Plan to spend your final pound on your final day on Earth
The dilemma for impending retirees and retirees is this: that an ideal financial plan will leave you, during your last day on Earth, spending your last one pound coin, only you don’t know how much it’s going to be. In essence, you have to plan on leaving a bequest. You hope the bequest will be small because you lived a long time.
When you plan for retirement, you’re actually thinking, in part, about people to whom you’d like to give your money afterwards. You don’t want to plan to spend it all down by the age of 65 or 70, or 75 because who knows? You may live for 100 years.
Some surprises in life are ones which are more expensive as you get older. Your clothes may be cheaper, you may not get quite such fancy clothing, you may not plan on such fancy holidays, but there may be unexpected and undesired expenses. That means, you’ve really got to leave quite a lot for the long distant future.
Today, that’s really difficult. It’s really difficult because if you stick your money in the bank, they will give you so little back in return that what they are, essentially, promising is that they will give you something which has lower purchasing power than it did on the day that you gave them the money.
That means you’ve got to do something, not just rely on sticking your money in a deposit account.
Ways to seek a higher return on your money
So what do you do to seek this higher return? There’s lots of choices. It could be property, it could be equities, it could be bonds, which we know as fixed income. What’s the right choice?
We used to think that the right choice would be similar for everyone. I chat today with Professor Elroy Dimson of the London School of Business about the options.
Property, you could expect that to have a somewhat higher yield for those who are fit and able to maintain the property. Not only maintain it physically, but to deal with all the complications with renting out a property. There may be higher returns. But, it may be, if you’re hanging on to this until late stage, that you’re no longer in a position to look after that property.
Diving into stocks and shares
Professor Elroy Dimson’s starting point would be marketable securities. That’s equities, the stock market, mutual funds.
Basically, assets that can be liquidated, hopefully liquidated in the long distant future.
Be aware of the costs. If you invest in a way which is expensive, and you hold for a long time, those costs start to look quite large compared to the investment that you’ve put in. Professor Dimson is in favour of getting rid of unnecessary risks, so a diversified holding in a moderate cost strategy.
Is there a role for bonds?
Bonds, as you know, when interest rates are rising, decline in value. Many older people have lived through a period in which interest rates fell, therefore bonds did well. Bonds have been a very good investment given that they were less volatile than equities, but they’ve been a good investment because interest rates and bond yields kept falling. When they fall, people are willing to pay more for bonds, so you could then exit. Today, we’re in a position where interest rates are low.
A little in bonds is a good idea. It diversifies. Bonds don’t move exactly in line with equities. You wouldn’t want to put all your money into equities. Some people want to keep a pot of safe money.
There is a role for having at least some fixed income investment. It helps retirees to budget, they know what will be coming in with greater clarity, and it provides something of a hedge against adverse moves in the equity market.
Above all, diversify
Professor Dimson likes the idea of diversifying in as many ways as possible. I’ve already talked about bonds alongside equities, that’s asset class diversification. He believes
in stock market diversification. That is, spreading your money across multiple markets. Nowadays, there’s a pretty free choice. If your taste runs to picking a really clever asset manager, that’s fine. But, if you want to diversity globally, there are unit trusts, mutual funds that hold thousands of stocks in dozens and dozens of countries, which are available at quite moderate cost.
Brexit: the Crise du jour
There’s often a crisis of the day. The market reacts to new news, or new shocks, et cetera, but on everyone’s lips at the moment is Brexit. What’s going to happen? What’s going to happen to the country, what’s going to happen to the stock market? How should we be concerned about this?
Let’s take a look at the potted history of the 23 countries for which we have data from 1900 up to 2019.
When we look at those countries, the more traumatic they were, the better the returns were. If you run forward through time, and you don’t use any hindsight, you don’t assume any foresight, if you were to buy into stock markets which were experiencing difficulty … What I mean by difficulty is a low economic growth rate, a currency which has depreciated, high inflation, any of these sorts of indicators, including a high dividend yield which is an indication that stock prices have declined, then what you find is that in the long term, you have a rockier ride but buying these low quality stock markets gives you a higher return.
When they see bad news, people want to avoid investment.
If we had known about Brexit, we might have invested and avoided exposure to Sterling compared to stronger currencies. We didn’t know about that.
Sticking with it
Professor Dimson’s view would be, you should be buying for the long term. Here’s a phrase that you must have had with a dozen on the people you’ve interviewed for this show. That is, that the important thing is time in the market, not timing of the market.
Being cautious because of the Brexit story is just too late. You should be sticking with a long term strategy.
One of the major roles for financial planners is to guide people through a long term strategy. That, I think, is part of the service that they deliver. That means, also, people who have got a planner to guide them on their investments should stick with that one person unless there’s a strong and compelling reason to switch. Otherwise, you’ll move from one person to another, who has a different frame of mind. It’s costly to switch.
Having a long term strategy and sticking to it is much more important than having a new long term strategy every couple of years when you switch from one advisor to another.
You can listen to Professor Elroy Dimson’s interview on The Retirement Café Podcast from Tuesday 30th April.