saving

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.

Is it better to spend time budgeting or choosing asset managers?

So I read an interesting blog post on Noahpinion today, regarding whether ’tis better to ditch active fund management (e.g. follow Jack Bogle’s advice and stick with index-tracker ETFs, which charge very little fees), or to save more, in terms of retirement savings.  The article gets a bit economist-like, involving some basic utility functions and the like, to come up with a tentative ‘better to ditch active management’ conclusion.  The short blog post + comments are worth a read.

Anyway, this got me thinking.  And when I get thinking, I get modelling.  So here’s a spreadsheet which models the analysis I think of, when considering this problem.  Method:

  • Hypothesis: I think the time spent figuring out asset managers (whether passive or active) is probably about the same as creating a basic budget.  The latter allows for increased savings.  So let’s find out whether time is better spent ditching active management for passive, or creating a budget, in terms of accumulated retirement saving.
  • Data: for simplicity, I use the total returns of the S&P 500, data which comes from Aswath Damodoran.
  • Assumptions:
    • Starting salary of $50,000.
    • A savings rate, without budget, of 5% p.a.
    • Salary growth of 2% p.a., which is reflected in increased savings (i.e. we save 5% of the new, higher salary).
    • Performance drag of active management over passive of 2% p.a. So I assume active managers under perform a passive S&P 500 fund by 2% each year.
    • Budgeting increases savings by 3% p.a.  So a person who currently saves 5% p.a. can up that to 8% p.a. by making a budget.
  • Results: 

  • Budget or bin the manager? Source: Damodoran Data.

    Budget or bin the manager? Source: Damodoran Data.

    • A Monte-Carlo simulation of 100 lifetimes (44 years of accumulated saving), randomly choosing years of S&P500 returns with replacement, brings the above picture.
    • Each run charts the net benefit, in terms of wealth at retirement age, of choosing to budget rather than switch the active manager for passive.  See the worst line there?  That’s happened because the luck of the draw meant lots of good years for the S&P 500 portfolio: in that case having the fee drag is a really bad thing versus just saving a bit more (however you’d be very rich in either case).
    • It turns out the ‘break even’ is around 4% for budget savings to exceed fee savings.  So if the savings ratio can be bumped from 5% to 9%, in this example, better to budget.
    • In brief: just choose the method that saves more.  Unless your budget increases your saving by a fair bit more than active fees (2% in this example), focus on active fees first.
    • In Noahpinion’s favour, one of his problems with this type of conclusion is that, because we can’t know how much more $1 today means to someone than $1 at retirement, we can’t use phrases like ‘better off’ to characterise the result.  All we can say is the wealth is higher at retirement.
    • Go ahead and play with the assumptions and see the accumulated benefit on the line chart, if you like!

In sum: suppose you’re holding some actively managed mutual funds, and are considering dumping them all for passive ETFs to save on fees, or even whether to dump one manager/ETF for another.  Before spending time with the withdrawal forms and whatnot, consider creating a simple budget to increase your savings.  The latter may pay off more in future.

Finance 101: Part 2 – Saving

Part 1 of the ‘course’ laid out the concept of patience, and its importance to creating finance.  The link between patience and finance is through 2 principal concepts:

  1. Saving – when I’m more patient with what I could consume, or have more than I need to consume.
  2. Borrowing – when I need to consume something I don’t have, or when I’m impatient to consume now.

Let’s discuss the first concept.

Saving

As a verb, saving implies a flow; that is, I’m envisioning a somewhat continuous flow of extra money from a regular pay check.  Those with lump sums, stay tuned.

Why are you saving?

This is the key question, in my mind, when answering how much to save and where to save it.  In the CFA (Chartered Financial Analyst) world, they speak of an ‘Investment Policy Statement‘, which is essentially a formal plan beginning with the goals of the investor – essentially, why are you saving?

How to save more

There are numerous ways to learn to save more.  Most things come down to being more patient with what you have, and what you think you need.  One of my favourite blogs about day-to-day savings is The Simple Dollar, or Money Saving Expert in the UK.

Hmm… this entry could go anywhere.  I’ll leave it for now, and revise as more ideas come to mind – suggestions welcome.