Benefits of an arranged marriage
by Doug Brodie
In this blog:
/1. Question 1 – do you need your income guaranteed or not?
/2. Question 2 – is this an area of your expertise?
/3. Possible vs probable vs guaranteed
/4. The most important element of the objective
/1. Question 1 – do you need your income guaranteed or not?
Binary question, yes or no, politicians’ answers not allowed. If you do, then do you think the guaranteed rates in 2027 will be lower or higher than today? Will annuity rates be better then? Will you be eligible for the guaranteed state pension by then, likely to be £23,000 per year per couple in 2027? According to the Bank of England estimates interest rates will fall for the next three years so should you ‘lock in’ today? Gilt yields for the next twenty-five years (the length of your pension?) are currently 4.34%, is that enough for what you need? Probably not because that income is fixed, will never increase. (Treasury 1.625%, 2054).
/2. Question 2 – is this an area of your expertise?
There is an often misunderstood relationship between capital and income – the two are not the same. Capital is unpredictable, which is why investment markets exist, whereas income is guaranteed or predictable. This is the capital value of that 2054 gilt that will pay you 4.34% every year, guaranteed by the UK government – you can see quite clearly that the capital value of that gilt is nothing like the income.
If you read the Weekend FT, in the personal money section there’s a weekly column written by a former fund manager in his 50s about trying to rebuild his pension following an expensive divorce. Last week he told the readers he’s buying bitcoin – taking a punt, not investing. The reason why is because the SEC is likely to approve bitcoin ETFs, meaning there will be buying by those fund managers creating ETFs (an ETF is a type of mutual fund). Looking at the price of bitcoin over the last three months we’d suggest that as a punt, he’s a bit late to the game: the price is already up 70%.
The relevance of this point? In our ‘Your Pension Scorecard’ on the website a question we ask is whether you are influenced by the media – are you currently taking your pension planning advice from journalists? An erudite and sage client who was once the MD of a leading economics publication pointed out to me many moons ago that retail publishing is simply a framework from which to sell advertising: you are the product, and next week they’ll be pushing something different in front of your eyes.
There is an understandable illusion that because economic outcomes...can be quantified, mathematical equations can be applied.
Of course, if economic factors could be accurately predicted then investment markets would not exist, the correct price of everything would be known at all times. The learned economist client I previously mentioned also points out that if ’economics’ was indeed a predictable science then economists would not need to exist – there’d be one economics handbook telling everyone what the future holds.
Looking for predictable patterns is the short-termist strategy of professional traders and optimistic amateurs, however, there are some structural issues that do affect the price of assets. The price of bitcoin over the last three months is an example, however, the professional trader was already there way before the weekend FT amateur, and the profits have been taken. Not only that but the professionals who banked that 70% probably did it using borrowed money (margin trading) using their employers’ cash, balance sheets and trading agencies.
I did note the following comment on the Collabfund.com, a New York site of sensible comments on attitudes to money and home of Morgan Housel (collabfund.com):
I noted above that investment banks used to close out their financial year in November and that the big guys no longer do. That has had a profound influence on how, since 2008, markets behave in January. Prior to the GFC, the investment banks stood there in December gleefully absorbing all the assets which the commercial banks were unloading ahead of year end. Then, as the banks began to reload inventory at the beginning of the new year, the investment banks had the stock and sat there ringing the till. Their accepting the call to become fully licensed banks also obliged them to adopt December 31st as year-end. Now they too have flat books on January 2nd and have to join the scramble to strap on inventory. That adds to the early January squeeze. Even if the December rally looked to be more than just a tad overdone – it happened in pretty thin December markets – it’d take a brave man to begin the new year by going short.
I didn’t know that; for a price to rise you need buyers, not sellers, and the structural year-end balance sheet balancing is not complicated. We’ll see, let’s look back in April.
/3. Possible vs probable vs guaranteed
From covid to moon landings to Trump to Brexit to 9/11 to penicillin to the internet we as baby boomers know that pretty much everything we can conceive of is possible. We now know it’s possible to crash a 108-tonne aircraft at 155 mph into a second aircraft on the ground, to burst into flames and for all 379 people on board to walk away unscathed.
For income to be legally guaranteed there is a price to pay for that guarantee, it doesn’t come free. In an annuity for a £1m pension, the price is £1m – have you ever bought an investment for £1m before? And one that is irreversible?
Swap the legal guarantee for ‘probable’ and suddenly your market and your wealth change immeasurably; we believe that natural income investments can outweigh the financial benefits of ‘guarantees’ for many people. In today’s market, dividends are exceptionally reliable and strong.
The chart above shows that the UK is not overpaying its dividends, though it’s interesting to note that the US retains more of its money and that’s probably for reinvestment, hence US corporate strength. The drawdowns chart also supports the position that dividends are not being overpaid, that they are supported by earnings. Having established that, when you then go up the cautious scale where income is paid not from dividends, but from ‘dividends + reserves’, we can understand how F&C has never failed to pay an annual dividend since 1869, the first ever.
Just because something is not guaranteed doesn’t make it likely to fail – otherwise, you would never get on an aircraft, you’d never trust a motorway at 70mph and modern medicine wouldn’t exist.
/4. The most important element of the objective
If I asked, which do you think will lead to a healthier, happier relationship:
An arranged marriage by someone who doesn’t know you.
Spending years meeting hundreds of people with different backgrounds, figuring out what you want and don’t want, and serendipitously meeting your partner only when you both happen to be ready to settle down.
— Morgan Housel
Going back to the FT writer’s punt on bitcoin and the observation about banks and the beginning of the year, like final salary retirees most people want to set their pension then wander off to enjoy the new found financial freedom. It’s not about this year, retirement income is usually for between 20 to 35 years, and this week we have been planning for someone who is still only 54, and so stands a good chance of depending on his investment income for the next forty years.
The chart above is a factual analysis by JP Morgan of the difference between short-term returns of the S&P 500 and 10-year returns. We don’t need to read the small print, the visual message is very clear – everything snaps into place, earnings over 10 years display a clear pattern whilst over 1 year they are completely random.