Finance 101: ideas for broke 35 year-olds

I *hope* none of my readers are broke at 35, though something tells me that, with the building mountain of student debt and poor job prospects post-2008, there are some.

I’m a fan of this blog, which sets out some very basic common-sense approaches to building some net savings 10 years after university graduation.  Once you’ve reviewed the spending principles, head back to mine for basic savings principles.


The Savers’ [of the bubble] Budget, by UK Conservatives

Let the campaign begin.  Source: Google Images.

Let the campaign begin. Source: Google Images.

I’m a bit late to the UK Budget commentary – I wanted to hear more experienced/knowledgable opinions before setting out my own.  Anyway, here are some quick thoughts that came to mind while watching the source material + reading summaries of those commentators:

  • The UK actually has a budget.  Not well-known among UK folks, but the US is utterly incapable of passing a budget.  Perhaps a triumph of separation of powers, or perhaps a prime example of how sensible things can’t pass Congress, but idiotic things can.
  • A clear campaign tool.  It seemed to me there were a few programs/expenditures selected for budget inclusion purely to make snide comments about the opposition.  Still, if I were in the ‘internet of things’, I’d be happy with the new subsidies nonetheless.
  • Savers win…I think.  A few items that were interesting to me:
    • Lower income taxes.  Yup, still a Conservative government, even if the policy was a Liberal Democrat policy.  The increase in tax-free allowance will mainly help middle-class folks; those who should be saving more.
    • Tax-free interest.  WOO HOO!  Middle-class earners now get £1,000 of tax-free interest a year; higher earners now get £500 tax-free.  With today’s average savings account rates of about 1%, that means accumulated cash savings about about £50-100k will earn tax-free.  Sweet – this is basically a 20% subsidy on bank interest.  Hopefully an incentive to save more.
    • More flexible ISAs.  For the non-UK’ers out there, one of my favourite programs in the UK is the Individual Savings Account (ISA).  They are tax-free investment/savings wrappers which can be used by any UK resident.  Like a US Roth IRA, but you can withdrawal funds at any time.  The new rules mean you can withdraw from an ISA, then put back the money in the same tax year.  Previously the withdrawals couldn’t be put back.
    • The Help to Buy ISA.  Ugh.  Continuing my rant on UK housing, the next ruse to prop up house prices is a 25% savings subsidy for those saving for a house down-payment.  The saver puts in £200/month; the government puts in £50/month, until a maximum £3,000 subsidy (so £15,000 total in the account).  Great – again using demand subsidies to treat a supply issue.  <humph>
    • Sell-back your annuity.  I see this as a big problem down the road, but one I hope doesn’t hurt too many folks.  I’ve written before about the new pension rules in the UK; now those who have recently been forced to buy an annuity can resell for cash.  Given annuities are basically individual insurance contracts, I can’t see a very liquid secondary market being setup.  That will lead to poor prices for pensioners, who in turn will be easy to scam.  Hopefully I’m wrong.
    • Pensioners – less savings for you.  Despite the above, the lifetime maximum allowance for tax benefit (i.e. tax-deferral) has been further decreased to £1m from £1.25m.  Given today’s annuity rates, the lower cap allows for a lifetime income of about £2,000/month (assumptions: retire at 60, joint, inflation-indexed, no guarantee, no tax-free lump sum).  That’s a bit lower than UK median income.  So seems a bit stingy to me – it’s a cap which many ordinary savers will probably hit.
  • What I didn’t hear enough of: infrastructure investment.  I’ve written before how I view the situation: use record-low government borrowing rates to build infrastructure (and more social housing, while we’re at it).

In sum: I’m looking forward to tax-free interest (even with peer-to-peer lending, apparently), and the lower taxes.  The rest is kinda ‘meh’, aside from my bad thoughts on HTB ISA and new pension rules.

Social Security Works (or not?)

You tell 'em, tea-bagger.  Source: Google Images.

You tell ’em, tea-bagger. Source: Google Images.

This morning I read a Huffington Post article by Nancy Altman, which piqued my interest.  It advocates shifting away from privatising Social Security, or indeed advocating 401(k)s or IRAs, and applying additional taxation towards extra funding and benefits from the existing Social Security system.

I see that Ms Altman has a book out, as well as a lobbying group named Social Security Works.  In lieu of buying the book – which I may yet do, given the thesis is far from my understanding of the status quo – I read a few of the lobbying group’s memos.  My thoughts:

  • Isn’t Social Security going broke?  Well, yes and no.
    • Social Security’s income comes from (source: the lobbying group)
      • Current taxation: around 85%
      • Investment returns: around 15%.  FYI, ‘investments’ are 100% US Treasury notes and bonds.
    • So what?  Well, lower yields for Treasuries means lower future returns for Social Security.  So that item will need to be supplemented by additional tax, or else benefits will come down.  Also, the large cohort of (working) baby boomers leaving behind a smaller workforce will lower the current taxation component.
    • And… that leads to projected deficits, and loss of benefits, beginning around 2033 under status quo.  Technically, the loss of any benefit would be a default – therefore bankruptcy or ‘going broke’.  The group claims this isn’t the case, as taxation will still be coming in.  If only personal bankruptcy worked that way, right?
    • How to fix this?  The group suggests abolishing the cap on income subject to Social Security tax – right now income over $117k isn’t subject to SS tax.  No mention of removing the cap on SS benefits however – those remain.  The progressive in me thinks this is generally OK: maybe the US can follow the UK National Insurance scheme, and tax the extra income by a lesser rate, like 2%.
  • Why not privatise and/or encourage IRAs and 401(k)s?  
    • Cost differential?  Your run of the mill IRA + fund management charge is probably around 1-2% of assets in the retirement account, per year.  Social Security spends about 0.5% of trust fund assets in Administration costs, per year.  So one can plausibly argue that Social Security is a more cost-efficient way to save for retirement – though I wonder what is the administrative cost of collecting SS taxes.
    • Return differential?  I’ve written before about how good a deal Social Security can be for current retirees, particularly against expectations for future generations.  So here’s a thought, keeping in mind where the money for SS payments comes from (see above): given a slowdown in demography (i.e. fewer workers paying in) and investment returns explicitly limited to US Treasury returns, how can there be enough money to go around in future?
      • For example, 30-year Treasury bonds currently yield 2.63% per year.  That means $100 of Bonds purchased today will be worth around $220 in 30 years.  If we assume the Fed can achieve 2% long-term inflation, and SS benefits continue to rise in line with inflation, that’s hardly any real return at all.  And that’s the maximum investment return allowed by Social Security.
  • How to fix it?  
    • Sadly, the mathematics just don’t add up unless taxes are raised – hence I absolutely see why the group wants to remove the cap on earnings subject to SS tax.
    • I suppose the amounts sent to ‘auto-enrolled’ 401(k) plans could just be reframed as additional SS tax to help keep up the program, and possibly increase benefits?
    • The only other method I can think of would be to massively increase population through either more lax immigration policy or through discouraging the use of contraception.

In sum: I was absolutely intrigued by the idea that, instead of thinking of Social Security as a slowly fading institution of old-time, New Deal America, we should consider the program as a better option for our future pensions.  The cold mathematics, however, means pretty unpalatable choices to make this happen.  But, as I’ve written before, the millennial generation faces stark mathematics regardless of how pensions are handled – there just isn’t enough money to go around.

On government (mis)intervention

So we’re in week 2 of the European Central Bank’s (ECB) quantitative easing.  Among the effects:

  • Bond bubble: some commentators have spoken phrases such as ‘bubbles are only obvious in hindsight’.  Well, despite articles justifying the purchase of negative medium-term bond yields, I hope it’s obvious to most that these 10-year bond yields are unsustainable:
  • Let's lock in 1% for 10 years, shall we?  Source: Bloomberg

    Let’s lock in 1% for 10 years, shall we? Source: Bloomberg

    Anybody notice in the above that countries such as Italy, Spain and France can borrow for 50% or less of the US Treasury?  Does that make sense to anyone?

  • Stocks flying: the S&P 500 is more or less even in 2015, despite tepid company results.  European stock indices are flying: the German Dax is up 23% YTD, for example.  While Germany is growing, that’s a big flier. (Side note: I’m happy I did that little bit of rebalancing a couple months ago).
  • UK house bubble keeps going: as written before, this market defies logic.  The UK government’s policy towards soaring house prices has been…um…subsidised mortgage financing.  It’s a sad joke.
  • US Dollar is king: as the Fed is turning the corner to raising interest rates, while Europe and the rest of the world are still cutting/QE’ing, the US Dollar index is up about 10% this year.  As mentioned before, if you’re American and thinking of international travel, or even moving offshore: go now.


Main street?  All the above is great news for investors (though not necessarily savers).  But I’m not convinced this QE helps these economies get back to business.

The direct intervention in financial markets means stock and bond capital gains are much greater (and more predictable) than business investment.  If you’re an entrepreneur, funding can be tight from the banks; why would they lend, when the government bonds they hold spare are making a better return on equity?  If you’re a corporate director, why borrow at low rates to build new plants or try new projects when the return on buying back shares is so good?

In sum: QE had a great initial function, in my opinion.  It loosened credit for big businesses; it jumpstarted merger activity; it finally anchored inflation expectations to essentially zero.  In my opinion, the usefulness of QE has been exhausted for the most part: as central bankers have mentioned around the world (and I’ve written about), it’s time for serious fiscal policy to kick in.  Let’s see some new roads, bridges, broadband, etc.

Friday listening: Promises, Promises

Piggies in trouble.  Source: Google Images.

Piggies in trouble. Source: Google Images.

I’ve been a bit discouraged by markets this week – the gyrations make for poor commentary.  I guess the general message is to be short: short stocks, short oil, short Euros, etc.  We’re back to zero S&P500 return in 2015.  Just stay long fixed income (particularly in Europe) and long the US Dollar.  That about sums it up.

Anyway, it’s Friday.  I’ve really enjoyed this BBC radio series called Promises, Promiseswhich traces the history of debt from an anthropological perspective.  Some really fun concepts and stories here, as narrated by the author of one of my absolute favourite books – Debt, the First 5,000 Years.  The radio series is 10 episodes of 15 minutes a piece, so very digestible for those short walks outdoors or quiet time in the house.

Let’s hope for better markets next week, eh?

Define market (in)efficiency: the Euro

Euro/USD prices: An anomalous move?  Source: thinkorswim by TDAmeritrade

Euro/USD prices: An anomalous move? Source: thinkorswim by TDAmeritrade

The Efficient Market Hypothesis is a well-known, well-respected theory.  It’s frequently cited by folks in the economic & financial space to justify very conventional, buy-and-hold investment products.  Particularly in the stronger forms of EMH, all publicly available information is immediately reflected in asset prices.

I’ve written before about the impact of ‘known unknowns’ versus ‘unknown unknowns’ in financial markets.  The recent crash in the Euro strikes me as an interesting case study:

  • Why is the Euro crashing?  In a term, policy divergence.  The European Central Bank is providing quantitative easing to the Euro-area, which means (all other things equal) higher money supply and a cheaper currency.  In contrast, the Federal Reserve is gradually pulling back from their quantitative easing (i.e. letting their purchased bonds run-off), and thinking about raising interest rates this summer.  Both these actions should mean a stronger US Dollar.
  • Why such a prolonged slide?  This is where I think the markets are interesting.  In an informationally-efficient world, I would have expected a big move at the onset of European QE, with not much happening thereafter (perhaps some oscillation around a new equilibrium level).  Instead, we’re being treated to a managed futures manager’s dream scenario: a fairly steady downward trend, without many pull-backs.
  • Perhaps behaviour economics can answer?  An explanation could be found in the inefficiencies considered by behavioural economics.  Among the possibilities:
    • Discrete decision points: perhaps each business/investor considers the QE announcement at different intervals, and thus make moves in sequence.
    • Loss aversion/disposition effect: folks long Euros have been holding on, while losses pile up.  Over time, they accept their painful losses at different points based upon relative aversion.

In sum: efficient markets shouldn’t really show these kind of smooth trends.  But the trends exist all the same.  Hence it’s worthwhile considering momentum as a viable investment strategy.

Makin’ it blow: investing in renewable energy

Old school renewable energy.  Source: Google Images.

Old school renewable energy. Source: Google Images.

I’ve written before about one of my main principles of portfolio management: diversification.  Very important, as I come to this investment game with much humility regarding my ability to forecast asset returns.  Choosing many different return streams should *hopefully* give the family portfolio the best chance at steady, but appreciable, gains.

The latest iteration of this approach finds me looking at renewable energy; in particular, corporate bonds secured on renewable energy infrastructure such as solar panels, biomass power plants or wind turbines.  Here are a few websites I came across while researching the space:

Some thoughts:

  • Returns seem decent-high: most projects offer 6-10% p.a. interest, with tenors of 5-10 years.  Way better than the ~2%ish on government debt, or ~3.5% on corporate debt.
  • Bond security seems decent: in the docs I’ve seen, the asset (e.g. a windmill) is pledged as security for the bonds.  So more security than you get with the debt mentioned above.
  • Key risk is government risk: the economics of renewable energy are still tightly bound to government subsidies of various sorts.  In the UK (the focus of my research) the overarching EU scheme forces countries to generate ~30% of power through renewables by 2020.  The UK, for one, is nowhere near this.  So the government has rolled out several programmes to ensure those building renewable infrastructure get a guaranteed revenue stream.  BUT – as my dad always says, the only risk you can’t hedge is government risk.  In this case, suppose way more windmills get built than can possibly be used – would the government still provide the subsidies, particularly when some/all of these subsidies are paid through consumers’ energy bills?
  • Other risks seem mostly insured/hedged: these include construction insurance, operating insurance, power purchase agreements, etc.
  • In sum: the juicy return is in return for government risk.  If subsidies get slashed, with no grandfathering, you (as bondholder) end up with a windmill which generates uneconomic power.

Will I invest?  Given the timeline for most of these subsidies/schemes/agreements/quotas measure decades, it might be worth a punt for 5-10 years.  By then, we’ll likely either have far too much renewable energy than we know what to do with (not, in itself, a bad thing) or maintain status quo of needing more (with associated subsidies).