Let’s take a butcher’s hook at one of these offending families, kindly drawn to my attention by Lemondy, who was in the market for a good rant, pleased to oblige

What’s been going on here? It doesn’t start well, we have a blended family of two of Ray’s daughters from a previous relationship and three of his wife Katherine’s kids from her previous relationship. Fair enough, these things happen, looks like there is no contribution from the other people who helped bring these children into the world.

Raymond, a former educational software writer, has been jobless since 2001. His wife Katherine suffers from bipolar disorder with an anxiety disorder and is also unable to work.

Says Ray: “The market for my skills dried up 10 years ago – there’s a total lack of work in my area of expertise.”

There are two problems here. One is that Ray, despite being unemployed for the last ten years, decided to sire a son five years ago. At least it was with his wife. Ray, me old mucker, precisely why did you decide to produce this child when you knew you were unable to support it? Perhaps you ought to take a look at what the NHS has to say about stopping this happening in future…

Don’t get me wrong, I am open to taxpayers supporting families up to three children in some cases. After that I believe family support should be supplied in kind – food stamps, clothing vouchers for named individuals with a photo, and free school meals. Why is that? Because having children when you can’t afford them should seriously screw up your standard of living!

I am happy with supporting normal sized families (that’s up to 3) through the tax and benefits system, though they’ll have to move to cheaper areas. However, larger familes should be actively discouraged if you’re going to do it on the public purse. In the past, when I asked myself whether I could have children, the answer was no, I couldn’t afford it. So I didn’t do it, FFS! What makes Ray and Katherine so damn special that not only do I not get to have the experience. I have to pay for them to do it?

When I was growing up, when parents couldn’t support their children longterm the children were taken into care. There was a lot wrong with that, but there’s a lot wrong with people like me paying for the likes of  Ray and Katherine to have that special experience of having a child of their own blood too. Supporting these children and only the children via food and clothing vouchers would at least screw up the parents’ living standard a bit while protecting the child’s essential needs.

The second thing wrong here is Ray’s assertion

“The market for my skills dried up 10 years ago – there’s a total lack of work in my area of expertise.”

Don’tcha think it might be time to learn something new, then, rather than sitting on your big hairy butt firing out children on the taxpayers’ dime then, Ray? You have sat on your lazy ass for longer than I aim to retire early. For a quarter of your potential working life you have done diddly squat, while Gordon Brown, in addition to saving the world solved child poverty by dropping money from helicopters to people like you. Solving child poverty was a laudable aim, but not if you start creating more of it by making it easier for people like Ray to sit on their Lay-Z-Boy recliners watching Sky TV….

Talking of which, let’s move on to the spending of this feckless bunch of time-wasters

‘There are four children to supply school uniforms – including gym kits – each year. The school trips aren’t days out to Alton Towers – they’re educational trips for several of the courses, like history, geography and media studies, that the school tells us will form an important part of their course. Then there are seven birthdays a year, and seven children to make Christmas happen for each year.’

Whenever anything that looks like frippery is given the adjective ‘educational’ we know we are being rooked. In the 1960s and 70s families sometimes just had to say ‘we can’t afford it’ to school trips. If enough families didn’t sign up, the trip was cancelled. It wasn’t the end of the world. And I’m sorry, but media studies isn’t even worth the time it takes in the school day, and it definitely isn’t worth some of my money to send Ray’s children on school trips for.

As for the seven birthdays and Christmases, well, used to be if you couldn’t afford Christmas you’d make the presents yourself. Ray and Katherine need a spine transplant, so they can say to their kids “we can’t be bothered to go to work to give you that iPod you wanted, so you’ll have to do with this tube of Smarties instead”. Instead they tell their children the lie that the fairness fairy will given them their heart’s desires, propagating the entitlement gene across the generations. Oh and you, dear reader, and I get to pay for it, too…

‘We get the Sky Movies package because we’re stuck in the house all week – otherwise we wouldn’t have any entertainment.’

Bit of a battle for the old remote control, eh? And why are we paying the Digger £780 a year, Ray? Tell you what, since you’re so keen on things ‘educational’ howsabout you haul your lazy ass down to the library and borrow some of those flat things called books, and get your lot to read?

Anybody who has Sky TV should have benefits docked to the same amount. It’s a want, not a need. My TV delivers enough entertainment without Sky, I reused the dish for FreeSat. Want Sky to watch the footy? Get a flippin’ job, Ray!

‘Most of this goes on our eldest son’s bus fares to college and back. For me, if it’s less than five miles, I’ll walk.’

For the first time, I tip my hat to you, sir. That’s the right attitude. Heck, I’d be okay with putting some of the saving from the Sky TV package I’d cancel to get you a reasonable pushbike.

‘My wife and I have mobile phones, and so do all of the teenage children. You try telling teenagers they’re going to have to do without their mobiles and there’ll be hell to pay.’

How about telling them where to get a paper round if they want a mobile? It’s back to spine transplant time for you, Ray, my boy. And why the bloomin’ heck is this costing you over £1500 a year? What part of PAYG and ‘shut yer gob’ do you and yours not understand? I have never paid £1500 a year for mobile phone service. Nor even £200, which is the per head rate, and I don’t plan to start. Ever heard of Skype, since your lot seems to spend most of the time at home?

‘Gas and electricity bills have gone up massively over the last couple of years – two years ago we were paying £20 a week. If they do cut our benefit we are going to have to choose between eating and heating the house properly.’

Even when I was running a video conversion firm with loads of electrical gear I never paid that much for heat and power. Presumably the jumper is not an item of clothing your family is familiar with? Or the clothesline, though I accept that may have limited use in Wales.

‘ Rent £76: This is social housing in Wales, so the rent is hardly massive. If we rented privately in this area, then the cost would be four or five times as much.’

Nicely played, sir. At least it is a different bunch of taxpayers keeping a roof over your head… There’s a lot to be said for diverisfying your income.

Looks like tobacco is £65 then. So I can sort your £82.40 weekly saving at one fell swoop. Cut the ciggies right out, drop the Sky TV and the remaining couple of quid can either come off the children’s Christmas and Birthday presents or you can drop a tinnie or two of the lager. They do have Aldi or Lidl in Wales?

There you go, Ray. Fixed that for you, and you’ll have your no doubt lovely wife with you for that much longer because she doesn’t smoke now

For far too long the goal of reducing child poverty has led us astray.We did not raise our eyes to the monster that we were creating as a byproduct, of increasing the ranks of the undeserving poor.

It’s all very Victorian, but we need to start discriminating again between the deserving and the undeserving poor, because at the current rate of progress we are all going to be poor.

We could start by making access to a higher level of welfare payments contingent on having paid into the system in the last few years, like many European countries. I wouldn’t mind paying toward’s Ray’s brood if he’d been working for the last 10 years and then lost his job in the current downturn. What incenses me is that he had another child while on benefits! We could make child benefit payable in kind, particulary if the child appears more than 9 months after you’ve been claiming!

Something that always puzzles me is how many poor people smoke, or is it that smoking makes you poor. In the end if you can afford it I don’t give a toss if you smoke or not, as long as you don’t do it near me. If you’re on benefits then I do mind. If I were on benefits I would expect to have to drink less!!!

A first step of capping benefits at £26,000 (the average wage) seems like a pretty good start. Bring on the Welfare Reform Bill. £26,000 is a high proportion of my annual wage. Hearing slackers like Ray and his bunch get it for free make me feel like a right mug for working for a living and going without to try and buy myself a few years out of work.

Hearing him whingeing about having to choose between heating and eating when outing the tobacco and the Sky TV would more than bridge the gap makes me want to slap him round the face with a wet fish and insert a bit of steel into his spine, and tell him to man up and sort out his responsibilities rather than moaning about his rights.

Oh and I’ve borrowed the concept of a complainypants from Mr Money Mustache. And tagged the posts about moaning benefit recipients as such. In the end if you get benefits, then that’s nice. Just don’t build a lifestyle on it, OK?

Why do I say that? Look at the words of Bill Gross from PIMCO where he asks where credit goes to die.

Where does credit go when it dies? It goes back to where it came from. It delevers, it slows and inhibits economic growth, and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this up as we go along for what may seem like an eternity. A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets – bonds, stocks, real estate and commodities alike – is now delevering because of excessive “risk” and the “price” of money at the zero-bound.

We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time.

Your frickin’ benefits are being paid from that abundance. Austerity won’t be paying them in future. Child poverty will reappear. All benefits will fade away. I’d be surprised if I get to draw a State Pension in 16 years’ time, it will probably be means tested and hopefully I will have too much capital, though Bill’s prognosis isn’t so good for that either. That is the trouble with relying on benefits – governments can take them away, just like they did for people that paid into SERPS who took the shaft recently.

So don’t have kids on benefits so that you get more CTC. You’re likely to see that kid go short over the next 18 years unless you get a job. The writing is on the wall, pal, and it’s going to stay up there for a long time.

We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time.

They aren’t – some firms continue to allow employees to drop previous SAYE schemes and reallocate the dropped scheme’s allowance to the current year’s scheme, up to the HMRC £250 a month limit.

This was how my company used to do it, and I always took the line to drop the previous scheme and reallocate to the current one if the current offering’s option price was lower than the previous scheme.

I backtested the efficacy of this approach, compared to the rolling equal allocation I’d have to use now. Turns out the orginal gut feeling to drop was right. Tragically I always spread myself across the 3 and 5 years schemes, failing to appreciate how much better the 5 year schemes were, because of the longer time in the market. So going with my gut was overall only half right, a reminder that for those things that are amenable to analysis, there’s no substitute for doing the analysis, which is what I should have done in those dark days of DOS and Lotus 123, way back in the early 1990s…

cumulative returns of differing approaches to sharesave, using FTSE100 index prices

No-brainer. Go for the 5 year scheme and drop underwater schemes. Note you should still test this with back-values from your employer’s specific share prices, sampled at the time of year your specific sharesave options are granted. This is using the FTSE100 as a proxy for the share price, and your industry may have peculiar cyclical patterns that just might make a difference.

It stacks up with my recollection. Feast in the barnstorming years of the late 1990s, mostly famine since then…

For this to be any use to you you need to be a worker drone in a company that is listed on the London Stock Exchange, and has a save as you earn scheme. In practice I think that means it’s probably  a FTSE100 firm. If your firm doesn’t allow you to reallocate previous sharesave allocations before the term is due, the original How to Use Sharesave SAYE post is more relevant to you.

Diversification is okay. I’ve sliced this by sector rather than geography. I have terrible geographical diversification in my ISA, 93% UK exposure. A lot of these companies are big fish so I am not 90% exposed to the UK domestic market, which would have me running for the hills. I have much more than my ISA in pension AVCs balanced 50:50 UK/emerging markets so I am okay with that geographical imbalance.

ISA diversification by sector, Jan 2012

The investment trusts are going to start to be a problem with evaluating diversification, unless I find a way of representing their internal structure.

There’s a theory that in a HYP you shouldn’t look at the capital value it’s hard to resist. Mine happens to be a little bit up on purchase cost after I take out the dividend income – it depends when you look at it so it’s hard to say how much. So the total value is constant, as inflation knocked 5% off the value of money. For comparison the FTAS is off about 3%, not sure what the yield on that is. At times in August 2011 my ISA was 7% down on purchase cost. There’s no real statistical significance I can ascribe to this with such a high noise level in the signal.

I bought shares in five different companies this year, added to an existing holding, and intruduced low level of index tracking to benchmark how I am doing in future. I will use more index tracking for foreign markets. It’s expensive to trade individual shares in non-UK markets for me and what the hell do I know about companies in emerging markets anyway. Something that concerns me is that index tracking is totally dumb money, and if it is targeting a popular index like the S&P500 that dumb money may unbalance valuations. I look at popular index tracking as a potential source of trouble for concentrated indices like the FTSE100 (which I don’t track in my ISA) or the S&P500, which I may track at some point.

what went wrong

I screwed up a few times and crystallised nearly a thousand pounds of losses, though I also crystallised about £500 of gains. Dealing costs this year were at most £90, there are no annual charges.

I should never have bought BARC, but at least saved my hide by acknowledging the mistake for the cost of a couple of hundred quid. The draw of my past history as a speculator sometimes breaks out. How am I to evaluate what is a fair price for a bank in this environment, FFS, especially a slippery bunch of characters like Barclays? I got sick of Aviva acting as a europanicometer, it fits most of my requirements but I couldn’t stomach the volatility. I should have either qualified the volatility first or held out for a lower price, which would make the volatility easier to take. I know that’s called price anchoring, but I can only fight so many investing character foibles in any one year.

Having two financials added a huge degree of day by day volatility. And I hate Euro exposure at the moment. No good will come of it IMO until people work out exactly what they want the Euro to do for them, and then do whatever’s needed to make it do that. Or surrender to the steamroller of the irresistible force of the market meeting the immovable object of the canard that is a unified currency without a unified government…

Other shares I’ve sold I should have let be and left them to mind their own business, reviewing what I thought at the time and what happened since. I move all sales to a ‘sold’ portfolio in iii to keep a watch on how that went. It is instructive, in general the right response to a sell urge (other than BARC) is to ignore it. Selling IAPD was daft, it wasn’t really doing any harm in my portfolio, it just a little down. D’oh.

Selling IUKD was good after I discovered it didn’t really match what I thought it did, ie value invest. IUKD can be ascribed to a failure of research and thinking, so the need to back out of it was reasonable, it’s better to acknowledge a mistake and correct it that leave it to fester. It’s also a reminder that income investing is inherently subjective, no passive approach is possible because of the problem of identifying and avoiding value traps.

what did I learn from 2011?

Overall, I seem to be OK on picking what to buy and a bit on the trigger-happy side in selling. If I’d taken Charlie Munger’s punch-card approach and just sat on my hands as far as selling I’d have done better, even after eating an increased loss on BARC. Guess that’s why Charlie is Warren Buffett’s wingman and not me, eh?

Becoming a better investor is largely about mastering impulsive tendencies and getting lost in the fog of war, I paid £500 for the training this year which isn’t so bad. Something I have noticed is it is far easier to retain equanimity in the face of individual variations once there is a decent number of holdings and reasonably sector-diversified. I have 12 holdings, though two are index funds and two are investment trusts and therefore internally diversified again. Half of these I’ve held since buying them in the first full year of having this ISA.

what went right?

The big picture did. For all the cock-ups, I consider I did okay and reasonably battle-tested the greater stability of income versus the volatility of share values. There’s no need for me to take along my CV to become a trader in the City of London, and I’m still a little way from matching unemployment benefit in income, but getting there.  In some ways investing against my worldview makes the exercise a lot more intellectual which makes it easier to stand back and learn. I’d hope not to look back at the end of 2012 and have repeated too many of 2011′s mistakes. Heck, there are no end of new mistakes I can explore this year

I was able to weather serious market volatility (and even buy into some of it) during the summer riots, US budget freeze-up induced volatility and general bad temper without taking too much of a hit. However, the Eurozone break-up is yet to come, and that will test nerves no end. The FTAS suffered a 50% fall from July 2007  to April 2009 so there’s precedent for some serious grief ahead.

2011 was a rough year, but I was genuinely surprised to find out I hadn’t taken more of a hit this year. For this year I want to diversify into oil, mining, and beef up utilities. The pharma didn’t start off so high, it had the temerity to quietly go away and increase of itself, so I’ll leave it be and go elsewhere this coming ISA year.

Geographically I could do with some US exposure, and maybe some AsiaPac again. I’m still just not going to do China, but India may appeal. Theory would indicate I should also increase Europe exposure, but I just can’t bring myself to do it at the moment. Temporal diversity seemed to work too, buying across the year rather than all at the start or all at the end smoothed some of the volatility.

unlike most people, I don’t invest for the world I expect

Keeping a clear head is difficult for me because my world view remains that industrial civilisation is running on borrowed time. Events this year seem only to confirm that the assumptions behind our economy are failing. Unemployment is still rising, to levels among the young that I have never seen.

To me this looks like the advance guard of globalisation and resource crunches reducing Western living standards. It will happen for the rest of the Western population by inflation as governments create money to service their promises to the electorate; “you will be poorer tomorrow that you are today” is not a vote-winning thing to say. Mervyn King claimed that we have averted a Great Depression. The time you can say that is when you look back at the darkened valleys from the sunlit uplands of the next bull market, not when growth has switched back into reverse and we are about to enter the second dip.

We have had an oil war in Iraq, another one in Libya, about to have another one in Iran. Oil is the magic that enables the myth of continuous growth, and the last decade has seen us add a huge number of people who want a slice of that action, just as production seems to be levelling off for the decline.

These problems seem to be inherent in industrial civilisation – as JK Galbraith said in The Age of Uncertainty

The present age of contentment will come to an end only when and if the adverse developments that it fosters challenge the sense of comfortable well-being.

Galbraith had another pithy quote, however, for those who would act on their specific worldview.

the only difference is between those who know they don’t know and those who don’t know they don’t know

I’m in the latter camp here, and the world has always had existential dangers that could finish it off. I therefore diversify world-views, and choose to invest as if I saw a distant sunny horizon.

Unlike some, who are upbeat enough to see sunrise as a bullish indicator I am fighting my beliefs to invest in the market at all. I have also diversified to non-financial investments to hedge against being totally wiped out in a financial firestorm, assuming some form of the rule of law still held. If it doesn’t, I just have to do the best I can with whatever I have to hand, you can’t save against that…

2011 had the London riots, and all over Europe we see high youth unemployment. Across the West the Occupy movement gives some expression to the feeling that something, somewhere is more fundamentally wrong. Greece is yet again to surrender more sovereignty to the technocrats, because the one thing they can’t do is take the hit for their uncompetitive ways through currency devaluation. I wonder if there is the scent of Steinbeck’s bitter harvest rising in the air

“In the souls of the people the grapes of wrath are filling and growing heavy, growing heavy for the vintage.”

I aim to become a better investor over time

Reviewing what happened, and discriminating between errors of judgement, and random noise seem to be the key here. I slowly grind out some of the  foibles and irrational predilections over time. I think it begins to show. Fortunately in the way an ISA works with the limited input, I was able to remind myself of some of the things that I should have learned in the dot-com bust with the least amount of money at risk. The road to self-improvement is rarely a straight line. The Delphic Oracle’s enigmatic  Know Thyself is the key here, so that when, eventually, my ISA holdings begin to deliver about half my income I should be a safer pair of hands.

So despite a naturally fearful and non-optimistic viewpoint, an ermine’s ISA survived intact and delivered most of its aims, indeed it’s the second year that the yield has been > 4% on purchase cost. Although I don’t use the income at the moment, it would be a decent bump up in tax-free income if I did use it.

One of the limitations of an ISA is also starting to make itself apparent. If I leave work this year, I will be spending several of the next few years trying to get money into the ISA in order to win a tax-free income from it. The money I’ve saved in pension AVCs destined for my 25% tax-free lump sum would take several years to shift into an ISA, and this year is complicated by a possible need to bed and ISA some of the sharesave shares. Next year I will also have to think about opening a S&S ISA with a different firm. I’m happy with iii, but I only want to fill it to about three-quarters of the FSCS compensation limit (*) of £50,000 to give it room to breathe in the forthcoming awesome bull run from 2015 to 2020 .

*Note FSCS compensation on S&S ISAs is against the ISA provider iii going bust, it doesn’t compensate me for making crap investment moves

At school there was the consideration of whether to go to university. At that time only about 7% of school leavers went to university, and I recall there being books with typical subjects and the sort of jobs that subject helped you into. I was academically capable enough and figured my choice was between electronic engineering and something wider, like Physics. I was totally unaware of any choices for university courses that weren’t part of the mainstream O and A level courses offered at school, which were English, Maths, Physics, Chemistry, Biology, French, German, History, Geography, Music and Art (though I don’t think the school did either of the last two at A level). I chose Physics rather than Electronic engineering because there seemed to be a wider range of jobs possible.

What puzzles me about what university students are increasingly studying is that it seems to be for specific  things that offer little potential for employment.

change in university studies, 1996 to 2010

I’ve taken that from this Higher Education Policy Institute report, which I chased up after reading this and this because I just didn’t believe people would do something so bizarre.

If you consider the red line as the baseline (because the number of students was increased by 50% over the Labour administration), what are people really getting into? Nutrition, Journalism, Architecture, Drama, Philosophy, Politics, Marketing.

What are people really getting out of? Production and Manufacturing, American Studies, Agriculture, Sociology, Ophthalmics, French, Computer studies, Social Policy, Software Engineering. Science and Engineering of nearly all sorts is in retreat.

Now we are in a financial storm, and people need to find a load of money to go to university nowadays. What kind of jobs do Drama, Nutrition, Journalism set you up for? Newspapers across the country and shrinking,the Guardian seems to be going titsup, the theatre never makes money and the Arts Council has less taxpayer’s cash to flash around, and there are only so many nutritionists that Britain is going to need in a recession.

There’s more rationale for what people are getting out of. There’s no need for Production and Manufacturing in the UK unless you’re aiming for the high-end, and the sort of thing you needed Computer Studies and Software Engineering for are going to be done in India and eventually Africa.

There is far more information available to prospective students and their parents today, though there is also more uncertainty about what will be in demand in future. For all that, I’d expect people to be running away from what they’re getting in to, for the simple reason that it’s hard to see why people would spend a load of money studying for a dying field (journalism), or one that’s never made money ever (drama). Architecture and Marketing? maybe. The wholesale retreat from the sciences bodes ill for Making It In Great Britain as Saint Vince Cable would have us do. A double whammy for this project is demographics. There will be an awful lot of engineers and scientists from those white heat of technology days who will be quitting the workforce in the next 10 years. Hopefully that will mean opportunities in these fields but if graduates aren’t studying these subjects then those opportunities will go to waste and be exported. They may well be exported anyway, of course, if someone is looking for what to study they should perhap try and get a more accurate analysis of opportunities. The number of budding journalists looking to dive into a shrinking industry indicates this doesn’t happen, unless there is something I am seriously missing.

UK Personal Finance Blogosphere, Source: www.moneysavingchallenge.com

It’s reasonably obvious that frugality is at the opposite pole to consumerism, and indeed money management is also an antidote to consumerism. It did make me wonder, however, wherther frugality is a hazard to growing wealth. Although it’s a small sample, it indicates that British personal finance is sparser on the growing wealth axis than the American PF scene. Although the American Dream has taken a serious hit over the last few years, perhaps the myth of continuous progress is helping people in the States feel more chipper about their plight.

Some of the same optimism, though in a more understated British way, is displayed by Monevator who is still upbeat by the end of Gruel Britannia, leading one commenter to observe he may “see sunrise as a bullish indicator“.

Perhaps that’s where I’m going wrong…  There is also the implication that frugality is not necessarily the best way to growing wealth, and this is another notable difference with US perspectives, there tends to be a stronger bias to increasing your income rather than cutting spending. This wasn’t my experience; I only started to build significant financial assets after taking an axe to spending. For most of my working life I was building non-financial assets, in particular buying out my mortgage. Cost control worked for me.

I also observed an interesting gender distribution on the plot, let’s just say that the distribution does not appear to be gender-neutral to me. And that’s all I’m going to say on that front, but it is interesting what areas are focused on by the ladies and the guys For the sake of clarity, I don’t think this is because MSC imposed this distribution, I’ve observed it in the PF blogosphere as a whole.

The idea of sharesave is to encourage employees to take a share in the company, all considered A Good Thing. They’ve been running for years, I recall my Dad doing these. If your company offers one, they are a no brainer, do it, do it now, and do it to the max (£250 per month), as long as you don’t go into debt and have cleared your consumer debts other than mortgage. Once you have five year’s worth of contributions, you get that one way bet at no extra cost. It’s rude not to take part in an offer like that

Caveat employer… don’t hold shares in your employer longer than you need to

You should generally avoid holding shares in your employer other than as part of sharesave or share incentive plan (another wheeze like SAYE, without the one way bet but with big tax advantages). That is because if your employer falls on hard times not only do your savings take a hit due to the share price bombing, but you are more likely to lose your job. The only exception I can think of is if you believe your employer is likely to be bought by another company, which is usually terrible news for employees but can be associated with a share price hike. It’s still a long shot and there are better ways of preparing for redundancy…

For a similar angle but from a bunch with more financial clout than me, see the FT on will you buy into the John Lewis economy on the hazards of over-exposure to your employer. Think Northern Rock when you fancy holding onto shares in your employer longer than you have to…

What’s so good about sharesave?

The reason sharesave is a no brainer is that it makes you the kind of offer you will never get anywhere else, a one-way bet on shares. The worst you can do is simply end up saving cash for three or five years.

What happens is in any year you are offered the option to buy shares in three or five years time at a price fixed at near what it is now. You start a monthly savings plan for up to £250 p.c.m. post-tax allocated in any proportion to the three and five year schemes. In five years time if the share price is higher than the option you exercise the option and then sell the shares immediately, pocketing the difference. Obviously if it’s lower you don’t exercise the option, and say I’ll have my cash back thank you very much, with some interest added usually. In a slightly depressing observation on the financial acumen of some of my workmates, I’ve known some people exercise the option when it isn’t in the money, and that’s even after the firm has added a letter to the maturity note saying you should note you can buy the shares cheaper on the open market. There’s no helping some people

In the past it was easier because you were able to drop schemes where the option price was higher than the latest offering, but HMRC has stopped that wheeze, (No, they didn’t, just some accounting changes made it so letting employees do that cost the company. See this comment for details. If your company still allows you to drop a scheme and reallaocate the savings allocation to fresh schemes, then you want to read How to Use Sharesave Redux) so though you can drop a scheme you aren’t allowed to allocate that monthly allowance to later schemes until the original term is up. This means you need to think first before acting, to avoid stiffing yourself further down the line.

How to play sharesave to best advantage

First you need to ask yourself realistically how long you expect to be working for this firm. If it’s only for five years then buy the three year scheme for two successive years, £125 a month in year 1 and the same amount in year two (i.e. £250 in total in year two and three, then £125 in year four). However if you are looking at working there longer, then you need a plan.

Diversification is still your friend with sharesave, even though you are only dealing with one share. What everybody seems to miss, is that you have two temporal periods (3 and 5 years) and the chance to sample the share price every year.

What you don’t want to do is look at the option price for the two schemes in the first year, decide the 5 year scheme is cheapest, and lob your whole £250 savings into that. You want to maximise the diversity of your time-slots.

Diversify your temporal risk

You also want to maximise the amount of time you’re in the market, so if you are going to be a lifer in this firm (or even aim to work there for a decade) then buy £50 of the first year’s 5yr scheme, £50 of the next years 5yr scheme, and so on. After five years, your allowance for the first year’s scheme will come free as it matures, and you can allocate that to the sixth year’s SAYE scheme. If you sell as soon as your options mature, assuming they are in the money, then you will have the cash to allocate to your next allowance, so this one-way bet is now free.

You can do that instead with the three year scheme, but your options will only be in the market for three years rather than five, which reduces the amount of time your cash is in the market exposed to that one-way bet.

I simulated this using the FTSE 100 index as a proxy for a typical blue-chip firm offering a sharesave scheme.

yearly Sharesave returns if the company followed the FTSE100 index

and the cumulative profits over a 20 year period:

Cumulative sharesave profits over 20 years

The cumulative profits understate things because of inflation, and it also shows the heady profits that were to be had from the stock market in years gone by, the fat years after the early 90s recession up to the dot-com boom, then the 10 lean years from the dotcom bust to now…

The pattern is familiar, I made most of the money from sharesave in the years leading to the dot com boom, and very little in the decade after. Unfortunately there was corporate action for my employer in 2001 which means I can’t get a historical time series back to 1990. The ride was a bit more choppy than this graph shows, and sadly I didn’t realise that the 5 year schemes are so much more valuable than the three, so I did a mix of 3 and 5 years.

Watch out for specifics

The industry your employer is in doesn’t necessarily have the same statistics as the FTSE100. It’s likely to be a damn sight more choppy – I know my company is. So it may be worth simulating the last decade or so of price data for your firm. Here is the spreadsheet I used, exported to Google docs. There may be cyclical patterns in your company’s share price that make some of the assumptions break down. Having said that I’d have done fine running rolling five years sharesaves with my employer’s shares.

Don’t go with your gut

I learned something from writing this post. From a gut feeling, I had gone for diversifying the period, buying a mix of 3 and five year schemes. I had not realised until now the fact that the 5 year schemes give me more time in the market and how valuable that was.

This may have been offset by the fact that for my entire sharesave career I was able to drop previous schemes where the option price was higher, and reallocate the allowance to the more advantageous sharesave scheme. HMRC disallowed that in 2009, so you won’t be able to do that. Now if you take out a 5 year sharesave scheme even if you stop saving you can’t reallocate that allowance until the original 5 year term is up.

Responding to exceptional share price events

My employer had a near death experience which resulted in some pretty nasty management practices. Previously I had assumed I was going to carry on working to 60 at that time, but one particular incident showed me I was unlikely to make the course, so I switched all effort into saving up to be able to retire early. This near death experience slammed the share price in 2009, so the option price on that sharesave was very low. Though I didn’t know if I would still be working there in 2012, I dropped every single previous sharesave and threw everything into that year’s sharesave, with half the money allocated to the 3-year and half to the 5-year scheme. Obviously I have to put a lot more per month into the 3-year scheme as you only have 36 months to buy your shares, as opposed to 60 months. The aim is to have an equal monetary stake at the end. This works out to £94 in the 5-year and £156 in the three.

The principle is that you don’t know what will happen in 3 or 5 years time, so I want to bet on both horses. Say the Euro blows this year, then the 3 year options might lapse but the price on the option maturing may be lower. In that case don’t execute the option. There’s still chance for some of the storm to blow out and the 5-year option to come good. Although I don’t expect to be working there when the 5 matures, once the scheme has been running for three years then under some of the circumstances I may leave I could make it paid up.

If the 3 year option matured tomorrow, I would do very well out of this sharesave, indeed I couldn’t liquidate the shares without becoming liable for capital gains tax, which would be a first for me. I believe that the Euro is doomed beyond redemption, and that the denouement could very well happen this year.

So I have gone to IG Index and shorted half the number of shares I have options in. Barmy, you might say, why the hell short something I own, but that has the effect of locking in half the options at the current price. If they go down I make a profit at IG to compensate, if they go up I have to pay IG but I get more selling the options. I’m prepared to pay that as insurance. In three month’s time I will short half the remaining half, assuming it makes sense, to lock in the price for three quarters of the shares.

Spread betting comes with an extreme wealth warning, but it’s the right tool for the job here. Another case where you may want to short a stock you hold is to avoid eating a capital gains hit. Just carry on holding the shares and short them, buying the short and the number of shares you own / 100 (because IG prices move £1 for every penny the share price moves, with you rescale back but selling 1/100th of the amount). If nothing untoward happens I may have to do that in August; sell half the shares to avoid the CGT liability and roll over the IG short on half the total which I will still hold, eliminating my exposure to my employer without selling the entire stake.

Spread betting works for the tax-free employee share incentive plans too. With these, you buy up to £125 of shares from pre-tax and NI income, which you have to hold for five years before you can sell.

Sadly, this is another trick I missed, so some of the shares I hold went through the near-death experience, though they’ve come back up. I could have shorted thse guys as I bought them every month, taking the tax-free bump up and protecting my purchase against the vagaries of the stock market. However, it just goes to show one of the dirty little tricks of capitalism. By the time I got experienced enough to spot this insurance scheme, I’m about done with the opportunity to use it. As a colleague once wryly observed, money is drawn to money…

Optimum pension contribution rate from the paper referenced by the FT. There is some similarity with my AVC contribution rate.

I was tickled to read in the FT that maybe we’re not so daft after all. Why Starting a Pension Early Could Be a Mistake originally appeared in the Financial Times  Merryn Somerset Webb puts far more accurately succinctly what I’ve been driving at with Compound interest is Overrated.

I was probably wrong – compound interest is all very well. Why it doesn’t work as well as people like to make out is that in your twenties you can’t put any decent amount of money into a pension, because of where you are in your financial lifecycle. You’re not earning much, so the basics of life are a higher proportion of your outgoings. And you’re starting out in life, so you aren’t as financially savvy as you may get, plus you have to buy lots of stuff to establish life as an independent adult. Merryn gets to the heart of the matter

We all think that we should start saving into our pensions from the moment our first paycheque hits. But it turns out that if we were “rational life-cycle financial planners”, we would wait until we are into our mid-thirties to save.

Everything we do financially should be to maximise our standard of living over our life cycles. In our early career years, when our earnings are low, we compromise our living standards if we save.

So we should consume our initial incomes and then step up savings as we earn more: with the percentage rising from zero before age 35, to 30-35% as we head towards 60.

Now I haven’t followed that exactly, but there has been a huge increase as I’ve got older. And as Merryn intimated, it gets so much easier to save as you get older, though with the caveat that having children and aspiring to help them with university costs can put the kibosh on that. Previous generations  became financially independent of their parents as they came of age, making saving easier for the parents once they got into their 50s.

The takeaway isn’t that you should blow it all in your 20s – you should still be saving or building capital. Either in house equity if that is your bag, and you expect house prices to continue rising (why?) or in financial instruments to give you a passive income, which is equivalent to home ownership reducing your housing costs.

It’s hard to know the benefit of not having housing costs until you experience it. In my twenties I perpetrated the biggest misallocation of financial resources in my whole life by buying a house at the peak of the market, signing a mortgage document that was to be discharged in February 2014.

That screw-up was redeemed by paying down that mortgage about six years early. Not having to pay the mortgage means I can save much faster, for the simple reason that I need access to far less of my salary. Using salary sacrifice I can stop the Government stealing a lot of my pay, allowing me to save two year’s gross salary in three years by booting much of my salary into pension AVCs.

I don’t have to live on thin air I live on an annual expenditure of less than the national minimum wage, but I have a standard of living that is much higher than you’d expect from that because I am using the accumulated capital from earlier years.

That is why compound interest doesn’t benefit me much in investment, I haven’t got the 40 years it takes to do anything useful at a 5% compounding rate – but that doesn’t greatly matter. I focused my investment as a young man in paying down my mortgage debt. That is still working for me – by dramatically lowering my costs so I can save and invest now.

Investing is a dangerous game, particularly for the young-ish and optimistic – I was slaughtered in the dot-com bust, largely from being too hot-headed and not knowing some of the ropes. You can get round some of that as a young investor by using passive investing, provided you start at a good time when equity market valuations are cheap. If you passively invested in the dot-com boom you’d still have been slaughtered in the last ten years, just not as quickly and perhaps not as comprehensively as I was. (edit – no you wouldn’t – see this comment for why)

Am I a better investor now? It’s impossible to know without looking 10 years ahead. I have better guidance, I have the learning from last time, and I am richer, so I won’t become a forced seller because I have more than half my non-pension savings as cash. I diversify by sector and to some extent by geography, though not financial asset-class, I’m either an equities guy or into non-financial assets. Well, apart from cash, I guess.

It surprises me that there’s so little said about life cycle financial planning. If you’re wealthy enough to be doing financial planning, you will probably experience a similar sort of life cycle. Yes, timing will be different for people who have children, but the arc of the life-cycle will still follow similar stages – you’ll probably be skint and capital-poor when young, you’ll be better off though probably with more dependents when middle-aged, then more capital rich but with a lower income when older. Saving 5% of my salary was a much bigger ask in my 20s than saving 70% of it in my 50s.

I was lucky in a lot of aspects, despite being hopelessly incompetent with the housing market.  Rolling with my financial life cycle was probably one of those pieces of luck. I didn’t sit down to do it at 30, though some of it was instinctive in following the financial life-cycle of my parents, who discharged their mortgage when my Dad was in his late 40s, earlier than me.

Someone in their early 20s who takes Merryn Somerset Webb’s article and uses the information with self-knowledge, determination and persistence could do well by maximising their life-cycle standard of living. Of course, the need for self-knowledge, determination and persistence at 20 may be the rub. I struggled with the self knowledge, else I would have listened up and not bought a house at a market peak because I wanted out of the endless having to move because of other flatsharers’ life decisions.

Anyway, in one sense I was wrong about compound interest being overrated. It’s great. It’s just not useful to most of us who start out their adult lives skint and with massive claims on our income for the necessities of life. Obviously if you start work at Morgan Stanley in your twenties, fill your boots and all the great stuff about compound interest will come good for you.

References

For the more analytical, the Pensions Institute papers referenced by the FT are

Age-Dependent Investing: Optimal Funding and Investment Strategies in Defined Contribution Pension Plans when Members are Rational Life Cycle Financial Planners by David Blake, Douglas Wright and Yumeng Zhang (Sept 2011)

and

Target-Driven Investing: Optimal Investment Strategies in Defined Contribution Pension Plans under Loss Aversion by David Blake, Douglas Wright and Yumeng Zhang (Sept 2011)

Equity funds saw their largest outflow on record, with net outflows of £864 million in November, compared to a monthly average inflow of £506 million for the previous twelve months. Equity funds have seen net outflows in four of the last five months, following over two years of net inflows.

For the third month running, the highest selling asset class was Bonds, with net retail sales of £443 million, above the monthly average of £332 million for the previous twelve months.

Balanced funds were the second highest selling asset class when excluding the ‘Other’ category. Net retail sales of Balanced funds totalled £262 million in November, the lowest since April 2009 and well below the monthly average of £493 million for the previous twelve months.

The message is clear. Buy equities this year   I was so chuffed on reading this I caught up with my regular purchase of a FTAS and a global EM tracker funds which had gone astray over the Christmas break. As Warren Buffett  said:

Be fearful when others are greedy, and be greedy when others are fearful.

Looks like people are fearful…

What did we learn in 2011 – well, the drumbeat of bad news continued, we learned the Euro was pretty much shot to bits and heading in the wrong directions. We learned we are poorer than we thought we were, we learned in August that shares could go down as well as go up, as if we’d forgotten from 2008… We observed some creative solutions to the problems of inflation in the summer, unfortunately somewhat at odds with the law.

We learned an awful lot of people in Arab states were mightily pissed off with their lot, we learned that we could bump off dictators like Gaddafi but as usual we weren’t so good at putting something better in its place (cf Afghanistan, Iraq). The trouble is the West is too economically and imperially weak to invade and hold and transform a situation, some of us (well, the US of A to be honest) can project force, but we hate the messy part that comes afterwards. Iran seems to be the next place for an oil war, and those North Korean dudes seem to be genuinely barmy despite no doubt being useful to their northern sponsors, but at least they haven’t discovered the elixir of eternal youth yet.

So what of next year? We seem to be coming up against a bifurcation. Established economics would have it that 2012 will be a pretty rough year but that it should be a turning point. On the other hand it could also be a different kind of turning point, where we discover that capitalism is beginning to eat itself as Karl Marx foretold all those years ago, as it continues to destroy the jobs and livelihoods of the people that it needs as consumers. Like so many things, some is good, more is not always better. Or it could be time to consider surrendering to the forces of peak oil and perhaps engineer an economic system that doesn’t demand we consume more and more consumer tat and make up for the empty feeling inside with Prozac, there has to be a better way.

This is becoming apparent as the shocking youth unemployment and rising joblessness. It is hard to say where that is going, it is a bad combination with an education system that has been debased and which seems to take as its most important job bolstering its customers’ self esteem. Sometimes it is better to know that you are stuffed than to just feel good about yourself, as knowledge leads to effective action. We have been here before, it was pretty rotten to look for a job in Thatcher’s first recession, and the 1990s one was no fun for jobseekers either.

For me, 2012 is the year that, after three years of frugality wins me the second goal of financial independence, assuming, of course, that there is still a financial system to be independent in The first was reached nine months ago, when I could survive on the stored capital. This New year feels like the last leg of the journey started in February 2008, when I listened to a twerp of a line manager try to pressure me, and I decided that I needed options in future, in particular the option to call punks like that out and tell him that while he may be desperate for the money, not all of us buy our middle class lifestyle on a tower of debt, and I think my own way and dream my own dreams.

So now I am on the final approach, and it does feel like I am gradually surrendering the potential energy of a dynamically unstable job for the lower energy but more stable position of my final aim, to be independent of working for a living.

My hopes for 2012 are personally, to be able to stay the course until the third quarter of the year. Two and a half years ago I took a chance, to carry on and risk crashing and burning, and so far it has worked out, and a lot of luck has favoured my journey. The road is getting harder all round, however. One of the pieces of luck was to get on a London 2012 project, which will be a great swansong for my engineering career.

More generally it is that we find out whether this financial crisis is a financial crisis or something more serious, in that the assumptions behind an industrial economy are starting to break down.

Finally, what we desperately need is for enlightened leadership to rise to the surface. Not ‘strong l’eaders, but a political leadership that can see the wider picture and is not so craven as to endlessly tell the people what they want to hear. There are some serious challenges coming in the years and decades to come. We would all like things to carry on as they were, but sometimes we need to recognise that isn’t possible, and then to take decisive and effective action to adapt and select one of the better alternatives.

I did this in 2008, realising that working for another 12 years until retirement would come at a significant cost to my well-being. I had the advantage of being just one person. As nations, there are a lot of areas where effective leadership is needed, In Europe, the people of the Eurozone need to decide whether they have sufficient common cause politically to make a political union that reflects the economic union. It would be good if the politicians, particularly Merkel and Sarkozy, were slapped around the face with a wet fish often enough that they got to understand that it would be really good if they asked people first, before implementing it. I am not sure that this process was done in the creation of the Euro, and repeating the undemocratic exercise makes me uneasy.

If the people aren’t up for it, then it is time to back away and unravel the Euro, carefully. Because it seems pretty clear that without political union monetary union with always fail Europe in times of financial stress.

Closer to home, we need to decide how we want to earn our living in the UK. We can probably rebuild the banking edifice, though we could do well to diversify. I am not sure that the time is right for us to go down the line of making things again – time and time again it disturbs me how many of the principles of logical thought and basic engineering seem to have been lost from professional life in the UK.

If there is one things I’d like us to achieve in the year ahead, it is to find a way for our economy to give decent jobs for most people to do as Obama called out in his state of the Union speech earlier this year. At the moment we are racing headlong into a winner-takes-all world of work, where most people will end up unemployed and a few will reap most of the rewards. Though chaotic and unstructured, there are sounds of dissent as the ’99%’ feel this without understanding. We need to apply understanding. It may be possible that having most people unemployed is the only way an efficient modern economy can work. It’s not necessarily a bad thing – the 1970′s dream of a life of leisure I was sold at school and that Keynes foresaw  doesn’t sound that bad, and heck, this is what I have been striving for this last three years. Work just isn’t all that. However, we must then change a lot of the incentives and designs of society – Martin Ford has given this a lot of thought, n particular how we deal with a world where most people are not capable of being employed usefully  in his scenario where the majority of jobs have been automated away.

It takes brilliance to see the possibilities when all around seems lost, just as JM Keynes, standing at the depths of the Great Depression when all semed lost in 1930, wrote Economic Possibilities for our Grandchildren.

But beware! The time for all this is not yet. For at least another hundred years we must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still. For only they can lead us out of the tunnel of economic necessity into daylight.

I look forward, therefore, in days not so very remote, to the greatest change which has ever occurred in the material environment of life for human beings in the aggregate. But, of course, it will all happen gradually, not as a catastrophe. Indeed, it has already begun. The course of affairs will simply be that there will be ever larger and larger classes and groups of people from whom problems of economic necessity have been practically removed. The critical difference will be realised when this condition has become so general that the nature of one’s duty to one’s neighbour is changed. For it will remain reasonable to be economically purposive for others after it has ceased to be reasonable for oneself.

The pace at which we can reach our destination of economic bliss will be governed by four things-our power to control population, our determination to avoid wars and civil dissensions, our willingness to entrust to science the direction of those matters which are properly the concern of science, and the rate of accumulation as fixed by the margin between our production and our consumption; of which the last will easily look after itself, given the first three.

It’s hard to see how this could transpire, looking back over 8 decades, and decades in which we have very definitely failed to control the human population, or eschew wars. I hope his vison was clearer than mine, and he simply called his solution to the economic problem in a bit early

Happy New Year, and may 2012 be good to you!

I didn’t. I effectively started at 28, and even worse because I want to retire early I effectively started later in my working life. For a normal worker in my industry retiring at 60 I would have been saving for 32 years whereas I’ll be lucky to reach 25 years. I’m therefore like a normal worker starting at 35. Because my company pension is a final-salary one, the difference is less than it would be with a DC scheme. However, I’ve had to make changes in the last three years to try and make up for the difference.

Because I own my house outright this has been easier for me, and it make me wonder if the standard advice is simplistic, and people should take a systems approach to their lifetime finances. In a later post, I will try and work out what proportion of income I did spend on the various key aspects of life (housing, hedonism, tax and pensions). The information isn’t precise for some of the early years, and yet I believe it shows that as long as you do save for some key asset classes in your 20s, it doesn’t have to be a pension in those earlier years.

I’ve analysed  my working life, and mortgage, rescaling values to eliminate the scourge of inflation which makes it so hard to compare values over a thirty-year working life. Here, I have looked at various pension saving scenarios and how they would work out, as if I were saving into a defined contribution pension at 15%, about twice the rate of NEST’s 8%. Defined Benefit (final salary) pensions are better than NEST largely because more money goes into them, usually from the employer so it is not always visible to employees. However, a pension is deferred pay, so two employers both offering  the same salary but one offering more contribution to a pension are actually offering different salaries.

First off, an extreme wealth warning. If you are in your 20s and looking for an excuse to live it up at the expense of saving this is not your ticket to ride. You have far more unknowns ahead of you that I have in describing this story, because I am in my early 50s and my career trajectory is known. If you’re young and you use this to justify not saving your 8% of income into a pension then you need to save 8% of your income into some other asset, and assets do not include most of the things you might want to buy

I got into deserved hot water over here for the assertion that you can make up for a lack of saving in your 20s, and that compound interest will not necessarily ride to the rescue. Not because I didn’t get away with it, but because

@ermine — Thanks for the follow-up. I’m going to argue strongly against what you’re saying, for the sake especially of young readers reading, as I think it’s dangerously misleading.

[...] I don’t want Monevator to help put people on the exactly the opposite path that I set out to postulate, and that we post on every day – i.e. at a minimum, realistically aiming to achieve financial security within their lifetime, or better yet some financial freedom.

Consider yourself warned young person, Monevator is right in that you can’t know until you are 50 that you won’t take some important hits I didn’t. I am looking back over my working life and I know what happened. Young reader, you are looking forward over an unknown career arc. You may have less luck that me. In particular, if you are a woman in your 20s do not follow my path. I will explain why later, but you are exposed to more serious risks statistically that men at the same age. It’s not feminist, it’s not fair, but it seems to be what happens, and you should protect yourself against the world as it is, not as it should be.

Having said all that, I consider this pretty clear proof that the magic of compound interest is not all that it is cracked up to be, and that is is perfectly possible for someone who has a career path similar to mine to catch up for the lack of early pension savings in ther 20s. Observe that I did not accumulate any debts in my 20s, and my savings went towards putting down part of a 20% deposit on a house I stupidly bought at the height of the Lawson boom. For all the good those savings did me I could have drunk it all in the Television Centre bar and had twice yearly holidays in the sun, but I stuck with just reasonably excessive drinking and one holiday most years.

The community that can take inspiration from this analysis is the one of the greybeards who didn’t follow the recommended route, and delayed saving till their thirties or even forties. As long as they didn’t screw up with debt, and as long as they paid their mortgage down at the recommended rate, they can recover without working till they drop, through the application of ERE’s methods, but perhaps calling it Earlyish Retirement Extreme

Setting the scene – how I simulated different saving approaches

To try and make sense of the last three decades, I have taken my salary and normalised it to 1 for my first proper job with the BBC in 1984. I am British, and unlike our American friends I just don’t like talking about how much I earn. Regular readers have probably roughed it out by now, but you ought to have to work for it.

I’ve then rebased everything by scaling for inflation using the RPI index, setting that first BBC job to a nominal value of 10000 pounds. In the RPI adjusted world I have created, that 10000 pounds holds its value across the three succeeding decades, because I deflate prices and my salary by RPI inflation.

an ermine's inflation-adjusted income and mortgage stupidity

You can see that over the years I improved my income in real terms by over two times. The dip in 1987 was when I took an MSc with a Manpower Services Commission grant. You can also see that the ermine is taking a hit from the stinginess of my employer and the rampant inflation of late towards the end. The actual high-water-mark of my real income was in 2008.

I’ve also represented my mortgage on that. Look at that awesome income multiple of what, 5 times? Millennials and the Priced Out generation take note, I had to stump up a deposit of about 10% to bring that multiple down to within spec so my debt was lower. I then had to borrow another 10% interest-free on a credit card advance to avoid taking the shaft from high loan to value insurance, which I paid down in the first year. Whenever it looks like a good idea to pay more than 4*salary for a starter house, STOP. You are either earning too little or paying too much, just like me What isn’t shown here was I had an endowment mortgage which I only managed to conclude a mis-selling case on in 2004. Friends Provident sold a single ermine with no dependents a life insurance product, FFS. Fundamentally I shouldn’t have been so stupid, but at least I did get the situation restored to what a repayment mortage would have been (the endowment had fallen behind by 1/3). That payment from the endowment is why it looks like I robbed a bank in 2003/4…

Although I was a feckless young ermine, taking my BBC final salary pension as a cash lump sum on moving to my current company, I am lucky enough to have been in a final salary pension scheme since then for the rest of my working life. Taking a leaf from SG, I have simulated that pension with a steady pension saving rate of 15% from my rebased and inflation-free income, compounding at 5% which seems a reasonable estimate for the long run stock market total investment return after inflation. Mind you, someone who has been saving using an index tracker over the last decade may take a dim view of that 5% assertion! I’ve then modelled how various different variants of me would have done with different pension savings strategies.

Meet the Cast of Characters

Steady Eddie

First we have Steady Eddie. He starts work, saves his 15% gross into a pension scheme from 1983 until he retires at the end of 2010, 27 years later. He is the benchmark for how you should save into a pension. In all these graphs, the magenta bars are the parts contributed by the magic of compound interest. Note that most of this is Eddie’s own saving, though I do agree it would be churlish to deny the value of compound interest, as it makes up 48% of his pension capital.

Steady Eddie. Take it slow, Eddie, this is how pension saving should be done

He has experienced the same career progression in real terms as I did, so he earns just over twice as much as a greybeard as when he got his first real job. I normalised his wages to £10000 in 1984. I don’t count my very first job as that was a poorly paid technician post; I started looking for work in 1982, into the teeth of Margaret Thatcher’s first serious recession, so I took the first vaguely relevant job I could get. Eddie is sitting pretty with a pension of 6554 pounds in my normalised universe with a pension capital of £131000. That’s slightly under 40% of his average salary and 28% of his final salary. I am lucky; if I left and drew my pension now I would get a higher percentage of my final salary, and I am duly grateful for my good fortune in that I have had a stable job that has been interesting and rewarding for the vast majority of my time there, regardless of things that may have gone wrong in the recent past.

 Sensible Susan

The only lady in the bunch, Sensible Susan follows the same path as Steady Eddie for 11 years. Ball-breaking feminists are going to hate this, but she then quits work to have children.

What can I say? I’ve observed it happen that way often enough, and even if Susan returns to the workplace the missing years are critical to one’s career deveopment. Though my pay didn’t go anywhere in real terms in my 30s the projects I worked on built the platform on which I got the next decade’s rises. However, since she was sensible, Susan has built the classic early starter ‘magic of compound interest’ example of saving for ten years and stopping. Except I’ve had her save for eleven years, because I took time out to to an MSc in 1987 and it seems a bit tough on the Sensible Susan version of me to KO 10% of her earnings as well as well as have her stop work early. Articles like this,  this and this lead us to believe that the magic of compound interest will save her pension, but a casual inspection of her savings graphs relative to some of the later more feckless versions of me will show that just isn’t true. I have kept the vertical axes the same scale.

Sensible Susan - the magic of compound interest (magenta bars) works for her but it doesn't make up for the serious lack of contributions

Sensible Susan is on less than half of Steady Eddie. Compound interest makes up more than half her pension capital (66% of a total of £53000). She’s going to feel the pinch with less than half the pension of Eddie. On the other hand, she’s contributed less than a third of Eddie’s contributions. That she is closer to half than a third of his pension speaks something for the magic of compound interest but no way as much as you’re led to believe.

Feckless Freddie

He’s a lazy B’stard, our Freddie. He spends far too much time in the BBC Television Centre bar eyeing up the beautiful people of the luvvie set, who are far prettier, and, er, of the right sex, than the hairy-arsed engineers in the bowels of TVC where he works. As a result, he doesn’t realise till too late that London prices appear to be getting away from him. One day he ends up in the Broadcasting House bar (a classier lot in those days, the Radio types than Freddie’s Television Centre chums) and listens to yet another gorgeous sylph-like Rebecca and her pretty-boy BF talking about how much the price of their house has gone up and “oh gawd, Tarquin, ahhhrn’t we rich, dahlink”. On the radio Freddie hears Elvis Presley singing “We can’t go on like this”.

and thinks to himself that yes, London, we can’t go on living like this, I am caught in a trap. As Freddie pulls his head from yet another pint of E.S.B. he looks up and gets his coat. Freddie figures he needs to go up the value chain a bit from being a studio engineer, and get away from the city that won’t let him live in it without paying exorbitant rent. After a Tube journey he gets on his bike to cycle up the Western Avenue from TVC to Hanger Lane, and thinks about a research job with more pay and a chance to buy a house. But first he needs to fix his ropey Batchelor’s degree. When he gets home he notes the beginnings of a gleaming white pelt starting to show.

Yup, Feckless Freddie was me. I did the MSc, returned to London for a year then moved up to Suffolk. House prices were still sky rocketing, and I had to get on the ladder before it became out of reach. Oh dear…

I did investigate whether my BBC pension could be transferred to my current employer, but it didn’t work out. If I had those three/four years they’d be useful but I’ve been here long enough it isn’t a huge amount. As a deferred pension it would be diddly squat, as it is referred to my final salary on leaving the BBC, so even if it didn’t lose over the years to inflation it would be referred to as final salary less than half of the one I retire on. So I used the £700 surrender value to a good purpose towards the deposit on the house. Oops…

So how does my alter ego Feckless Freddie get on?

Feckless Freddie and his Frantic Antics at the end

The three yellow bars are the savings I have managed over the last two and a bit years, effectively twice my gross annual salary. If we ignore these, we still see that Feckless Freddie has an accumulated pension capital of £78000, less than Steady Eddie but still a lot more than Sensible Susan. Why is this? It is because twenty years of compound interest doesn’t make up for Susan’s shortage of contributions, and this is made a lot worse by her lack of the boost provided by career progression.

It is the weakness of compound interest at realistic rates of real return, combined with the fact early pension contributors are contributing from a low earnings base that means all those stories about early starters staying ahead are just wrong. Feckless is obviously feckless, because he is about half short of Steady Eddie. However, he’s paid off his mortgage by the end, so he can now hit the tax-advantaged pension savings hard. His risk of the government shafting his plans is reduced as he is within a few years of drawing his funds, and the tax-free-pension-commencement lump sum could be just the ticket to make up for his fecklessness earlier. Feckless Freddie ends up with £129k, compared with Steady Eddie’s £131k. After three years of austerity, Freddie can sign up for his pipe, slippers and cruise brochures too.

The fact that Freddie ends up with the same as Eddie isn’t totally coincidental. I targeted making up for the lack of pension contributiuons due to my missing years as well as compensating for retiring early. I can’t compensate for both unless I work another two or three years, but I can eliminate one. The bar was set by what my own pension would be if I stayed to 60. My assumed real rate of return was 5%, and though I can realise that as dividends I don’t believe I will get a total return of that much even though I have bought mostly since the crash, and a lot at the early 2008 low. I think my share capital value will fall behind inflation in the years to come, but this will hopefully happen slowly so if won’t kill me off in the period between leaving work and actually drawing my pension. If my share capital and dividend income starts to get nuked, well, that’s why I have about the same amount as my shares ISA in cash savings, because there is the mother of all economic shitstorms coming our way. I won’t be a forced seller in that intervening period unless the value of that cash is destroyed because this sort of thing happens.

Looking at Sensible Susan’s holdings, note that what early saving and compound interest have bought her is insurance. She is unlikely to be totally unable to work again, and if she returns to the workforce then some of the same techniques used by Freddie are open to her. She is likely to reach a lower maximum salary in real terms than if she hadn’t taken time out of the workplace because other workers will have been honing their skills and schmoozing their way up the greasy pole in the gap, but there’s nothing stopping her making up some of the difference. Had he not done something drastic, Feckless Freddie would be closer to her pension than to Steady Eddie’s.

Finally, let’s meet

Stupid Steve

Steve couldn’t see the point of all this saving for retirement malarkey, life was for the living here and now. He’s been a bit stupid, really, our Steve, and only started saving for retirement for the last ten years of his working life. He’s almost like Sensible Susan in the number of contributions, but what makes him stupid and her sensible is he did it the wrong way round. Everybody tells you you have to save early on, right? So what happens to Steve, he’s going to get slaughtered, right?

Stupid Steve loses out, but not as much as people would think, since his contributions are twice as high as Susan's

He’s had the same career progression as I did, so his pension contributions are made at the peak of his earning power. He’s on a pension capital of 43,000 compared to Susan’s 53,000. But he’s still got one ace to play that she doesn’t necessarily have. He’s still working, so if he manages to sock away twice his gross salary towards the end, getting himself up to 94,000.

Now there are some things about Stupid Steve that make you think perhaps he may not be the most financially savvy cookie. But there may be mitigating factors. Say Steve is self employed, and he’s been building up his business all his life. When you or I leave work, we have nothing to show for it expect a few beers down the pub, a gold watch and of course the pension. When Steve leaves work and retires, maybe he has a viable business he can either get someone to run and it pays a dividend, or he can sell the company as a going concern and recover the capital he built up over his working life. Suddenly Stupid Steve isn’t so Stupid at all, perhaps he is Smart Steve. He’s only doing the pension saving at the end because it’s rude to say no to a 40% tax break with five years or less to run.

Conclusion

The advantages of compound interest are vastly overrated as they apply to real-world pension saving. Real people

1. don’t have enough time
2. can’t get enough real investment return
3. haven’t advanced enough in their careers

for the much vaunted example of Sensible Susan ending up with more pension capital than Feckless Freddie, even if he starts 10 years later. They’d have to achieve an investment return of > 8.5% in real terms for that to be true, and it just ain’t going to happen.

The main thing you buy by saving into a pension early is insurance – against long spells of job loss, unpaid sabbaticals or incapacity.

Earlyish Retirement Extreme

The message to greybeards who have spent too little time saving in their youth – there is hope! You can do it. Austerity is a lot less painful for a 50-year old with their house owned mortgage-free than it would be for a 25-year old. Most of the things that are wrong in my life are to do with the fact I am working, the environment is enervating and it consumes a lot of my time. Very few of the things wrong in my life can I solve by spending more money!

The Archdruid identified the key issue in this post.

What most Americans do not know, and have no interest in learning, is that it’s possible to be poor in relative comfort.

I found the transition, from a normal average consuming lifestyle to one of consuming less, very hard. I was far more motivated to go through it because I was under the impression I would become unable to work or ejected from work in months. I wouldn’t have been able to complete the transition otherwise, but after six months of consumerism detox I was off it.

Above all else, if you’re doing Late Retirement Extreme saving as opposed to Early Retirement Extreme saving, you are probably saving at the peak of your earning power.  To save in real terms what I saved in the last nearly three years would have taken me nearly seven years of saving at the BBC – I didn’t work there that long! Plus my outgoings were a higher proportion of my pay than they are now; what would I have done about paying the rent? Not only that, the money I saved would be locked away for three decades for governments to try and get their sweaty mitts on it, and I would have saved less tax.

As for seven years staying in my sleazy bedsit as opposed to three years reduced outgoings at home with the lovely company of DW, well, I dunno. Getting on isn’t all bad

the young person’s dilemma

Even for young people, and subject to this dire warning I’m just not so sure that locking your savings in a pension for 40 years (by the time you are 30 the retirement age is probably going to be 70+) is the best thing to do with any cash you may be able to save between 20 and 30. There’s lots of contrary opinion, like this and this to the effect that I am wrong here, so you have to make this call yourself. The primary risks that mitigate against later saving are if you expect to take significant time out of the workplace to pursue lifestyle choices or you expect career progression to be lower than mine. Taking time out tends to lower career progression, switching jobs between and within organisations more than me tends to increase it.

Look at those charts, and they are for a relatively short working life of thirty years, compared to 40 or 50 years that are implied by State retirement ages of nearly 70. As long as you start by the time you are 30, giving you 40 years to save before retirement, I’d say there may be other more pressing calls on your saveable cash. After all, though I was a dipstick for using my BBC pension funds towards a house, the financial strategy was right – put this into a capital asset. You recognise an asset because it either saves you more money in its lifetime than it costs you, or it pays you an income.

A house is a capital asset if it saves you rent, and the many reasons for not buying a house don’t outweigh the many reasons for buying a house. Machinery, services and supplies for a business are an asset if the business can turn a better profit than the cost of those assets properly depreciated would return on the stock market on in a bank. Your van is an asset if it lets you get more work than it costs, your Ferrari, designer suits and your Sky subs are not assets.

So as long as you understand assets, and as long as you save into assets or RPI index-linked cash the amount you would save into a pension (at least the equivalent of 8% pre-tax), I would say a young person might do well to take a strategic view that saving to a house or saving to buy assets for a business or saving cash is more relevant to their financial lifestream. Pensions advice is so one-dimensional. Do it. Do it now. How about no, let’s work out that this makes sense?

Assets can help you save in a pension later on. My house contributes £9800 p.a. to my pension saving – it would cost me £7k to rent it but I don’t pay myself rent or a mortgage and I’d have to pay 41% tax and NI on that, which I save going into a pension. That’s not a bad ROI, it’s actually over 10% p.a. on the RPI adjusted price I paid for it.

There’s a time and a place for pension savings. As long as you heed the dire warning and understand it, I’m not so sure between your 20s and 30s are that time. Just save that 8% of income somewhere accessible and tax-sheltered if in financial assets. Yes, you’ll lose the tax break now, but heck, you’ll probably pay basic rate tax on it on the way out so don’t sweat it. Who knows what tax will be in 40 years’ time! It is possible to make up for lost time. The amount I have in pension AVCs alone is enough, at a real return of 5%, to compensate for the six years of contributions I am short.