Effective Investing

by Mark Dampier

  That is certainly a change from the past, when the word pension tended to make people’s eyes glaze over and the subject was often seen as a quite distinct subject from investment. Yet, of course, as I have mentioned more than once already, in reality they are not. For this I blame the final-salary scheme so beloved of the public sector and until recently also popular in the private sector. In this type of scheme, the liability to pay you a pension rested entirely on your employer. As an employee, there was little need to know anything about investment. Your pension was just a function of your final salary and length of service with the company – typically around two thirds of your salary. That was enough to cover most of your daily needs, with any savings you had managed to build up as a bonus. There was no need to keep tabs on what was happening to the stock market. Someone else would take care of all that.

  Today, the age of lifetime employment and the final-salary scheme are long gone, at least in the private sector, which is why nearly everyone now needs to understand the basics of pensions in a way that was unnecessary before. The old way lives on mainly in the public sector, where nearly all workers are still in final-salary schemes. The beneficiaries include politicians, so perhaps it is no coincidence that the constant meddling with pensions rarely affects them directly. If they had a private pension, I am confident that they would acquire much greater understanding of what impact the changes they approve are likely to have on you and me. I cannot think of a more important change than making them face the same practical problems that the rest of us now have to do.

  What is fortunately also true is that private pensions are much better value than they were 30 years ago, in the days of sky-high charges and commissions. The big change is that the liability has passed from the employer to the employee and the self-employed. Given that your pension fund may well be worth more than your house, this has become a huge personal responsibility. How much pension you end up receiving will depend in no small measure on how you choose to invest it. It is no longer enough to rely on someone else to make decisions on your behalf. You either have to make them yourself or find someone qualified to help you make them. There has never been a more important time to educate yourself on the subject.

  The issues can be quite complex, but the point I hope to impress on you is the need to start thinking about your pension fund as what it really is: just another investment fund. The better your fund is invested, the bigger the pension you will be able to draw from it when the time comes. On a day-to-day basis, a personal pension is merely a tax-efficient savings plan – no more, no less. So treat it as such, alongside your other investments. If your employer has a defined contribution scheme, and pays into it alongside you, don’t just automatically take the default fund choice the scheme offers. Have a look at how your money is being invested and whether there are better alternatives. If you decide that picking funds as I have described in this book is a realistic option for you, apply the results to your pension as well. If you take advice, the more interest you take in what your advisor is proposing, the more likely you are to end up with a satisfactory outcome. My argument would be: you really can’t afford not to get involved.

  This is not the place to go into every aspect of the issues raised by the new pensions regime, not least because the new rules only came into effect in the course of writing this book (and there are more changes still to come). We will need to see how it settles down. In practice I view these changes, which you can find summarised on government and other websites, as a real mixed bag. On the one hand, the freedoms not to have to choose an annuity and to be able to pass on your pension savings tax-free to your spouse or dependants if you die before the age of 75 are genuinely positive and ground-breaking improvements. For those who have accumulated significant pension pots already, these changes could be particularly valuable.

  On the other hand, the steady process by which successive budgets have reduced the lifetime allowance and annual limits on pension contribution tax relief are backward steps that limit how much value the other pension changes will have, especially for the younger generation.24 I also share the concerns of those who fear that people with limited experience or knowledge about pensions are at risk of making mistakes and falling prey to wrongful sales patter, bad advice or even fraud. (God knows the pensions industry has enough skeletons in its cupboard on the first two of those counts.) Whatever else you do, therefore, I urge you not to do anything in a hurry until you have really understood the changes that are being proposed.

  One of the real problems with pensions which rarely gets mentioned is that, as it is with buying a house, there is a lot of luck involved. So much depends on when you happen to retire (and later also, for your heirs and dependants, when you happen to die). What is happening to interest rates at the time, and how the stock and bond markets are being valued at those moments, can make a huge difference to how well off you are in retirement. If you take your pension as an annuity, as people were forced to do until they introduced the drawdown system, the level of annuity rates can vary quite significantly from one year to the next.

  My father-in-law was one of the lucky ones. He retired in 1994, just when there was a sudden sharp rise in annuity rates. It was a year when the Federal Reserve, the US central bank, raised rates unexpectedly, causing havoc in the bond market. Annuity rates are normally priced off the yields on government bonds, and gilts had their worst year for 36 years, yields soaring and prices falling. It was a shock to the market, but good news for my father-in-law. He retired just as annuity rates peaked. For his £300,000 accumulated pension pot, he got almost 10% a year for the rest of his life – a real bargain as interest rates and inflation both went down from there. Today he would be lucky to get 5% from an annuity. He would need £700,000 to have the same annual income.

  If you have opted for drawdown instead, taking what you think you need and leaving the rest invested, the same lottery applies, depending on where the markets are when you start drawing down. If you started to draw down your pension at the end of 2007, it would have been horrendous, as the stock market promptly fell by 50% over the next 18 months. If you had started in March 2009, you would have been in clover, as the stock market is up more than 100% since then! As nobody can confidently predict exactly how the markets are going to behave over such a short period, there is no way round the problem of luck that I can see. You have no choice but to accept “the slings and arrows of outrageous fortune”, as Hamlet says.

  Two difficult issues

  The problem of timing certainly complicates two of the most difficult issues posed in pensions planning: (1) deciding how much you need to guarantee an enjoyable and stress-free retirement and (2) the problem of whether to choose the annuity route or drawdown. The pension freedom legislation frees everyone from the need to take an annuity if they don’t want to, which is intuitively very attractive. What people don’t like about an annuity is the idea that the insurance company goes off with all your money when you die. You give the insurance company all your savings and if you die the next day, the company cops the lot and no one else gets any of your money. Of course, if you live longer than the actuaries expect, you benefit at somebody else’s expense, but the unfairness of it still rankles with many people. It has got worse as annuity rates have continued to fall.

  The trouble is that drawdown is much more appealing to people as an idea, but devilishly difficult to get right in practice. Having managed drawdown for one or two clients, I have hated every moment of it, if I am honest. It is very stressful, knowing that you are always having to take a view about the markets despite knowing that it is impossible to foretell what they are going to do from one year to the next! If the markets are about to fall by 50% over the next two years, as happened twice in the last 15 years, what are you meant to do? It is easy to decide with 100% hindsight, but something of a nightmare at the time.

  This is therefore one of my biggest worries about the pensions legislation changes.
If professionals like me cannot be sure what the best drawdown strategy to adopt is, is it reasonable to think that most ordinary investors can do any better? There has to be a fair chance that if they do choose to go down the drawdown route they will eventually run out of money, forcing them back onto reliance on the state. In practice, given that the majority of people have less than £30,000 in their pension pot, many will simply take the cash and spend it.

  As it is, something like 80% of all people with pensions fail to take any professional advice before deciding what to do when they retire. When they opt for an annuity, the great majority simply take the deal offered by their insurance company, instead of shopping around, as they should. That must also cost them thousands of pounds. It does not suggest to me that they are crying out for the opportunity to make any more decisions! I don’t know if anyone has ever studied this in any depth, but my gut feeling is that most of the time most people who have chosen drawdown in the last ten years will probably look back now and wish that they hadn’t given up the annuity option. The only way most people will have benefited from going for drawdown is if they happen to die early – and that is not the kind of thing that you want to wish for – at least I don’t!

  To my mind, therefore drawdown only works for quite sophisticated people with a lot of money. Government claims that five-million existing annuity holders will benefit from the freedom to exchange their annuity for a cash sum needs to be put into context. It is not yet clear that such a scheme can be built and even if it is, it might only benefit a small minority. For most people, I venture to suggest that it will probably make sense to retain their existing secure annuity income. Anyone who does opt for drawdown should keep the equivalent of at least two years of pension income as a reserve, so that if the markets do tumble, you can stop the drawdown payments rather than see your capital diminish any further.

  On the need to save

  With pensions still in mind, I cannot reiterate enough times (a) how important it is to start saving early, and (b) why it is worth taking the trouble to read more about investment and – as more and more are doing – become something of a DIY investor yourself. I worry that most people are too put off or frightened about how complex it all seems to do that. If they need advice, they don’t where or how to get it. There is a genuine problem in this country that most advisors won’t touch you unless you have a minimum of £250,000 or so in assets.

  If you haven’t got that sort of money, or are only just starting out down that road, you really have no option but to try and fend a bit more for yourself. After all, if you never start investing, you may never get to the stage where you can afford good financial advice. Even then you may well want to go on taking an active interest. Why? Because what most financial advisors offer is actually not investment expertise itself, but financial planning.

  Financial planning involves looking at your overall circumstances – whether you have a property, the age and needs of your children, life assurance, pensions and so on – as much as it does doing the actual investment of any money that you have. Of course, many financial planners would love you to hire them to look after their money on a discretionary basis, and earn another fee that way. Sadly many of them simply aren’t that good at the investment part of the equation. You know the old saying: “If you want to make a small fortune, start with a big one”. I am afraid that it is often true.

  I like to contrast what happens in investment with the way people go about buying a car. You don’t need to know how an internal combustion engine works to buy a car, yet when people do go and buy a new car they won’t normally just go into a garage and say, “I’ll buy that red one,” and then two weeks later complain that what they’ve bought is a two-seater and they’ve got a family of six!

  But that’s what seems to happen in finance so often. Whether or not you have got an advisor, or are doing it yourself, people just don’t forearm themselves with things to ask or any basic understanding of what they are trying to achieve. I don’t think the financial industry helps itself in this respect. Like all industries, it has its own jargon and needlessly complicates things.

  Attitudes to money have changed over the years. Once upon a time unit trusts were very much the poor man’s way into equity. If you were at the golf club, you couldn’t really talk about unit trusts as you could about how well or how badly your Shell shares had done in the previous week. There was an incredible snob value in having a stockbroker. It was also bizarrely thought that having your own stockbroker was the way to get the best professional advice. Unit trusts didn’t fit that bill at all, although ironically, because of their favourable capital gains tax position, they suited higher net worth people far better than they realised.

  A big change to people’s attitudes came in 1966 when Barclaycard came out and brilliantly called their card a credit card rather than an HP card. Hire purchase was seen as very working class and my parents, for example, would never have borrowed money. Of course, this was before inflation started to take off and the cost of money got much higher, but my father thought that HP was a shocking working class habit (as well as an expensive one).

  Barclaycard brilliantly broke that by calling it a credit card. I take the consumer society to have started pretty much from there. If you remember, in those days Barclays just mailed out their credit cards. You didn’t apply for them – they actually mailed them out to you, and you got a card more or less automatically. The biggest change is that it’s still very easy to get credit, but thanks to regulation, it’s much harder to get anything on savings and advice into the public arena.

  It has always struck me that it is remarkably easy to go into John Lewis and get five grand’s worth of credit within two or three minutes, but if you came into Hargreaves Lansdown with £5,000 and said “help me”, you’d be here half the day! That is because of all the forms that have to be filled in and the background research into your circumstances and attitude to risk which we are required to undertake before we can give you advice on anything.

  If we are ever to develop a proper savings culture in this country, which we need if we are to invest in the future of our economy, we have got to make saving and investing easier and simpler. Education is obviously a big part of the answer, but there must be a better way to incentivise people to spend less time gambling and more time trying to put their money to work in more productive ways. The rules governing TV advertising would be a good place to start.

  The trouble with banks

  My first piece of advice to any would-be DIY investor would be: don’t go near a bank for almost anything on the savings or investment side. Obviously you need a current account and banks may be able to offer you a decent mortgage deal, though these days it really pays to shop around before you commit. Yet their bank is the first place that many people go. I suppose that is because it seems the obvious place to start.

  The trouble is that banking is not what it used to be. We all learnt that with the most recent financial crisis. Over the last 20 years banks have gradually changed from being guardians of people’s money and financial interests to giant sales and gambling machines that see their customers only as the source of more product and trading profits, not as people they can – and should – be trying to help.

  Anyone who has dealt with a bank on the retail side will have seen for themselves what a rip-off they can be. Partly that is because virtually all branch employees are now salesmen in disguise. I can still remember walking into the Lloyds Bank in Teddington years ago and being struck by the fact that the first thing I saw was a graph showing how many endowments they had managed to sell in the past week.

  My grandfather was a bank manager at National Provincial before it was merged with the Westminster Bank to become NatWest. He was what you would call an old-fashioned bank manager. He knew a lot about South African gold shares and would buy them for his customers when he thought they were cheap. Can you imagine a bank manager doing that today? H
e’d be thrown out. Bank managers today no longer owe their careers to how well they treat the customers of their branch, but to how well they meet sales targets set by some manager at regional or head office.

  The real rot with the banks set in when they allowed the retail banks – the ones that take your money as deposits on the high street and lend them out to businesses and individuals – to be taken over by profit-chasing investment banks. Nearly all the scandals we have seen in the last few years –mis-selling of pensions and insurance, interest rate and foreign exchange rigging and so on – have stemmed from that calamitous change in culture and behaviour.

  Although there have been some tentative steps at reform in the last few years, it will take many more years to stamp out the bad habits and poor decision-making that has been allowed to creep into the way our banks do business. I wish I could say that we are through the worst, but in all honesty I find that hard to do. Don’t trust them with your money!

  Financial product advertising

  For years the regulators have introduced ever tougher rules to clamp down on misleading sales and marketing practices by financial services companies. I have no problem with that. God knows there have been enough scandals over the years. When I started out one of the big talking points was the advertising done by a firm called Barlow Clowes. This was run by a man who filled the newspapers advertising a fund that invested in government bonds, yet magically promised investors a higher income return than government bonds themselves were generating.