What caught my eye this week.
How many more billionaires would there be if the millionaires of yesteryear had embraced passive investing1 and saved themselves a bundle?
That’s the provocative opener in this short video from Robin Powell, the man behind The Evidence-based Investor blog.
Robin’s subject – Victor Haghani of fund manager Elm Partners – makes plenty of sensible points about keeping costs low and investment aims simple. The video is a nice five-minute introduction to the case for passive investing.
However the class warrior in me is rather glad that the super-rich continue to pour billions into expensive hedge funds.
If we’re to ease wealth inequality, we certainly don’t want the 1% to care as much as us about getting their fees under 1%!
From Monevator
Make sure you understand your investments – Monevator
From the archive-ator: Creating an emergency fund – Monevator
News
Note: Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber.2
No plans to scrap 1p and 2p coins, says Downing Street – Guardian
Auto-enrollment contributions to be tripled for millions [Search result] – FT
London slump shrinks North-South divide in house prices – Guardian
Bank of England warns Brexit could still rock the City – ThisIsMoney
Over $60 billion wiped off the value of crypto-currencies in 24 hours – CNBC
Phillip Hammond eyes new Patient Capital EIS funds [Search result] – FT
How the financial crash made global cities unaffordable [Search result] – FT
Products and services
NS&I bumps Junior ISA rate up to 2.5%, but eight providers pay more – Telegraph
The case for prize draws, Premium Bonds, and lottery tickets – ThisIsMoney
Why is antique furniture now so cheap? – Marginal Revolution
Fees and returns: A brief history, from equities to Bitcoin – Bloomberg
There are 21 investment trusts on the new Dividend Hero list – ThisIsMoney
P2P player LendInvest launches retail bond paying 5.375% – Telegraph
The Echo Dot is £10 off at Amazon right now – Amazon
Comment and opinion
The tipping point: When compound interest starts to motor – The Humble Dollar
Growth and value stock indexing are both broken – Bloomberg
A $500 a month allowance saved our marriage – Slate
What real return should (US) bond investors expect? – Charlie Bilello
Infrastructure funds on the road to uncertainty [Search result] – FT
The pros and cons of ‘bucket’ strategies [US but relevant] – Retirement Cafe
Pursuing understanding in a messy, polarized world – Abnormal Returns
Real estate will always be more desirable than stocks [US but relevant] – Financial Samurai
Steve Webb: What’s an acceptable pension pot to retire on? – ThisIsMoney
Into the woods – SexHealthMoneyDeath
When value goes global [Deep factor geek-out] – Research Affiliates
Thinking the unthinkable about corporate and government bonds – The Macro Tourist
Kindle book bargains
Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street by Sheelah Kolhatkar – £1.99 on Kindle
The Spider Network: The Wild Story of a Maths Genius and One of the Greatest Scams in Financial History by David Enrich – £1.99 on Kindle
The Man Who Owns the News: Inside the Secret World of Rupert Murdoch by Michael Wolff – £0.99 on Kindle
Off our beat
Making it look easy is hard work – A Wealth of Common Sense
Inside the booming market for Spotify playlists – The Daily Dot
The man who knew too little – The New York Times
Worms, glorious worms – 3652 Days
And finally…
“When he died in 1525, his fortune came to just under 2 percent of European economic output. Not even John D. Rockefeller could claim that kind of wealth.”
– Greg Steinmetz, The Richest Man Who Ever Lived: The Life and Times of Jacob Fugger
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- Of course they couldn’t, over the time period discussed in the video featured here. Which isn’t just pedantry – it’s very possible that making investing easier and cheaper has reduced the expected returns for equities and other assets going forward. [↩]
- Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]
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I found the Macro Tourist article about corporate bonds very interesting. It’s thought-provoking, but I’m not sure I’m entirely convinced whether one can hedge against a sovereign debt crisis by investing in corporate debt.
It’s true that there have been many sovereign defaults since 1800, then again, there have been even more corporate defaults. Companies don’t live as long as governments, and for a corporation a default is often the end of the life cycle event.
It’s true that you can’t make a government pay if it doesn’t want to, it’s also true that corporate bond holders have a claim on the issuer’s assets. The ting is, governments have power to confiscate these assets, which they may employ with various degrees of subtlety, especially if the need is dire. If I expected developed western economies to begin defaulting on their debt en masse, I’d stay away from corporate bonds.
It’s interesting to see in recent news that the govt. is testing the waters of public opinion with new tax suggestions on softer targets where there’s likely to be less resistance, like sugar, waste, [packaging] & anti-social categories like chewing gum. They are starting to get desperate what with the tax intake falling as the so-called self-employed army don’t earn enough to pay even marginal taxes, [ ….a giveaway of the true cost of the low-unemployment miracle – they’re mostly just BS jobs, mostly earning nearly squat]
Practically, my guess is to watch for ‘public enemy taxes’ to ratchet up for the usual suspects – sin taxes, or be newly created, anti-pollution, sugar, nuisance, [the likes of gum] plastics in general, needless waste, BTL again. Ironically it might even do some social good, but will need bearing in mind if you’re stockpicking affected companies…..
That article on the compound interest tipping point was fascinating, it would be exactly the kind of easy to understand point that parents should use when they sit down one day with their kids to explain the facts of life. Even now in mid-life, when I feel demoralised, nervous about the future or just flagging in financial discipline, I find it helps reassure me to run my current wealth numbers through the compound interest calculator on this site.
Kickstarting a kid’s future with gift money in an account with observable compound interest when they’re that young would show them clearly how it works even if the amount involved was not life changing. All my good financial habits even now I can trace back to watching what my parents did when I was surprisingly young – smart kids notice what their parents do, more than what they say.
I find the changes on autoenrollment pension contributions an interesting subject. I think it is positive that the government are finally forcing people to put more into private pensions. However, I wonder if there will be some unintended consequences.
For example, when contributions go up from 2% to 5% in April that is actually quite a lot of money being pumped into the pension fund market, which otherwise would not have happened. Will that be noticeable as a spike in demand? Also, as much as the financial press talk about a hope of real wage growth on top of inflation, I wonder if the slight reduction in take home pay will cause people to be more cautious about their spending and effectively feed a “recession” type mindset. Maybe that’s a step too far and I’m assuming your everyday person pays as much attention to their finances as I/we do! Nevertheless I’d be interested to hear any other views on what might be the fallout from these changes.
It’s a dirty job but somebody’s gotta do it.
The fellow from The tipping point: When compound interest starts to motor ‘fesses up to the dirty li’l secret about compounding by hiding it in plain sight
Let’s take a look at the human life cycle. You waste the first twenty years getting from the mewling and puking stage to be able to earn. High paying jobs in the City burn people out in their 40s to 50s at the latest. You’re gonna die somewhere 70-85 in most cases.
And – the whole Retire Early part of FI/RE. I got no quarrel with the theory of 40 years of compounding overtaking the amount of money you put in. But working for 40 years is a long squawk out of an adult lifetime of 65 years. It’s Saving Hard, not compound interest, that will do the heavy lifting to get you to FI/RE. Compounding will help, but unless you have a long working life you won’t get to the tipping point before you cut the engines and start on the final approach. A long working life is the antithesis of RE.
So focus on the Saving Hard, FI/RE folks. Compound interest ain’t gonna motor for you – RIT showswhy not. Compounding, at asset class returns typical of the last 50 years, is the feeble ion drive rocket, not the dirty great Saturn V that gets you off the ground.
@ ermine, agreed that the power of compounding takes time and that savings are as, if not more important, but I think this is arguing two different points that aren’t a zero-sum game/exclusive. Both surely are the biggest, most useful tools in the kit to getting to FI/RE and most people here realise that you should use every tool if possible, if you want to get there/faster; every little literally helps.
Where compounding really is effective is with luck, if you get a windfall it’s easier to psychologically accept not touching it because you didn’t earn it and may not have expected it. In that case, putting it to work in a high-earning account you don’t touch for decades even is a no-brainer. I have a close relative who inherited 3 times in his life when most people don’t even get that shot once, myself included, yet frittered it away relatively quickly each time so that it made no overall difference to his life, let alone helped in any meaningful way. (He now worries about and has to be careful with money in his old age)
In comparison, you have the new finance blogger, YoungFiGuy, who with the same circumstances but a serene dose of commonsense, catapaulted his security (invested freedom fund) so as to be FI in his 20’s. This is the ‘making your own luck’ part, yes you may never get dumb luck like that, but there is no excuse for not positioning yourself to hit the ground running. I try to be always like a seed in the desert, poised to burst into as much life as possible should rain fall; so when you die, you can at least say ”I really tried”
@ermine — Here we go again. 🙂 I’m at the ‘Master Investor’ show in Islington so can’t easily check the link, but from memory his point is after 12 years (in his example) annual growth is outweighing savings.
This snowball effect is very real, and I’ve hugely benefited from it in my 40s. NOT after 40 years. 🙂 In fact I can play around with compound interest calculators that show the impact of anything other than a huge savings rate is kind of moot from here.
To be sure I did save hard in the past 15-20 years. But compound interest is very real.
As I understand it you effectively didn’t save much until late 40s. It’s great that you changed track and I’ve enjoyed all you’ve shared over the years but the fact is there are many paths. 🙂
For anyone reading this blog it shouldn’t be either/or, anyway. It’s both.
The part I push back on with CI is primarily the you must start early routine. Most people see career progression, their future selves earn more in real terms than their younger selves. CI roughly doubles your real terms money after 30 years at typical rates. As I retired I earned over three times in real terms than when I started, plus I had paid down my mortgage. Saving was much easier for my older self, tax breaks were more, the rate of accumulation so much higher.
Life is tough enough in your 20s without people telling you you need to put 20% of your meagre earnings into a pension. Young people can save in different ways, arguably even into middle age, actually paying down a repayment mortgage is a form of saving too. Tax breaks on pensions are poor value for the young unless they are already 40%+ taxpayers, and even then the decades long embargo on the funds makes them less good value.
Agreed if you get lump sums early in life CI is a potential big win. But as youngFIGuy acknowledges such sums are tinged with sadness too…
though absolutely hats off to him for playing this hand dealt by Fate well!
Just to add that in my early 20s, way back in the 1990s in the land before financial blogs and early retirement movements, I read a Jim Slater book, properly grasped how I could apply compound interest to my savings, and worked out if I could scrounge up £500 a month for an ISA I had a decent shot of being a millionaire in 25 years.
£500 a month is not nothing – especially not then – but it’s not a fantasy figure either.
This stuff works. That’s why I always feel the need to reply to a suggestion that it isn’t important. I’m very glad I understood otherwise at 22. 🙂
P.S. I just redid the maths on my phone and clearly I was projecting a return of c.12% — the spirit of the 1990s and the optimism of youth! 🙂
In reality saved more and in recent years I’ve returned more, like most of us.
The point was I got started, in a meaningful way, meaningfully young. 🙂
Despite living in London, and owning a property here, I am glad that the property markets across the country are equalising. The anti-London feeling is really growing around the country, and I think this will help to balance it.
And yes, I’m waiting to hear all those auto-enrolled complaining about having less money when pension contributions go up. I wonder how many will then change their contributions to have money to spend today rather than investing for the future.
Hedge funds perplex me, they seem to do very complicated and borderline unethical transactions, yet people seem to adore them and really look up to hedge fund managers? Fair play to them that they only take money off the super-rich, and I do agree with @theinvestor that we don’t want the superich to also go low fee index investing.
@TI, Fully, I remember seething in frustration on turning 30, panicking that I was getting nowhere in life & having just read Rich Dad, Poor Dad – there were some useful generalities, but the gist of it still didn’t seem practically helpful to start immediately with.
If I understood it correctly & with the caveat that it was US-centric, it seemed the main thing that’d power you to real wealth for your effort, [the best bang for your buck if you like] was buy property. The skill was in learning which were good to buy – type, location, price, condition, future trends for that locality etc., & essentially then trust in the swelling planetary population combining with globalism to ensure prices could only go up with the demand for movement to world-popular places.
That has more-or-less proved correct if you planned intelligently to ride out the bust periods & had the means to do so, but for a smart youngster starting out [financial] life, today, you can’t just go & buy a property as the first step. Even if you could, putting all your eggs in one basket is such a hairy risk …..so this is why the FI/internet-enabled scene has been a godsend for the new intakes, what with these sites giving real, quality, practical step-by-step advice, enhanced by the commentariat adding their real-life tips based on their experiences; Its incomparable & though mostly self-taught, better than the ‘professional’ equivalent incumbent players, given their past records & conflicted interests in that they’re incentivised to sell.
> projecting a return of c.12% — the spirit of the 1990s and the optimism of youth!
I’ll have some of what you were drinking 😉
Seriously, though, I would venture you are an outlier, and compounding may work faster for you because your rate of return is higher. If the rest of us have to chunter along at a 4% real return, your own compound interest calculator indicates after 30 years the end value is about twice what it would have been without CI. That’s well worth having but not transformational IMO.
Good point, to the vast majority of investors getting a low single-digit real return through a lack of knowledge or as an acceptable price of hedging against cyclical risk, compounding as an input might seem insignificant enough to be irrelevant in the short-medium term.
There was a great post by Nick at Of Dollars and Data (Saving is For the Poor, Investing is For the Rich) that’s a great explainer on how compounding appears in practice. In summary he says: “savings have a larger impact on the poor and investments have a larger impact on the rich.”
I think that for reaching FI, it’s the saving hard/spending wisely that will drive how quickly and successfully you make the journey. That’s not to say that good investing and compounding returns won’t, but for a long time it’s pennies, then pounds. It’s not until you have a big stash that those pennies and pounds become hundreds and thousands. And once you’ve built a good sized pot, that compounding becomes very real very quick.
I think that famous Hemingway quote is rather apt: How do you reach FI? “Two ways. Gradually, then suddenly” – Saving is the gradually, compound interest is the suddenly.
I’ve tried to explain compounding to my children (6 and 8) but you have to offer payday loan rates to get them interested. A rate of 1% a month wasn’t nearly enough to convince them to raid their piggybanks and make a deposit at the “Bank of Daddy”. It required 1% a week (68% annualized) to get my oldest to make the move. The youngest still isn’t interested. Perhaps she’s concerned it isn’t covered by FSCS!
Well worth having?! 🙂 Double is huge — longevity hasn’t advanced so far that somebody can finish one 30 year stint and then save for another 30 years to hit the same amount… Compound interest is essential!
If we are arguing about whether compound interest is all-important on a 10-year timescale earning 4%, well, not it’s not.
But that wasn’t what the article was discussing (he talks of a tipping point at 12 years) nor what most people are engaged in. 🙂
Excellent comment thread here, thank you TI, Ermine and YFG. I think you’re right, all of you.
Nobody has yet mentioned the Permanent Income Hypothesis, which has always made rough sense to me. The core idea being that we all have a rough sense of our lifetime earnings, and we spend at any point in time relative to that – so you don’t save when you’re young but you do save when you’re in your earnings prime.
Speaking from a little bit of experience….. if you are a young man in a hurry, you’re probably hoping that 20% of your starting salary is a sum that will soon dwindle to be <10% and then <5% of your income. So why stress about saving when you're in year 1 of your career, if you are reasonably confident you will get your act together before year 10?
For a concrete example, back in the early 1990s my starting pay was just over £20k, and I spent it. All of it. If I had stashed £2k a year, I'd have missed a load of good nights out/ski trips/similar, and those savings from my first two years might be worth today, if I was lucky, £20k. I'd rather have had the nights out/ski trips/etc. But these days I save at least £20k per year – and I do consider £1k saved as £5k+ to be enjoyed in 20+ years time.
Phase of life, and expectations about future earnings, are a crucial factor to this discussion.
I’m 42 and i’ve got more in my share portfolio than I’ve earned in my life….
I remember buying my first shares. 138 shares in Edinburgh Investment Trust in 1990. They cost £250 and I thought that was a fortune. £250 now is three days dividend income…
Before anyone asks I’ve not received an inheritance.
@ZX – your eldest drives a hard bargain – mine shook on 10% AER
@Gordon A 14 year old Warren Buffet!
Only if you experience no career progression. I didn’t need longevity, I earned three times in real terms at the end of my career than when I started working for my last company. It’s that much easier to save, particularly as I had (foolishly) discharged my mortgage entirely before my peak saving years. Then add in the great favouritism to the rich that is the 40% tax break compared to the 20% SIPP tax break.
This year I rammed my SIPP drawdown to just below the higher rate tax threshold of about 45k to extract enough money to bridge a house purchase. I paid about £7k tax on that, and that was all. When I look at my NI record on HMRC it appears several years I was paying ~£5k in NI alone, never mind the tax, before I jumped to sal sac SIPP contributions. The value of those pension tax breaks are just so much more if you start running into HRT.
For people that earn a flat real term wage for their entire 30-40 year working life, CI makes more difference. For people who can achieve more investment return than the average passive indexing real return of ~4% it makes more difference. But I’d say most people that can consider early retirement will see some career progression, and that dilutes the magic of compound interest. I do agree it’s unwise to rely on that, particularly with the increasing pace of change and the high burnout rate of the typical industries the better-off Monevator readers work in.
But I do want to push back on the shibboleth that the very existence of compound interest means twenty year olds should thrash themselves to have savings. FvL put it more eloquently, but the problem is basically that “Spring, mishandled, cometh not again”. The main win for twenty-year olds is avoid consumer debt IMO, which yes, is compound interest running in reverse, but usually at higher rates than the CI you can earn on savings and investments. It kills you faster than you can get ahead.
The arc of a human life is not a steady state. I have no argument with the theory or the maths of compound interest. But the real-terms savings capacity varies across the lifecycle and the wrinkles of the tax system amplifies the effect of career progression hugely towards the end of one’s working life, where you are closer to 55 and getting hands on the SIPP money and more likely to be a higher-rate taxpayer.
According to https://en.wikipedia.org/wiki/High-net-worth_individual there were 465,000 HNWIs (pronounced Henwy) in the UK as of 2012 constituting 0.7% of the population.
The threshold for a HNWI is $1m or about £700k-ish of investible assets, i.e. excluding primary residence.
I was wondering what % of the MV readership would fall into that category? Is it significantly greater than 0.7%?
PS – feeling a little lonelier today -> http://www.bbc.co.uk/news/world-africa-43468066
Did you know that old Sudan weighed more than the entire Welsh rugby team (but a bit less than Mathieu Bastareaud)?
> Is it significantly greater than 0.7%?
I would imagine yes 😉 Inferred by many folks on here being exercised with the LTA etc and the deep loathing for inheritance tax which implies that for a couple remaining assets > ~700k, given the main residence is excluded these days.
Does investable assets include pensions? Or must it be free disposable wealth to go towards the fine living, vacations, Patek Philippe watches and the yachts etc?
@ermine – not sure about the pension situation, maybe only includable once you’ve turned 55? (or 105 if you’re a millenial)
I am pretty sure that wealth stats include pensions (with some kind of valuation for defined benefits). The IFS published some reports looking at wealth fairly recently.
@Vanguardfan possibly you mean the ONS rather than IFS? The ONS put out this fascinating report https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/wealthingreatbritainwave5/2014to2016 earlier this year. It got a bit of news coverage e.g http://www.bbc.co.uk/news/business-42904875 and https://www.theguardian.com/politics/2018/feb/01/uk-hit-peak-wealth-position-on-eve-of-brexit-vote-ons .
FWIW it claims ~13% of “households” are above £1million in assets, but that includes pensions and property… I couldn’t see anything there which would let me figure out the percentiles for just what it calls “financial wealth” and/or pensions, but there are a lot of links in it to the data used.
The way for the young to become rich is to spend 10-15 years acquiring a set of skills in permanent jobs that are in such demand that they can quit and return as contractors, on 3 times the pay, and much greater control of the income, so they can exploit all the loopholes of salary sacrifice, company dividends, reduced NI rates for the self-employed etc.
I was a civil service plodder, but when IBM went searching for people to satisfy the terms of a £50m supercomputer project, one of the job descriptions was effectively “extremely rare skill set, someone like John B”
Once you have rare skills, you often don’t need to work hard, just know where to kick the machine occasionally
@tim thanks for that. These days I can’t remember where I read stuff.. maybe I’m thinking of Resolution Foundation? I guess the source data is all ONS though, and if you picked through it with enough care you’d be able to judge whether you think its likely to be reliable/tell us something meaningful.
Regarding compound interest, I largely agree with Ermine on this one based on the math. First of all, I think Monevator, Escape artist and other such websites are truly valuable and hugely additive to the average persons knowledge. Also great to have UK perspective when there are so many US websites around. So well done to you all and thank you.
On the escape artist website, the example given is of a person who contributes £2k per year from 18 years old to 25 and retires at 65 having received 10% nominal growth annually achieving a £1m. All well and good based on historical US returns. But the crucial statement is “True, inflation means that a million pounds isn’t worth as much as it used to be”. Accordingly to the Credit Suisse 2018 year book, annual real returns were 6.5% from 1900 – 2017. Which would mean in real terms, the investment would be worth £235k at aged 65.
Ok that’s still pretty good and conclusions are (a) equity investing your best bet (b) compound interest can help a lot particularly in the latter stages (c) invest passively and keep costs as low as possible to give yourself the best chance of achieving near to the 6.5% (ok I admit my analysis doesn’t lead to that conclusion but other analysis does :))
but the other conclusion (d) is that the person needs to keep saving because £234k in real terms doesn’t feel enough to retire on. If that person saves £2000 for 25 years from 18 then that’s a circa £470k pot at 65, which at 19k (4% withdrawal) is probably okayish.
As an optimist, I ignore the siren calls that 6.5% may be unrealistically high notwithstanding the fact that recent real returns are lower (also see the Credit Suisse 2018 year book).
Please do say if you disagree with the (simple) math as I would love to be wrong!
and if the response is why aren’t you just commenting on the EA website, fair enough but there was a nice discussion here…..
@Seekingfire — One thing to add to your analysis is that if you’re taking into account inflation, you might also want to think about how that £2,000 a year saving might realistically be up-rated by at least the rate of inflation, too. (At a 3.5% inflation rate then after 40 years you’d need to be saving £8,000 a year when you’re 65 to be putting away the equivalent in same money terms!)
Even that ignores pay increases which will likely be ahead of inflation for many, which is of course one of @ermine’s salient points. 🙂
Also, a really pertinent thing about compound interest is early years count for a lot, but they count for a lot mostly if you keep those early contributions compounding for the long run. (i.e. You don’t FIRE and start spending!)
From memory £1000 a year saved for 10 years between 25 and 35 and then left to compound until 65 is worth more in the end than £1000 a year saved for 30 years from 35 to 65, assuming a 7% return over all periods. (I may have mis-remembered some detail, but it’s in that ballpark.)
Of course this again ignores the fact that £1000 (or whatever sum you want to choose) is for most probably easier to find in your 50s than in your 20s.
But basically I feel people shooting down compound interest are saying “hey, it doesn’t work if you give it no time to compound!”
Well, no argument there. Compound interest needs time to compound. 🙂
i.e. It doesn’t do the heavy lifting for all-out nuclear escape the office in a decade investing. But I don’t think many people claim it does. 🙂
I always try and avoid inflation in my calculations, as the presence of inflated numbers has a bad psychological impact. You might need to have save £8k a year in 40 years, but with beer at £20 a pint you might react less badly at the time.
Its like the helpful museum signs telling you some peasant was earning 2s a day (and thats 10p in new money), as if you have any feeling what that meant to their lives.