. Per the FCA commentary on the BoE’s effective interest rate data:
a). Share gross mortgage advances with interest rates 90% is only 4.0%, more or less unchanged from last year, but a 1.1% decrease compared to previous quarter.
2. ONS average. earnings data, excluding bonuses, up 7.2% over 12 months, from 6.7% rise recorded in March + higher than 6.9% rise forecast by a Reuters’ poll of economists.
4. Unemployment only at 3.8% when an increase to 4% had been expected (mainly down to 250,000 increase in employment over three months to April).
If Wednesday’s data doesn’t show signs inflation & wages moderating, then I’d be getting pretty worried if I were Mr Bailey.
As I said elsewhere in comments on other articles, base rates are over 2% below the core inflation rate (4.5% v 6.8%), whereas from 1985-2008 base rates averaged 2.5% above it. How’s that supposed to work?
@E&G We need to sort that out rather than forcing unforeseen pain on the young while the old coin it in again.
Really! you need to get out a bit more. Many of those “Old Coining It” paid their dues which presumably included your education, whilst relying on interest rates from a £20/£30k nest egg only to see the rate fall to less than 1% and remain there for 14 years. I don’t recall the “younger set” complaining on their behalf.
What you have now is the result of worldwide cheap money, and the piper want’s paying.
@TI It all seems like another boot in the face for Britons under 45 though.
It was ever thus, regardless of the era. I seem to recall, 1992 bank rate was 15% and in 1979, Thatcher increased it to 17%, to curb inflation. In 1996 1000 homes were being repossessed each week totalling in excess of 300,000. Five out of eight colleagues lost everything, home, job, marriage, and one topping himself leaving two children. All that whilst the council were looking through your windows counting residents for the Pole Tax.
It’s easy to knock the old, “shooting fish in a barrel” is the phrase I believe. Let’s not forget that some never made old age, thanks to EOKA.
Small correction. Where I typed:
“Share gross mortgage advances with interest rates 90% is only 4.0%”
It should have instead read:
“Share of gross mortgage advances >90% is now only 4%”
Hope that it now makes more sense and my apologies for any confusion.
@AlanS. Where are you getting 3.80%, 3.40% and 3% for 30, 35, 40 year linker ladders? I get somewhat higher payouts.
@Boltt (#27):
It is a pretty memorable set of DB parameters!
If anything your revaluation is (at a first glance – see below) more generous than your indexation; but IMO it could be worth spending some time to try and understand any such asymmetry in a DB scheme.
The case I had in mind had a distinct positive difference between indexation and revaluation in the on-going presence of high inflation (say 5% or more).
However, in such circumstances the AR itself could swing it too unless, as you say, the AR were revised. All of this is subject to the over-riding proviso that the [reduced] DB provides sufficient floor income.
It took me a while to come round to this view on DB timing and another factor at play is the effect of elevated inflation on fiscal drag.
Who knows where inflation is going in the medium/longer term, but it sure is not just a quick blip up and down again any more!
@Time like infinity #30
> Share of gross mortgage advances >90% is now only 4%
People are buying too much house at 90%. I had a 20% deposit in 1989 (implying a gross mortgage advance of 80%) and it was all burned to the ground faster than you can say rising interest rates. And I had to pay the blasted negative equity on top of that. I recall later shifting the endowment to buy another house, that’s after several years of pouring money down the toilet and flushing it. I was paid better then, and the mortgage droid was suggesting I take a higher LTV and I said no. I have seen this fricking movie before and I don’t want to ever see it again. 60% is quite enough.
You are actually supposed to pay your mortgage down over your working life, not endlessly spaff it on holidays and treats for the kids. Your LTV should drop over time. I can just about drum up a smidgen of sympathy for those who bought in the last couple of years, particularly those jumped into it by the benighted stamp duty holiday. If you’ve had a mortgage for 10 years and you’re mithering, not so much. As ZXSpectrum48k #7 said, you’ve had a decade of free money. “They did save that money didn’t they?”
Re: “As ZXSpectrum48k #7 said, you’ve had a decade of free money. “They did save that money didn’t they?””
Leverage works an absolute dream on the way up, and a total nightmare on the way down.
As the Berkshire boys put it, if you’re smart, then you can only go seriously wrong if you decide to use leverage. It’s one thing entirely to use nonfinancial levers (like education, connections and persuasion); but quite another their financial equivalent of borrowing.
There’s a good reason most active, long-only equity funds, if they use leverage at all, keep it to 20% to 30% (1.2-1.3x), and don’t go to, say, 400% (5x).
I can’t recall where exactly, but I think it may have been in a link in a many-moons ago weekend reading list on this very site, there was an article (which might have been Ben Carlson @AWOCS) showing the results of a thought experiment for an imaginary fund manager who knew in advance the 5 year rolling SP500 return and then, with that prescience, went and used different degrees of leverage. From what I can remember, even with such godly foreknowledge, they would still have gone to right down to zero if they’d used >1.5x leverage.
And a 80% mortgage is really just going 400% long / 5x leveraged on real estate.
For those borrowing to spend rather than to invest, it’s even more precarious.
The OPM they used to fund their lifestyles has gone. They spent it. It’s not coming back. They have neither a productive (income generating) asset mix to show for their borrowing, nor anything to sell down in the face of rising interest rates on the debt.
There is the paradox of thrift here. If we save and invest all of what we don’t need to spend to just minimally survive then the whole economy crashes (one reason to try and engineer 2.5% p.a. inflation). Also there will then be a savings + investment capital glut, interest rates will fall too low (mispricing risk), and people will get burnt reaching out for higher yield with less suitable & credible investments, for which they’ll typically overpay.
But, the slip side of the paradox of thrift is the reality of living beyond one’s means.
Economies are not like household or business finances. They simply can’t go bust in a conventional sense. However, household and business finances are very definitely like household and business finances. They both can and frequently do go bust conventionally.
And households are not Too Big To Fail; and therefore are are generally quite unlikely to get bailed out in some way.
Hope you’re still riding (skateboarding) Mr Investor, or if you aren’t it isn’t due to your age. I bought my most recent (long) board when I was 60 and rode it yesterday afternoon. With drop-through decks, wide trucks, and soft wheels the new generation of boards have a low centre of gravity and are easy to push and ride. Treat yourself: https://vandemlongboardshop.co.uk/products/lush-longboards-freebyrd-woodgrain
@AlanS. Just to follow up. I’m getting 3.95% for 30-year, 3.49% for 35 years, 3.12% for 40 years and 2.56% for 50 years. I’m using prices as of COB Friday and all 29 linkers with 3m lag (so ignoring the 3 linkers with 8m lag) with standard reverse bootstrap. I’m assuming 1 year buckets and all redemptions that are earlier than required can be invested at a 0% real yield.
I’m asking because I’m trying to do this using excel analytics rather than my usual approach of excel as a front-end with C# libraries being called. Quite an experience to use excel analytics. Truly appalling. They still haven’t got Act/Act daycount correct and it’s only been 25 years!
I could well have made an error though since only spent about an hour on the sheet. Anyone who has an equivalent set of numbers to cross-check against would be useful.
@ZXSpectrum48k
Your calculations are more sophisticated than mine. Since,
for a quick calculation on the linker ladder, I’m using a flat yield of 1% and then sticking it in pmt(1%,30,-100,0,1). It at least gets to the right ball park (probably good enough for rough planning?).
“These have no guarantee period – adding a 10 year guarantee reduces the income for the 70yo couple by about 60 basis points (and a bit less for younger couples)”
A correction to my earlier post (#25) – the 10 year guarantee reduces the annuity payout rate by only 6 basis points – i.e. by very little (anyone would think zeros are important!)
@Al Cam (#26)
Thanks for the info.
I’ve seen a number of recommendations for the retirement portfolios book, but have never got around to reading it – time to put it on my list (it even seems to be on offer on kobo at the moment too).
There is/was some good stuff on the retirementcafe site – the floor and upside article was linked here on moneyvator too (https://monevator.com/weekend-reading-three-graphs-that-boil-down-the-retirement-income-conundrum/).
I’m now seriously considering taking a good chunk out my S&S ISA to reduce my mortgage in half and hence reduce my monthly payments considerably. The S&S ISA has been, so far, intended to be my RE fund. Where the E bit is rather late, say 55 instead of 60+. I arrived late to the FIRE party, you see…
Thing is, now my current fix is coming to an end the new one will increase my monthly outgoings by £300+ which is fine, I can ‘afford’ it. I just need to make cuts in discretionary spending elsewhere which is what I don’t like so much.
The extra cash flow I could get by sacrificing my ISA could be used to enjoy life today rather than postpone it to that uncertain, but certainly less able future. But part of me feels it would be somehow wrong, even though the S&S funds are all separate from the emergency fund and pension which is getting the full 40K allowance over the last couple of years.
Can someone talk me out of it? 😉
I completed in January with a mortgage offer from May 2022 but I’m still feeling quite sanguine.
My fix expires in 4 years, when a mortgage rate of 6% will cost me 45% more than today, however since I spend “only” 40% of my take home pay on our mortgage I will need only a 18% pay rise, which annualizes over 4 years to 4%/yr.
So I’m monitoring the situation, and intend to keep money in to my pension while I’m sheltered, before UK Ltd get the cute idea to punish our millennial ambitions further and hobble the tax benefits.
@AlanS. Thanks for the clarification. I’m going for something more flexible to be able to choose time period (n years), choose which linkers, then generate ladder automatically via bootstrap. Also option to hedge parts of ladder into two or three bonds/funds. It’s getting there (see https://ibb.co/YRj9VPF) but wow Excel finance functions are really archaic!
@ZX (#42):
Intrigued by your mentioning of funds.
I was always under the impression that ‘duration matching’ with funds was not straight-forward as the profile of bond fund maturity dates can change with time. For example, medium term maturity dates today will be different in, say, five years time.
@ The Weasel #40
> I’m now seriously considering taking a good chunk out my S&S ISA to reduce my mortgage in half and hence reduce my monthly payments considerably.
From one mustelid to another I’d say it’s rational to let go of the ISA given your boundary conditions. Because your RE starts after 55 which is when you can start drawing pensions – subject to the change to 57 which is worth noting/keeping some residual ISA for the two years if it applies.
Someone able to contribute £40k p.a. is likely to be in a lower tax bracket drawing a lot of the pension. In which case sweat the pension contribution opportunity and let the ISA go, as you have the emergency fund sorted. Best of luck!
@AlCam. Funds can be used as a dynamic hedge but not really as a static hedge. Given I’m rebalancing my positions fairly frequently, at least annually, if not quarterly, I can rebalance the dynamic hedge during that process.
In this case, I’m discussing using a 2 or 3 bonds or funds to replace the majority of bonds in a linker ladder. Clearly, as time goes by the duration of the ladder would fall while the duration of the fund would likely not (due to reinvestment of redemptions/coupons). Plus the composition of the bond market could change, altering indices, which would be reflected by trackers. Nonetheless over a quarter, this impact isn’t going to be large at all.
With respect to ILGs, the issue is the lack of funds. INXG reflects the whole market with a real duration of 16. Fine if you want to hedge a 30-year bond ladder but clearly not so helpful for a 10-year bond ladder. In TIPs it’s much easier since you can get a 1-5 year fund, 5-10 year fund, 15y+ fund etc.
@Barney #29 – “Pole Tax”.
Unless your tongue was wittingly in your cheek (pole being a synonym for shaft n’est-ce pas), then for the record, it was of course Poll Tax https://en.wikipedia.org/wiki/Poll_tax_(Great_Britain)
Interesting FT article. Just cannot understand why rents have gone up so much. Yes I know the population of England has increased about 7 million in 20 years, immigrants tend to want to work in the cities leading to more housing pressure, landlords are being told they aren’t welcome with policies to boot, interest rates rising, consistently building >100k less homes annually than needed but seriously, everyone is entitled to a nice home whether they can afford it or not, it’s a right isn’t it? isn’t it? 🙂 I’m sure post the next election everything will be fixed won’t it?
Pretty amazing that only two years ago, the govt was encouraging people to buy homes through the stamp duty holiday at rates around 1%. Presumably a lot of people did this on two year fixes, which will be rolling off to the latter part of the year. For me it re-emphasises that pretty much everyone, including the govt. hasn’t got a clue what’s going to happen.
I feel I have made a huge mistake. For years I have been busy paying down my mortgage like a madman. I have ignored the huge potential for growth in the stock market in favour of the safe and secure return on paying down debit, earning an effective return of just 2.75%. I now find myself with a very small mortgage, but have not benefited from the huge returns I could have gained if I had invested instead.
I am reassured that my housing is safe and secure, but I don’t FEEL wealthy. If I lost my job tomorrow, I would not be able to eat or keep up with my bills very long before running out of money.
@Seeking Fire (#47): re: you last sentence: Karl Popper (Conjectures and Refutations: The Growth of Scientific Knowledge (1963)): “our knowledge can only be finite, while our ignorance must necessarily be infinite”.
Here is another example of mortgage pain: I had a 1.29% 5y-fixed repayment mortgage that expired last summer. As the LTV is only 5% and the term is reasonably short, the impact of higher rates is small. So I left it alone as it ran into the standard variable rate back then while I have been trying to decide whether to fix and for how long, or go for a tracker, or pay the whole outstanding and become mortgage free. Meanwhile, that SVR that was about 3% shot up to almost 7%. At least I am convinced now that I’d rather keep the money invested than pay the rest of the mortgage, but I need to make up my mind about what kind of mortgage I want soon.
I guess I have been hoping that this inflationary period was going to turn out to be really short and rates would come down fast, so better to wait and see before fixing in a hurry. I shall hope no more 😉
Just looking at the chart for INXG. I know we’ve covered it on here before but that makes for truly scary viewing for those thinking it would have provided them some inflation protection (e.g. about a 20% nominal loss over 1 year, and 30% real loss).
After reading a bit of Wade Pfau I’m now toying with the idea of a building a very simple 5 year gilt ladder in my SIPP to cover income from the age of 55 to 60, which should be enough to cover the worst of any sequence of returns risk.
I always pooh-poohed the idea when yields were on the floor as being too much of a performance drag, but it is starting to make a lot more sense now.
My divis and distributions are now fairly consistent and spread quite evenly throughout the year, so it is a bit belt and braces. But I can’t see any big downsides.
To The Weasel, regarding 55 being a bit late for FIRE. You’re not alone.
I’m now trying to downsize home to both dodge the house price crash, lock in those house equity gains and get close to a FIRE age of 55 rather than 60.
Staying put would be a catastrophe for FIRE, whereas moving house will both wipe out the mortgage, fill a few years worth of ISA allowances, and enable a 50% savings rate via pension salary sacrifice for remaining working years.
I want any work post 55 to be on my terms only.
@The Weasel (#40), @ermine (#44) & @Semi Passive: Finimus (11 Jan 2020) did a pros & cons exercise on paying down mortgages or instead contributing to ISAs: https://www.finumus.com/blog/how-to-get-an-80000-annual-isa-allowance.
Finimus then went on to outline a very complicated idea (which may or may not be possible now under the current ISA rules) of trying to move money to and from an offset mortgage and an ISA.
I cannot (& do not) comment either on that idea (DYOR as they say) or on its suitability (or not) for any given set of personal preferences and circumstances.
I only mention Finimus’ article here for the immediately preceding pros and cons exercise, which might be of interest, and not for that idea.
@Semi Passive: The fall in INXG was truly terrifying. I think the phrase ‘safe asset’ should really either not be used at all or only used with appropriate caveats; i.e., even AAA sovereign debt can only be relied upon to return principal (even if indexed linked) if brought at or below par for a positive coupon and then held to maturity, cash will not keep pace with inflation, and gold may or may not keep up with prices. There are no truly risk free choices.
For me personally, that’s one reason why I’ve been 100% global equities for some time (tracker mainly, and a small sideline in discounted ITs), i.e. if there are actually no risk free real returns and no truly low risk assets (that is to say, no assets that are low risk in all cases), then the question that I then ask myself becomes, “which asset class(es) offer the most attractive combination of both real long term returns and risk-adjusted returns?”
Of course, sequence of returns’ risk is a stinker with equities, but that’s arguably also true of bonds to an extent, as last year showed.
@Factor 46…….Just Testing
” the day you’ll be glad to own bonds has been pushed back even further” do all bonds react the same way to interest rate rises? I have a VLS 40/60 I haven’t looked as I don’t need it for a few years as I’m a little cash heavy but it’s still a little disconcerting to read. Bought initially in 2016 and added to in 2020 and 22.
@Tom Newton #35
I remember when skateboards first came to the UK, in the late 70’s. Where I lived, they were taken up by the younger kids. Being a bit older that put me off, especially since no-one in my peer group was into them.
Fast forward 40+ years and I have matured enough to not worry about looking uncool and being FIRE’d helps keep you young at heart, so I could be tempted by one of those longboards. At least I have a good suggestion for a birthday present if anyone asks what I would like! (Or I might just treat myself.)
@all — Another brilliant discussion, cheers. Clearly I can’t reply to all, but… agreed on the music, however I haven’t been on a skateboard since the Powell-Perelta Bones Brigade UK tour years. (Great soundtrack to the accompanying videos, to merge the themes!) Riding is one thing, falling is another. Doesn’t seem worth the risk to me nowadays! 🙂
@david winkler — The short answer is yes and the long answer is complicated. Essentially interest rate rises affect the ‘yield curve’ which by definition is the movement of yields of all bonds (maturities) stretching out into time (yield moves are a consequence of bond price moves, but we talk about the yield moving rather than the price moving with fixed income as it carries more useful/comparable information).
However with that said, many (including me) would say BoE interest rate moves are reflective of yield curve moves as well as driving them (driving them at the short-end anyway) so it’s all a bit of a dance.
I expect what you’re really asking is “are the 40% in bonds in my LS worth owning or a problem waiting to happen?”
To which the answer is, as ever, we cannot know for sure, we can only weigh up the odds and think about what we’re trying to personally achieve with any asset in our portfolio.
Duration has come down a lot, which means the riskiness stored-up in longer-dated bonds has been reduced. (Basically prices have already done a lot of falling). They have more ability to respond to an economic shock (/rate cuts) and to thus potentially buffer an equity correction.
But if inflation were to persist up here for years without end (and the UK is already basically in stagflation) then you’d probably rather you didn’t own a lot of bonds even from this level. However (a) that is not expected and (b) in as much as it is expected it’s in the price and (c) equities would presumably do a bit better and (d) what else are you going to do with your money? (Cash would be decimated, eventually. Maybe index-linked bonds?) (e) At some point you *would* want to own some bonds, are you ready to time the pivot? (i.e. Invest actively, with all the associated hassle and risks…)
Unfortunately we’re just living through ‘interest times’ for bonds, having lived through a decade or more than turned out to be a bonanza for bonds.
These reversals are inevitable in markets but the timing is a bastard. I can’t give personal advice at all, but I can say we’re all in the same boat one way or another. 🙂
@ZXSpectrum48K — Thanks for the gentle Swaps pointer. I can get proper SONIA rates from here: https://www.chathamfinancial.com/technology/european-market-rates but not charts. If anyone knows a public source for SONIA charts please shout 🙂
From memory there was a less of a divergence when I first started to root around swaps but maybe I was just sloppy and revisiting the area after too many years… (GFC!)
@TLI — Forgot to say thanks for the kind words and plug for membership! Much appreciated on all counts. 🙂
Thanks to the Investor, for your thoughtful reply I’m in the (60%bonds) VLS but that decision was taken in 2015 and my risk tolerance hasn’t gone up so I’ll hang on tight.I’m certainly not ready to pivot anywhere as I’m very aware of my knowledge (lack off) and limitations. Great resource. Thanks from a recently retired worn out paramedic
@ZX (#42):
I was sufficiently intrigued by your bond ladder (thank you!) to try and recreate the bulk of the calculations. Reverse bootstrapping is beyond me so I took your cashflow on redemption (I’m aware this is the guts of the problem to be solved). Some observations that may aid others:
1. Clean price (and therefore yield and duration) don’t match the Tradeweb closing prices (I guess yours are from an industry source?).
2. T28 isn’t included in the cashflows although “Include in ladder” = 1 and the coupon <= 0.5%.
3. TR45 being recently issued is in a short first dividend period.
4. Calculation of "Bond Notional" includes a full years coupon rather than coupon/2 (FWIW I've little confidence in my interpretation here!).
5. I derive 22 "Total bonds" not 20.
I copied the concept and created my own ladder based on providing sufficient cashflow on redemption to satisfy the income per annum until the next redemption (https://ibb.co/LzW08B8). i.e. I'm ignoring intermediate dividends. Notes:
a. Inputs from Tradeweb.
b. n years of income from redemption of TR24 (e.g. 30 years ends 22-Mar-54).
c. Real duration and effective yield calculated as weighted average.
By ignoring the intermediate dividends I overestimate the total cost by £23.6k or 3.6%. FWIW I get 3.7%, 3.2%, and 2.9% for 30, 35 & 40 year ladders.
I guess there's no substitute for modelling all of the cashflows but my simplified method, although massively sub-optimal, doesn't necessitate reinvesting of intermediate dividends (just spend them!) and is very much a setup then forget affair.
@D:
To significantly simply the exercise you could try using just stripped bonds, also occasionally called bullets. However, I do not know if there are any stripped linkers available. I think that I only ever looked at stripped nominal gilts (coupled with an estimated inflation curve) and IIRC suitable STRIPs were pretty rare when I did those calculations a good few years ago!
@D.
Just to answer you in full:
Prices are from Bloomberg as of COB 16th. Just a generic price used really to check that Excel could do price to yield correctly (which it seems to be able to do).
TR28 was left out because (even though it’s available to be used) where there are two bonds in the same 1-year bucket, my algorithm just chooses the later one. If you want T28 you set that to 1 and TR29 to zero.
TR45 is short coupon and I’ve taken account of that. My accrued calcs all agree with Bloomberg/QuantLIB to a very close degree. The small errors are because Excel cannot do Act/Act correctly.
The coupons are calculated on a semi-annual basis but it’s quite possible I’ve messed up somewhere using the full year coupon. I didn’t think so but I would need to check.
The bond number 20 vs 22 etc you can ignore! It isn’t counting what you think or anything important.
I was really just seeing how close I could get a ILG bond ladder in Excel to the “correct” number using something more sophisticated such as the QuantLib excel addin. In Quantlib, I construct a portfolio bond with every cashflow from every chosen bond and then can tweak that to generate hedging sensitivities plus reinvest coupons at forward real yields. It even does Act/Act correctly!
Nonetheless I think the Excel bond ladder I’ve created is correct to <1% given the assumptions. Probably within bid/offer costs for many retail investors where the bid/offer is 10bp or more. The main issue is the 0% real investment assumption where there are substantial gaps in the ladder.
Frankly, you ignoring intermediate coupons is hardly a disaster since the coupons are typically so low. They do add up a bit over the long term but it's only a few percent. So a zero coupon approximation using the correct clean price is ok and far simpler. Plus if you are taxed at 45% on those coupons then they are even smaller …
@ZX:
Thanks for the comprehensive reply.
The Excel functions yield(), mduration(), and price() have been good enough for my purposes and have been useful to check yields when obtaining prices from dealers during telephone trades. The major limitation (ignoring edge cases) is that price() and mduration() can’t handle negative yields, although that’s not an issue in the current climate even for linkers.
I’ve not encountered Quantlib before so thanks for that. I raised a smile at the first example workbook: YieldCurveBootstrapping.xls. A steep learning curve no doubt but worth the effort to do this properly.