17 May 2013, 1:24pm
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  • The trouble with a HYP strategy now is everyone else is trying it too. Cash is still evil…

    A few years ago I decided to follow a HYP strategy. I read this, and in particular I liked

    But there’s a way of profiting from holding shares that requires no selling at all, by receiving the (generally) twice-a-year dividend.

    So I did it. And am still doing it. It gives me a yearly yield of 5% p.a. on my purchase cost and capital appreciation which more than compensates for inflation, indeed at the moment this is faintly ridiculous. That is due to the disgraceful activities of the Bank of England flushing away the national debt by debasing the currency combined with some hint of animal spirits returning to the business world. So far so good. I have two problems now, both good ones to have in some way.

    A HYP is not the approach to take at the moment because everyone else is doing it

    This doesn’t hurt what I have already, because the yield I earn is the yield on the price I paid. The problem is everyone else is bidding up the price of the shares so it makes it harder to find value.Some would advocate taking the profits and trading the portfolio but I’m not going to do that because this is not how a HYP is meant to work and I have no skill as a medium term trader 😉 I will sit on my backside and take the divi, indeed I have managed to avoid selling anything this year other than that mandated by iii’s change in funds policy.

    A first approach is to look for diversification in areas that are out of favour – I have no oil or mining stocks and could do with some for sectoral diversification. Both of these sectors haven’t been on the roll that everything else seems to have been on this year. I also don’t have the religious objection to tobacco many people have either. I’ve avoided all these sectors because I don’t understand them and when I constructed my HYP they were highly valued. If there were a sector index fund on these areas I’d consider going that way.

    However, at the moment I am suffering from a combination of RDR paralysis and the fact that everyone else seems to be destroying the opportunities in what used to be a quiet and tedious investing backwater in a search for yield. So maybe it is time to sod off and fish is some quieter backwaters.

    The FSCS compensation issue

    The second is that my ISA will cross the FSCS compensation threshold this year even if I leave it alone, and it will cross it sooner if I contribute this year’s 11k allowance. Even worse is that I have about half as much again in an unwrapped TD account, which I used to flush out my sharesave and ESIP holdings. I didn’t want a large unbalanced holding of The Firm’s shares so I took a share certificate for half the holding, which I will sit on and take the dividend thanks very much. The other half I moved to TD, and sold some to crystallise capital gains, which I converted into a Vanguard developed world exUK index fund and a Vanguard EM index fund. I have more than enough UK exposure in my ISA, so the Dev exUK was to balance that out a bit, but the aim of the exercise was mainly to cut down the exposure of having half my shareholdings in The Firm.

    A share certificate is a good way round the FSCS issue – I have a direct holding in The Firm and there is no nominee intermediary to worry about. However, you can’t hold an ISA that way so I have to deal with nominee accounts. Having both ISA and regular nominee accounts with TD was a tactical mistake I didn’t appreciate at the time. The FSCS compensation applies to each company, not each account, so I am already way over the top. The obvious thing to do is to move the trading account.

    However, at the moment there is loads of confusion in the UK shareholding nominee platform arena due to the change in regulation of funds, called the RDR. I have already taken one hit from the RDR last year. For this year I am going to sit tight, accept the risk of TD Direct going wrong, which I think is low. If there is general stock market mayhem in some ways the FSCS compensation limit of £50k is self-correcting, as a jolly good stock market crash will automatically devalue the holding – a serious market crash can halve the value of a portfolio in a year which would get me below the protected amount. So TD going bust due to a stock market crash isn’t the problem, it is them going bust due to an internal thief or management incompetence. I should add that I have no reason to currently suspect either, I’m not saying that they are a bunch of incompetent fools, I am merely considering the risk 😉 We have seen in 2008-9 that financial institutions that look solid are often built on sand these days…

    Cash is evil…

    Still a particularly rotten asset class. It makes me sore that my AVC fund is in cash because I will pull it in about year from now. The Bank of England’s destruction of the pound will have rotted the real value of that by about 10% compared to when I left work. Okay, so I avoided paying 40% tax on it, so in the round I am still better off than where I started, but that needs to come out and start working for me.

    I also hold cash because at the moment I am living off savings and that is decaying under my feet. This was highlighted recently when a three-year NS&I Index-linked savings certificate rolled over. It started out a £1000 and rolled over at £1,162, ie in three years the value of money has fallen by 16%. I at least have the benefit of being so poor (okay, hold on the strings and violins in the background, guys) that I don’t pay income tax this year and next, so I filled in my form R85 when I switched my Nationwide Flexaccount to a Flexdirect account. They will give me 5% on £2000 if I play stupid games shifting £1000 back and forth between that and my main bank account each month. With R85 I get to see 5%, too 😉

    Zopa

    I also joined Zopa, though unlike others I consider this bordering on mortgage-backed securities in terms of risk, so I only put into it an amount that I can afford to lose 100%. To see what’s wrong, we only have to look at the current case study.

    And borrower Jonathan is no exception – he used his loan to buy a splendid engagement ring for Charlotte, his girlfriend of 8 years

    Jonathan, me old bean, you have been with this lady for 8 years, and you’re getting married. I’m really happy for you and wish you a long and happy married life. However, despite it making me look like a hard-bitten unromantic old git, a quick word in your shell-like.

    Is it really such an illustrious start to your married life to go into debt for the ring, which is a consumer item, this isn’t an asset that reduces your long-term costs or makes you money?

    My father saved to buy my mother a ring. My grandfather did for his wife. Getting married is a very large transition in your life, and doubly so on the financial front if you are planning to have children. You really, really, don’t want to go into debt for any aspect of getting married. If debt is the answer, you can’t afford to get married, or your wedding plans are too extravagant 1. Save up for the expense, because, to be honest, if you do end up having kids, this point is probably about as good as it gets for a little while on the disposable income front. So, Jonathan, if you are borrowing to buy her a ring, particularly after having had 8 years to get ready, then you have just passed a great big red “Wrong Way, Do Not Enter” sign. And you, sir, need to sort your financial shit out and understand the simple principle. If it’s a consumable item, never, ever, borrow money to get it unless it saves you money. A house is a consumable item – the only reason you go into debt for it is because it stops you paying rent 2. Now what is the ongoing cost that Charlotte’s ring is saving you paying out every year? Zilch, thought so. So you need to man up and save for that sort of thing in future. Or do without.

    What Zopa needs is an ermine behind a leather-covered desk with a banker’s lamp on it. When people come in to borrow money, the ermine will ask them some pertinent questions about what they are going to buy with it, to the effect of:

    How to decide if borrowing money to buy it is a good idea

    How to decide if borrowing money to buy it is a good idea

    It’s notable that this accounts for something that we are very reluctant to acknowledge in the developed world today. That sometimes people have needs that they cannot afford. I have had the experience, and it’s a bastard. But it isn’t necessarily up to Them to fix that for you, sometimes you have to spit on your hands, roll up your sleeves and get to dealing with the issue at hand. Or, heaven forbid, do without some Wants so you can afford your Needs…

    The decision process for purchase of consumables would be slightly different if I were working for Zopa, because it would come down to whether I believe this punter is fool enough that I can get the money out of him with my heavies as opposed to the heavies used by the other guys he’s likely to borrow money from. However, though Zopa try and make out all cuddly with their Valentine story and all smoochy smoochy aaah ain’t it luvverly, in the end they are highlighting a fellow who shouldn’t be using Zopa for that purchase. Not because it’s inherently and deeply wrong for him to borrow money to buy his girlfriend a ring, rather than, say, a motorbike, or a holiday, because at least the ring is durable and hopefully gives them joy for years to come. But because he should have been saving for it over the previous 4-8 years, after all it was a reasonably foreseeable expense. Put another way, Jonathan has just chosen to buy £85 worth of ring for £100, because he wasn’t able to foresee this purchase, and he’s paying 5% over 3 years for the pleasure of not looking at the road ahead.

    Now if their disposable income is always going to be more than their living costs then so what, I have addressed that option in the decision tree. I have borrowed twice in my life to buy a consumer durable.  The first time was the wisest, though it didn’t look that way. When I started work and was living at home I borrowed 20% of my gross income to buy a secondhand preamplifier, on 0% interest free credit. I paid every instalment from income, just before time, and recently I had to fix this preamplifier – it is still in service after 30 years. In the round it was a stupid thing for a 20-year old to do it, but if you are going to do stupid things then you should do them wisely and not pay over the odds for it, 0% is about right 😉 The second was a personal loan to buy a car off a family member as they were changing it, which I discharged in six months, another piece of moderate folly in my twenties, but I ensured I could pay the loan before applying for it, which seems to be a detail a lot of people miss these days.

    Maybe the grizzled form of my future Self is in the process of building a time machine to go back and have a word in the ear of the young Ermine, because I stopped borrowing money to buy consumer durables after that, with one ghastly, stupendous and horrific exception, buying a house. By staying put I passed the criteria of the first box, but only in retrospect. I even borrowed my deposit for that on a 0% credit card deal, but at least I didn’t lose money on that, because I paid it down before it fell due.

    That’s the long story of why I don’t trust Zopa at all, and will probably limit my exposure to that to my original stake. They lend money to people who shouldn’t be borrowing it for the purpose they’re using it for. I took a butcher’s hook at what my borrowers were borrowing for

    1. Car
    2. home improvements
    3. consolidate debt
    4. car
    5. other
    6. car
    7. car
    8. home improvements
    9. consolidate debt
    10. wedding expenses (total of £7500! though only £10 from me, thankfully Yikes!!!!)
    11. Consolidate existing debts
    12. car
    13. car
    14. car
    15. Car
    16. consolidate existing debt
    17. car
    18. car
    19. car
    20. car
    21. car
    22. home improvements
    23. holiday (£5000, jeez!)
    24. home improvements
    25. car
    26. motorbike
    27. car
    28. car
    29. caravan
    30. home improvements
    31. car
    32. car
    33. consolidate debts
    34. home improvements
    35. home improvements
    36. car
    37. car
    38. home improvements
    39. consolidate
    40. home improvements
    41. home improvements
    42. car
    43. car
    44. consolidate debt
    45. car
    46. car
    47. car
    48. consolidate
    49. car
    50. car

    Now if you look at this lot it’s a fairly sorry story. Why are so many people over their 20s borrowing to buy cars, FFS? There are people my age at it, you are actually meant to learn something as you go through life. A car is a known running cost – they wear out and break down after you’ve had them for 10 years, so when you buy one you start saving every year 1/10th of the price so you have enough to get the next one. The price of secondhand cars actually drops – I paid about £5000 for my last one, a VW Golf which I had for 13 years. I could get a great s/h car for £5000 nowadays, and £5000 is worth less now than it was 14 years ago. I’d probably look at paying less, because to be honest I just don’t need £5000 worth of car.

    zopa loan purposes

    what people are using zopa loans for

    We have 8 debt consolidators in there. These guys aren’t going to pay that back – if you’re borrowing money to service debt you are in deep shit and going deeper. I hope the girl who’s borrowing £7500 for her wedding won’t have the shine taken off her marriage by the stress of paying that lot off. The summary is scary, because only the home improvements one would pass the Ermine’s beady eye in the test above, and that is for improvements, not Changing Places fun and games or new carpets because you’re bored with the colour of the old ones. Not if you’re borrowing money to do it, because that is telling you that you are living above your means. I have some sympathy for the people in their 20s – stumping up the money to buy a car to get to work may well need borrowing money. But there are a lot of people whose age indicates they should have got out of that stage…

    I feel a lot better about lending the Nationwide cash at 5% than doing the same for Zopa customers. And yet Zopa seems to have a strong following in the UK personal finance community. I have to say that if I were these Zopa customers’ bank managers I’d give most of them short shrift 😉 I’m sorry, but if you are over 50 and borrowing money for a car then you need to start buying less car. Mr Money Mustache gives it to you straight between the eyes in his usual inimitable style. Basically you do not need a pickup truck, and SUV or a people carrier to drive to work or take the kids to school.

    Notes:

    1. it’s come to my attention that there is a whole wedding industry whose raison d’etre is to make sure newlyweds start their married life in as much debt as they can persuade them to go into. On the ads they say getting married is all about the wedding and the honeymoon. For crying our loud these good people state that

      Your wedding day should be the most romantic and memorable day of your life

      I guess what they’re really saying is it’s all downhill from the end of the honeymoon, eh 😉 When you look at people who have been married a long time they didn’t need some ghastly extravagance to get married. It was about each other, not about their consumer purchases. If anything, going into debt to get married is more threatening to the  relationship than not having an expensive wedding in the first place. Get your priorities right – being stressed about owing money is no way to start a life together if you can avoid it.

    2. not paying rent is not a great thing in itelf if you have to tie up a load of your capital in an illiquid asset like a house. There’s nothing fundamentally wrong with paying rent, if it costs you less than you’ve have to invest in buying a house and all the ancillary parasitic costs of home ownership.

    Ermine – could I use your flowchart for my Skills for Life classes? I may make it into a board game if that’s ok?

    @Romany you’re welcome. It’s not going to be the same without the ermine and the banker’s lamp though 😉

    Many thanks Ermine. Hmmm -Now,where can I get an ermine & a bankers lamp? 🙂

    Nice post, but I’d query some of your categorisations. An engagement ring is not a consumable, gold and diamonds are not consumed. Saving up for it would obviously be better, but borrowing for it need not be a problem. It will almost certainly be a good inflation hedge.

    Some of those cars and debt consolidations might be smart moves: a car can make a new job possible, a reduced interest rate helps you to claw your way out of debt. Weddings, though, that is nuts.

    18 May 2013, 11:30am
    by BeatTheSeasons

    reply

    I think you’re making a logical error with the part about how much you paid for your HYP. Your assets are worth what someone will give you for them, and the market doesn’t care how much you originally paid. Why are you happy to hold at the elevated valuation if you don’t want to buy in at the same level?

    I agree with you on Zopa. It’s even being promoted on MSE as a way of getting higher rates on your savings. With all that cash pouring in I think we’ll see either lower rates or a deterioration on the quality of debtors or both.

    I’d never paid more than £500 for a car until last year when I wanted a larger, safer and slightly more modern people carrier for my family. So I went up to £1,200 and it hasn’t yet cost me a penny in repairs – even if it doesn’t get through the MOT that’s depreciation of £100 a month, so not really worth borrowing money for…

    @SG it’s not consumable like say chocolate, but it is a consumer durable that falls clearly into the wants category – and as such should be saved for ahead of purchase IMO as previous generations understood 😉

    @BeatTheSeasons – in an ideal world you’re entirely correct. However, the greatest point of danger to the stored wealth in my portfolio is myself, not others. If I sell, crystallising the profit, I have to make a decision on what to buy, in the hope of it giving me either the same return or rising in value. I have 20 years of experience showing me I am not good at that, compared to my ability to sit on my butt and accept dividend payments. I still need to make that sort of decision for new money for the next few years but not turning things over minimises the risk.

    Other people may have greater talent than I. If I could identify them I’d buy their funds if they didn’t charge too much for their skill. But I don’t have any talent for spotting that talent either 🙁

    @BTS >Why are you happy to hold at the elevated valuation if you don’t want to buy in at the same level?

    An oft quoted sentiment, but there is the question of asset allocation and, as ermine says, the use to be made of derived profit. I don’t think it is necessarily irrational to hold, rather than to add or reduce, especially where a dividend stream is concerned.

    RE Zopa, yes returns will track down in the medium term, but they are just following the rest of the market (but at a risk premium) and still represent a good asset diversifier. I aim to raise my P2P exposure from 4% to 6% by the end of the year.

    @ermine, we’ll have to agree to differ in the sense that you are coming from a PF point of view (and why not on your own blog?) re jewellery and borrowing, but I am thankful that a chunk of the population is willing to avoid the paradox of thrift.

    […] over at Simple Living in Suffolk, offers a glance at what people spend the money they borrow from Zopa. Most people seem to borrow to buy cars (a necessary liability), consolidation loans and holidays. […]

    19 May 2013, 5:45pm
    by Dylantherabbit

    reply

    I work with a bloke who just took out a three year £15000 loan to buy a car and he is 60, yes 60, years old ! Its insane, it represents about 30% of his current employed income and he will retire in three years.

    If you want an intellectual type argument for holding rather than either adding to or selling your HYP holdings, you could try a fusion of portfolio theory and the idea of marginal utility: up to a certain point the holding has utility for you, but as the price rises, additions give progressively less benefit (or add rather than diminish risk). A real economist might even try to compute this; I prefer to note that the world is messy, I might be wrong, and there are transaction costs, all of which can reasonably justify a certain amount of inertia in reacting to price changes. Enjoying the divi flows while the world spins seems an entirely sensible thing to do with a HYP.

    That doesn’t offer many ideas for what to do with ‘new’ cash, though. Recognising that a price rise means that risk is likely to have increased is pure Ben Graham – as is the understanding that a price fall makes something less risky. I have started sniffing around commodity ITs – hoping for discounts on discounts, with rising divis.

    27 May 2013, 11:54am
    by Grumpy Old Paul

    reply

    @Ermine,
    Lots of thoughts on your discursive post. Elements of your background resonate with my own. I too left the Firm with too many shares and AVCs.

    I sold shares at every opportunity during the dotcom boom despite my colleagues telling me that I was mad to sell at £3 when the Chief Executive predicted they’d be worth £5 by the summer. The moral is to recognise a bubble and get out without attempting to call the top of the market.

    My in-house AVCs were with Equitable Life and so did not grow as fast as I’d hoped but
    I had a get out of jail-free card which I played by taking voluntary redundancy/early retirement but at the cost of reduced pensions. I’d had tax relief at 40% on the AVCs so I was content with the small return especially as my company pension schemes gave me generous additional pension in return for the AVCs. The moral here is to recognise a good deal (which may not last) when it is on
    offer and take it.

    I too suffer from RDR paralysis and will not be doing anything the dust settles

    I’m somewhat agnostic about HYP even for retirees. I’m a mainly passive investor with an asset allocation which gives a nod in the direction of equity income. We have no children and, even if we did, I think I’d be happy to have spent all my funds by the time I’m 95! So, if and when necessary, I’ll start
    withdrawing 4-5% from my portfolio each year (possibly on a quarterly or monthly pro rata basis) and simply not care whether the money comes from capital or income. Assuming that markets rise in the longer term and my portfolio performs in line with portfolio theory (2 big ifs!), I’ll not even be dibbing into the real value of the portfolio. But I’m fully aware that, in the word of the bard, “The best laid schemes o’ Mice an’ Men, gang aft agley.”

    For me, an HYP would be unsuitable because it would involve selecting a suitable portfolio of shares and I have no confidence in my ability to do that. I’d also be worried about having a portfolio skewed by the dividend distribution across stock market sectors at the time the portfolio was created. Then I don’t know how/if would/should react when one of my chosen shares cut or ceased paying dividends.

    I suppose I could try to construct a HYP using funds or ETFs. But then I’m a passive investor because I’m poor at picking funds. Furthermore, it’s hard to tell, when a manager with a cracking track record underperforms for a couple of years, whether the explanation is:

    a) A temporary blip
    b) Previous performance was good because the market favoured his/her bias during that period
    c) The manager has had issues with his/her personal life and/or health leading to a permanent fall-off in performance
    d) Management within the organisation have constrained the freedom of individual fund managers
    e) Anything else which results in the end of outperformance

    So, for me, it’s a passive portfolio with rebalancing after major market moves.

    However, I’d be the first to recognise that there’s an element of subjectivity in this and that the best over-riding rule is to adopt an approach that enables you to sleep at night!

    By sheer co-incidence, I have just initiated a switch to a Nationwide FlexDirect account. My existing current account was with a subsidiary of Santander and I had concerns about the risk of contagion and on-going support of my account. I also have a preference for mutual organisations (The Wine Society and Vanguard(?), anyone) and prefer an account which allows me to draw cash at the Post Office terminal (not ATM) in our village.

    I’d concur with all your comments about Zopa, people borrowing to buy consumer durables. However, I’d point out that it did make more sense in periods of high inflation such as the 1970’s when wages increased with or above inflation and repayments on loans and real interest rates were negative.

    I don’t really share your moral repugnance to
    inflation. If inflation was 5%, wages, tax thresholds rose with inflation and interest rates were 6% and our major trading partners were in a broadly similar position, what’s to worry about unless you have a shrine to Ludvig Von Moses in your garden? However, I accept that the current situation is very different with sustained falls in real incomes for most people (excepting the top 1% and most pensioners). Falling real incomes obviously lead to a reduction in demand, reduced employment, reduced tax and NI revenues and self-perpetuating downward spiral of tax and spending (except for benefits, pensions and ring-fenced government departments) cuts.

    I’m not sure about Zopa. As a risk-averse saver/investor, it’s not for me. If you restrict your involvement to a small sum, then the extra return that you’d get would deliver peanuts. You’d do better to get everyone in your family to open a FlexDirect account and get the 5% interest) and look at other similar deals! This would also have the merit of being almost risk-free. Then should we be encouraging folk to spend money they don’t have on things they don’t need and pay interest to boot!

    […] easy to have in 2009 and 2010. Capital appreciation seemed the order of the day in 2013, though I contributed no new money to my ISA, simply shifted an ISA-worth of unwrapped holdings because I felt unable to make a […]

    […] over at Simple Living in Suffolk, offers a glance at what people spend the money they borrow from Zopa. Most people seem to borrow to buy cars (a necessary liability), consolidation loans and holidays. […]

    […] build one’s HYP, whereas frothy markets pumped up with QE are the time to either diversify or sell your own unwrapped shares back to yourself in an ISA wrapper to bloodlet some capital gains allowance. Every dynamic system has its systole […]

    […] have added a column in Excel to identify my original HYP shares and it is still yielding over 4%, the variation in numerical dividend year on year is low. Now some […]

     

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