28 Aug 2014, 8:43pm
personal finance
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  • Cash ISAs are king, it appears

    We have not just one but two bearish articles on the stock market now that the hacks have returned from their hols and decided everything looks less fun than on the beach.

    Maybe the teeming masses of our British ISA ‘investors’ are wise after all, as only one in ten of us 1 open a S&S ISA. The Torygraph asserts

    ‘Super Isa’ savers play safe by putting their money overwhelmingly into cash rather than investments in the first month of the new, enhanced tax-free plans

    Blimey, if that’s what they call safety, I’d hate to see what these guys think of a racy high-risk strategy. At least the writer got one thing right – you don’t invest in cash, because it always offends. The one good thing you know about cash is that it’s dying on you. I’ve will have lost about £10k to the depredations of interest-free cash 2 in my AVC fund by the time I get hold of it; fortunately I saved considerably more by not feeding it into the rapacious hands of the taxman so sometimes you have to eat the cost of doing business. In retrospect I should have left some of it in the market, but because I didn’t know when I’d need to draw it I left it in cash. And I’ve seen this safety at work, and t’aint pretty at the moment.

    The advantage of havign termites eat yoru cash is you can see the buggers and you know what the problem is. When the government does it who are you gonna call?

    Termites can also eat your cash, but the government can ruin its value without getting at it. They simply make a lot more of it.

    Not only that but I have a lot of cash outside pensions. That’s the trouble with having a low income – you need to hold a lot of cash 3. If you’re earning a decent wedge then if something goes wrong you slap it on the credit card, roll back your partying for a few months while you pay it off and that’s great. Whereas if you haven’t, you need to hold a lot of cash to cover emergencies. Or do without – Wonga is not an option because it never gets better if you have no income, something that an unfortunately large number of my fellow Britons haven’t jumped to yet.

    I have a cash ISA, from way back, in two halves – 2008/9 and 2009/10, when I thought I had very very few options and was going to be iced from The Firm in months, not three years. I’ve hung on to it because cash does give you some optionality, but I’ve never been tempted to add to it as an ISA, though I did take those nice guys at NS&I up when they were offering inflation-proofed cash. If they did that again to be honest I’d probably draw that cash ISA and whack it into NS&I. But they aren’t.

    Anyway, I’ve held this for five years, over which it’s fallen in value in real terms. Of course the nominal value hasn’t fallen, and indeed inched up, but it’s grim, and it ain’t going to get better. I retain this cash ISA purely for the tax-sheltered value – when I get control of my cash it’s going into my S&S ISA.

    Cash is king but has no earning potential

    Whereas my S&S ISA, which I have been feeding exclusively and to the max has increased by about 20% over the same time, relative to the total cost of purchase as of 2014 – not all of the money has been working for four years. Now there’s a very good argument to say this isn’t because shares are inherently better than cash over four years – over that period all you needed to make money in the stock market was to have a pulse, actually be in it, and not screw up. It’s been getting harder and harder to find much worth buying, and what with the relative strength lack of weakness of the pound, I have looked towards building out – in emerging markets, Asian smaller companies, Russia, and Africa. I could use some of the mayhem in the stock markets trumpeted by the Torygraph to get valuations down from the silly levels, particularly in the US.

    After leaving work and coming to the conclusion that my HYP will soon be able to make up the pension income I lose from leaving early 4 I started to look towards the longer term defence, and while emerging/frontier markets seem on sale this year it is a bit nutty to ignore the largest capitalist economy on earth. Although I couldn’t bring myself to buy the S&P itself at current valuations I managed to hold my nose long enough to diversify a shedload of The Firm’s Sharesave into Vanguard FTSE Developed World ex-U.K. Equity Index Fund which is more than half US. I was going to Bed and ISA that sucker but it’s had the temerity to appreciate by 12%, which puts the kybosh on that idea for this year as I’m capgain maxed. So the Coming Reckoning Of Doom will have a grain of silver lining amongst all the mayhem – it would let me Bed and ISA a whole load of stuff. It’s an ill wind, etc, and of course all the buying opportunities, yay 😉

    Maybe our cash ISA-niks are keeping their powder dry

    Beats the hell out of me what all the punters are doing with their cash ISAs. It’s not even like you can turn that much interest on cash for the tax difference to be worth the candle. Maybe they are mindful of the Torygraph’s second article and waiting for the Case-Shiller to drop back to historical averages. The trouble with that line is that it’s easy to say and hard to do. However, if the massed ranks of cash ISA savers are under the fond impression their money is safe, they need to think again. Knowing that you aren’t safe is better than believing you are, but discovering the power of inflation does destroy your money. You know that compound interest everybody goes on about? Inflation is it’s Mr Hyde – compound interest run by Bad Guys. Tax takes more than one form, and printing cash to devalue the debt takes most financial assets with it, as more and more money chases a finite supply of things of value. Most of the rise in stock market valuations isn’t real either, more money chasing the same or less Stuff. The advantage of the stock market is that the risk is printed on a sign above the door – “here be dragons, volatility and 50% swoons in a couple of days”. Whereas on a cash ISA it’s all marble hallways and apparent solidity, but in the night the termites unleashed by the Bank of England are in there, busily nibbing away and the value of your cash. The tax is the disappearing value, not the small part you pay to HMRC 😉

    There are some ways to greater safety than cash

    If our cash ISAniks really wanted more safety, they could do worse than ponder Harry Browne’s  Permanent Portfolio. (Permanent Portfolio at ERE) It’s one example of diversification across asset classes, wider than the usual trio of equities, bonds, and property/land. And cash has its place there. But you have to accept a lower return, because there are two passive non-income generating components in the mix, cash and gold. They are the sleeping King who will rise up when the Kingdom is in mortal peril – but obviously half your capital base is asleep in times of prosperity, and so far the prosperous times have been a larger proportion of the time than the recessions.

    The advantage of having a few year’s ISA behind me is that the decisions to be made each year form a smaller part of the whole picture. At the beginning, I was desperate for a sustainable income, and I was lucky to start from a bear market and one where income investing was particularly bombed and people could consider swapping income shares for income ITs on a discount. As time goes on preserving what I have becomes more important – and that means building a diversifying shell around the income core. I accept my yield will fall, and yields are generally falling at the moment. But there will come a time when things are different, and there will be a time to buy income again. Hopefully those ITs at a discount – I had only got started with one and was going to buy more but ran out of ISA space in 2009, there is unfinished business there. In the meantime, there is a time for everything – the various sectors fall in and out of favour over time. Buying into the ones in favour (right now US equities, UK residential property) doesn’t work for me. Some people make momentum investing work, but I’m not one of them. Buying sectors that are out of favour works for me, but it’s hard seeing things go down before they come good – I can get a feel for lows but not for market bottoms. Which is why I hate it when markets hit new highs – Mr Market want you to pay so much to get on the dancefloor, I want to sit those ones out 🙂

    the search for safety leads to danger

    Donald Rumsfeld had a point. It’s the unknown unknowns that are hazardous, but believing you have found safety leads you to have apparent knowns that are really unknowns.

    But one thing I know, from personal experience. A Cash ISA is not safe – over several years, never mind decades. Yes, the cash ISAniks will say – but the stock market can halve its value from one moth to the next. They’re right, but there’s a faintly discernible upward trend over the years, whereas cash has a downward trend that dares not speak its name 5. When I was at university in London many years ago, you could get a pint of beer for under a pound. Slowly and stealthily the value of that pound fell away.

    It doesn’t matter than 9 in 10 cats prefer the cash ISA door. Somebody should make a ‘here be dogs‘ sign for that door.

    Notes:

    1. I know they said ten to one which isn’t exactly the same thing
    2. great when you’re borrowing, sucks when you’re holding
    3. If you are going to retire early, before 55, then for God’s sake don’t pay off your mortgage if interest rates are low. They weren’t as low as now when I did that, so the folly wasn’t as clear.
    4. Once again I’m not claiming to be a fantastic investor with hot hands there – the ask is made a lot easier by the fact that my spend rate was so dramatically lower than projected I have been able to defer for a year, and indeed with Mr Osborne’s shenaigans will be able to defer for another year after that. In general, for civilian Sheep of Wall Street spending less trumps greater investing chops
    5. it’s called inflation, and NS&I were the last people to offer a believable hedge against inflation

    Kids at school are taught about interest and (if they’re lucky) the benefits of saving. Unfortunately few are taught about inflation or investments.

    The result? Cash ISAs are familiarity while S&Ss remain a mystery. I’ve seen posts on university focused forums from people bragging about how their £5k in cash ISA is going to give them a ‘free’ £75 at the end of the year. Extra drinking money! And this is from the brighter end of the IQ spectrum.

    I must admit that being currently cash rich from a pension lump sum with an outstanding mortgage does cause me a bit of head scratching. Whilst mortgage payments and other living expenses are covered by pension and other income, there is a certain sense of security in having the accessible funds for big projects. I think the inflation loss on cash is bearable for a year a two in my circumstances as a new retiree, because it was always the unexpected big ticket items that wrecked the cash flow when I was working that led to credit card debt (now gladly kissed goodbye). Segregating the cash buffer into designated pots seems to be working so far. I’m trying to adjust to a different lifestyle and spending needs; that buffer stops me coming a cropper on the budgeting front.

    How much is too much? I guess when interest rates rise the differential between my mortgage and savings rates and the rate of inflation will need to be revisited. Cough. Perhaps I need to do that calculation now for reference.

    29 Aug 2014, 2:10pm
    by Ray MacDonald

    reply

    In Canada our ISAs are called TFSAs and we can individually contribute a maximum of $5500 Canadian per year to a TFSA. (Our personal tax deferred pension scheme is called RRSP.)
    Most people keep their TSFAs in cash or cash equivalents but we don’t make any distinctions, and it’s possible to have many types of security in one. I fail to see why you need two different types of ISA in the UK.

    @EarlyRetirementGuy – I’d better get drinking my ill-gotten gains! That’s scary, though in all fairness I have to tip my hat to the students who are saving at all. Although I largely avoided debt, saving was a step to far for me at university or for the few years after. And hey, I did far more daft things with personal finance when younger – like buy a house at a time like this 😉

    @Hamzah a year or so isn’t too bad. I was running on the principle you don’t have money in the stock market that you might need within five years, and I guess my time horizon is about three or four from 2012. The accumulated depreciation of cash starts to hurt.

    As you say, though, a early retiree has to hold a lot of cash against those potential big hits, it’s a strange paradox of a lower income needing a higher savings buffer!

    @Ray I think that nice fellow we hired for the Bank of England may have been bringing a dose of Canadian common-sense to our Treasury. As of this April tax-exempt pre-retirement savings have now been merged into the general purpose NISA. However, the market hasn’t followed yet, providers still treat cash and investments as different products.

    And savers certainly haven’t jumped to it at all!

    Well today cash looks better than Tesco shares (sigh). It’s a good job TSCO is a small part of my HYP bit of my portfolio. In his youth in the early 70’s my dad with his father jointly bought a Aveling and Porter steam roller just for fun, it cost £500. Nowadays they fetch £40-£50k. Compound inflation at work again.

    29 Aug 2014, 4:50pm
    by Ray MacDonald

    reply

    One other comment about personal retirement saving in canada.
    Although in theory you are permitted to save in an RRSP up to 18% of your income to a max. of $25000/yr., this is reduced by an adjustment based on your participation in a Registered Pension Plan at work. If you are lucky enough to have a good defined benefit pension plan you may have no RRSP contribution room at all! In this case it pays to use a TFSA for your additional pension saving.
    TFSAs arrived on the scene quite recently and my wife and I did not have the benefit of saving for retirement with them. However we used the maximum we had available under RRSPs and both of us had DB plans which we collect from today.

    The new-style ns&i ILSCs are much less attractive than the old. The penalty for cashing-in is too high unless you do it early in the anniversary year, and cash-in the lot. So they are like a series of all-or-nothing one-year RPI-paying Cash ISAs. I’d rather have them than not, mind, not least because the income-tax shelter is heritable.

    I’m in flexible drawdown on my SIPP, but thanks to the Great Liberator I’ll be able to start contributing to a pension again next year, which will then pay out to my widow tax-free if I snuff it before I’m 75. So I’ll be withdrawing from ISAs and contributing to a SIPP.

    If you know of anything attractive that one can hold in a (small) SIPP but not in an S&S ISA, I’d be glad of a pointer.

    Ermine

    Great post, one gap / misdirected emphasis… It’s not the Bank of England who create the vast majority of new money. They create only the 3% which is notes and coins. The other 97% – electronic money which most people use for most things – is created by banks when they make loans.

    The 3% has been pretty slow growing over the past 30yrs. It’s the commercial bank money – created out of nothing and lent at interest – which has rocketed. A good chunk of this into mortgages, hence the housing boom – to your point about more money chasing the same set of assets..

    http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2014/qb14q1.aspx

    I always enjoy your posts, hope you don’t mind me pointing that out

    Not sure I’d recommend the Permanent Portfolio as a small step up from a cash ISA. Over time it has had stock like returns with lower volatility, but you have to cultivate a zen like detachment, which is really hard to do with something that feels so directly reflective of your own judgement.
    Sensitive PP investors were rushing to the exits this time last year when it was down about -8% whilst a stock heavy portfolio was up +10%.

    Cash is cash, nothing like it for ensuring a good nights sleep, particularly I suspect if you are saving within a retirement scheme and carrying a lot of your wealth in your home.
    Personally I quite liked the ideas around holding 80% cash in ilscs with 20% 2x stock eft, but ilsc’s dried up before I had the chance to consider it more fully.

    So erm yes, I’m holding way more cash than is rational, but (clutches straw) it did soften the blow last year.

    @Robert I got hit by TSCO too. But then that’s diversification I guess, it ranks as my prime dog at the moment, though a bit less bad on total return.

    According to the Bank of England your dad’s £500 would be about £6750 but now, so there must be some collector’s value add. Nevertheless it’s sobering to see that for almost forty-five years inflation has run at over 6% on average!

    @dearieme I have the ILSCs and cash reserves of last resort so I have been carrying them for several years now. The hit is therefore lowered by the carrying term.

    @Roland – thanks for the correction! The banks don’t do this entirely at will though – if the government wasn’t OK with what they were doing they would legislate to change it, and the BofE doc does indicate it controls inflation indirectly via interest rates.

    It was news to me that there’s no overall tracking of the total quality of money – since it is supposed to represent a claim on non-financial stuff it seems a little remiss to target the feedback system on the created excess as a proportion of the whole.

    @Nathan I hear of too many people who say the stock market is terribly risky so they are saving for long term goals like retirement or university in a cash ISA – just take a look at the MSE forums. But yes, the main problem they need to address is understanding the difference between saving and investing and why volatility and risk are not one and the same thing. If PP holders are the sort to cut and run on a 8% fall then they haven’t understood the principles…

    Cash is cash, nothing like it for ensuring a good nights sleep

    Not for me it doesn’t – my overall cash position is high because I have no income at the moment and therefore a poor risk profile for emergencies. And I’ll see that depreciation cost me about year’s ISA worth of money by the time I do get a hold of my retirement savings. That cash depreciation is seriously expensive insurance against the unknown unknowns of life and I’ll be glad to get that down to around a year’s spending once I have an income again!

    @Ermine – thanks for the note back. The interesting thing here is that because the BoE basically just has interest rates to play with, they really don’t have any direct control over inflation. They have the remit to manage it, but not the tools.

    Something like >30% of new money created by banks goes into mortgages, hence massive house price inflation over which the BoE has no real control.

    Yes – as well as creating new money, the banks also allocate it! Of course much safer for them to lend against a house than a small business’ financial forecast..

    Aside from interest rates, the BoE did have a go with quantitative easing, which turned out to be a good waste of £375bn…

    http://www.positivemoney.org/2014/06/waste-375-billion-failure-quantitative-easing-video/

    Sorry if getting a bit off topic here – just find this stuff astonishing, very poorly grasped by most finance media, and actually quite fundamental to a slightly more realistic view of the economy!

     

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