Category Archives: Section 2

2.8 Huge risks / big rewards

Shackleton knew about risk and reward
Shackleton knew about risk and reward

Chapter Overview
Risk = Reward

Another self-explanatory chapter but with a couple of references which are worthy of investigation.

Structured Notes

Wikipedia defines it as: “A hybrid security that includes several financial products, typically a stock or bond plus a derivative. A simple example would be a five-year bond tied together with an option contract. The addition of the option contract changes the security’s risk/return profile to make it more tailored to an investor’s comfort zone. This makes it possible to invest in an asset class that would otherwise be considered too risky.

The book says the benefits of structured notes are pretty much that – participating in some of the upside of an investment while limiting the risk or downside.

It certainly looks like they’re out there too.  This page lists a handful of deals.  I know the book circles back later to deal with this again, so I’ll investigate in detail then!

Market-Linked CD’s and FDIC insurance

The book says that Market-linked Certificates of Deposit are similar to structured notes except that they are insurance-backed by the Federal Deposit Insurance Corporation (FDIC).

The UK equivalent is The Financial Services Compensation Scheme (FSCS) which provides capital protection of £85K  for sole accounts, or £170K for joint ones.

Looking at that previous link about structured notes, all of them have FSCS protection – which seems like an essential component of protecting the risk of loss of capital – the entire point of this kind of an investment.

As with all FSCS protection, it applies to the institution, not the investment.  So, for example, if you had a number of different investments with (let’s say) Barclays totalling over £85K and Barclays went bust, you’d only get £85K back from the FSCS.

It’s worth bearing in mind that for full FSCS protection above £85K, the investments need to be with different institutions.  You can check which institution the FSCS guarantee applies to before making the investment – and it’s not always obvious.

For example, I know that Santander Bank now own Cater Allen Bank – but the FSCS generally applies to all Santander brands, not to Cater Allen.

Here’s a useful, Who owns whom? article.

Fixed Indexed Annuities

Not to be confused with Indexed or Index-linked Annuities. A google search mostly delivers results about the latter type – which are plain old vanilla annuities but index-linked to increase with inflation.

Fixed Indexed Annuities are linked to a stock market index and are also known as equity-indexed annuities and hybrid annuity. Here’s a good article explaining their pros and cons.

Basically, a fixed indexed annuity looks similar to a structured note except that some growth is also protected – compared to the structured note where only the capital is protected.

On the flip-side, the actual amount of growth is capped compared to a structured note.  So while you may be able to lock-in some of the growth AND protect the capital with a fixed indexed annuity – that growth (all other things being equal) is likely to be lower than with an equivalent structured note.

All this is probably academic because I couldn’t find any UK providers of these kind of annuities.



2.7 I hate annuities

This picture makes me laugh. Thanks to

Chapter Overview
All about annuities

As of April 2015, UK pensions are changing.  You will no longer be required to buy an annuity with at least 75% of your pension pot (if you’re over 55) – hurrah!

This chapter makes the point that not all annuities are evil, and they’re certainly not all created equal.

In the US, the annuity comparison site is easy to use, is there anything similar for the UK?

Yes!  The Money Advice Service have an easy-to-use annuity comparison tool.  I typed in a few (made-up) numbers and got this back in under 2 minutes

annuity quotes

For once, that was an easy like-for-like replacement, and, they’ve a whole section on saving and investing – worth an in-depth mooch.

Chapter 2.7 of the book also mentions something called a 1035 exchange which is a tax free way (in the US) of swapping an old annuity contract for a new one.

It appears that in the UK, once you have purchased an annuity contract, you’re stuck with it.  There’s no way out – much less a tax-free option. Source: This is Money.

Personally, I think annuities have a place – especially now that we have more flexibility about how much of the pension pot to use to buy one.

I think an ideal arrangement would be something like:

  1. Take 25% of the pension pot tax-free – spend or reinvest – maybe in an ISA?
  2. Buy an index-linked joint annuity which covers our basic living costs.
  3. Drawdown on the remainder (if any) of the pension pot at a safe withdrawal rate of (say) 3% per annum to provide an income for non-essentials.

One of the hardest things to gauge is how healthy we will be in our old ages and how much any medical care might cost at an unspecified point in the future etc, etc.

However, despite that cloud on the horizon, this seems like a good way to start ..

A quick update.  I put some real numbers into the annuity comparison tool – and they really suck!

As a rough guide, with a SWR of 3%, you’d need £400K in a pension pot to enable you to draw down £1,000 (before income tax) per month without eroding the capital.

For an inflation-adjusted joint annuity – you’d need more than double that amount – closer to £800K. Oh, and when you die, you have no capital left for your heirs (which may or may not bother you).

So, keep £400K in my pension pot and manage my own income, or give £800K to an insurance company and lose all control of it.

I’m rethinking annuities ..

2.6 Target date funds

target dateChapter Overview
The problem with target date funds

Target date funds are basically a mix of bond and equity investments which ‘automatically’ move to be more skewed towards bonds (safer) and away from equities (more volatile) as retirement age gets closer.

The chapter is pretty self-explanatory about why that mightn’t be such a good idea in practice.

I wouldn’t have bothered writing this post at all were it not to mention Vanguard’s LifeStrategy funds.

Basically, they’re a range of funds with low operating costs and different mixes of bonds and equities to suit your mood for risk and stage of retirement.  They come in two flavours: accumulation (dividends are reinvested) and income (dividends are paid out).

If you’ve read chapter 5.1 of the book: ‘The All-Seasons Strategy’ courtesy of Ray Dalio, Vanguard’s LifeStrategy funds look very similar in terms of asset allocation.  Soooo convenient!

Even though I haven’t been posting here for a few weeks, I have been researching this stuff almost non stop.

I’ve set up an online account with Alliance Trust (a trading platform) and this allows me to buy (or sell) Vanguard LifeStrategy funds directly – low costs and no IFA required.

I chose Alliance Trust because it ranked well as a low cost platform  – but it’s a dog to use.  It’s workable but quite frustrating. It’s possible that it’ll get less annoying over time – but it’s not too difficult to switch platforms later if it gets too bad.  On the plus side – their email and telephone support have been good.

My broad plan is to put the maximum amount possible into a stocks and shares ISA each year (currently £20K pa) and put away as much as I can into a SIPP.

The Vanguard LifeStrategy funds can be held either inside an ISA or a SIPP – or indeed not wrapped up at all.  The difference lies in how and when tax is paid.

With an ISA, I’m investing money I’ve already paid tax on.  With a SIPP, the money is effectively invested before I pay income tax on it.

With an ISA, when I eventually cash it in and spend it, the money will be tax free.  With the SIPP, some of it can be tax-free, but most will be taxed as income at whatever tax rate I’ll be paying at that time.

As an employee, I could save a maximum of £50K (2014/2015) or £40K per annum (2015 onwards) pa towards a SIPP tax free.  Also, if I haven’t maxed out my last three years of tax-free contributions, I can overpay this year to catch up.

As a director of a small UK company, it’s even better.  My company can make unlimited contributions to my pension tax-free. This makes lots of sense if you can do it.  Without this unlimited contribution via my company, I could (in theory) run out of tax-free investment allowance (£20K in an ISA and £40K in a SIPP) and would need to invest any further amount without any tax-efficiency – which is also possible via Alliance Trust.

However, the unlimited company contribution to a personal SIPP means this should never become an issue (assuming there’s enough cash there in the first place)!

Socially Responsible Investment

I was pretty much set on the above investment course when, while listening to a podcast by the director of the Origins Movie, Pedram Shojai reminded me that increasingly in the western world, we vote with our ‘dollars’.

With increasingly ineffective, broken, corrupt and powerless political systems, we vote directly for what we want to see in the world by the things we buy – including the companies we invest in.

I’ve tried really hard to ignore this because it’s really inconvenient. However, passive investing via an index fund (like the Vanguard LifeStrategy series) means investing indiscriminately in all the companies in that index: firearms, petrochemicals, tobacco, pharmaceuticals, big agriculture, big food.

For better or worse, I have quite strong opinions about many of the companies that are included in most index funds – and it doesn’t sit well with me choosing to invest in my own pension by investing in companies whose ethics and actions I disagree with.

Searching for Socially Responsible Investments reveals a much much smaller choice of funds, higher fees and some questionable definitions of Socially Responsible.

For example, Vanguard’s SRI Global Stock fund also includes holdings in Exxon.  It’s European SRI fund includes holdings in British American Tobacco.  Hmm .. socially responsible for what?

So, this is one reason, that I’ve ground to a bit of a halt – and with the 2014 ISA deadline looming in April too.  I might buy Vanguard LifeStrategy until I can find something more in line with my conscience – but I’d prefer not to.

All the stuff I’ve read online pretty much says that Socially Responsible / Ethical investing and passive investing are mutually exclusive.  I haven’t come across anything yet that demonstrates otherwise – how about you?

2.4 I’m your broker

pensionsChapter Overview
All pension plans are not created equal

America’s Best 401k: The promise of this service is that it will analyse all the fees that you are paying for your current pension plans and suggest a healthier alternative.  Alas, (as you guessed), it works for US plans only.

I tried entering my pension plan provider but it didn’t recognise it at all – no surprise really, since they’re not providing me with a 401k.

No amount of Googling led me to a UK alternative, but there again, I already know I’ve paid / am paying too much in fees for my pension plan (Chapter  2.2).  So, really what more do I need to know? has a list of pensions and some general advice – but nothing really actionable. has some good clear pension advice.

But still nothing to compare to the America’s Best 401k service.

Looks like I’ll be needing that IFA advice again – although I now have a better idea of what I’d like the underlying investment to look like when it gets wrapped up into a pension scheme.


2.2 Fees – a small price to pay

feesChapter Overview

The average cost of owning a mutual fund is 3.17% pa


I actually do have a small pension pot – which is in a fund of funds with Old Mutual Wealth.  In my last statement I saw 6 month fees of £48 on income of £196 – so 24.4% of growth went in fees.

Compared to the (current) fund value of £83K, that equates to just 0.12% BUT, as this is a fund of funds, it’s not easy to see what the underlying funds are costing me to own.  So, I looked them up individually on Morning Star – all 22 of them.

Here they all are: past | future | initial % | ongoing %

Funds out-performing their category and benchmark

  • Average initial fee 3.95%
  • Average annual fee 1.64%
  1. Aberdeen Emerging Markets Equity Acc
    5 star | gold | 2% | 1.97%
  2. AXA Framlington UK Select Opportunities R Acc
    5 star | gold | 5.25% | 1.58%
  3. First State Asia Pacific Leaders
    5 star | gold | 4% | 1.55%
  4. First State Global Listed Infrastructure
    4 star | silver | 4% | 1.59%
  5. Henderson European Growth Acc
    4 star | none | 5.25% | 1.70%
  6. Invesco Perpetual Global Equity Income Acc
    5 star | neutral | 5% | 1.68%
  7. Invesco Perpetual Monthly Income Plus Acc
    5 star | silver | 5% | 1.43%
  8. Neptune UK Mid Cap Acc
    5 star | none | 5% | 1.66%
  9. Newton Asian Income
    5 star | silver | 0% | 1.64%
  10. Standard Life Global Absolute Return Strategies Acc
    none | none | 4% | 1.59%

Funds performing similarly to their category and benchmark

  • Average initial fee 0%
  • Average annual fee 1.14%
  1. M&G Index-Linked Bond A Acc
    4 star | none | 0% | 0.66%
  2. Newton Global Higher Inc
    4 star | silver | 0% | 1.62%

Funds under-performing their category and benchmark

  • Average initial fee 3.63%
  • Average annual fee 1.57%
  1. AXA Framlington American Growth Acc
    3 star | bronze | 5.25% | 1.57%
  2. BlackRock European Dynamic FA Acc
    0 star | silver | 5% | 1.68%
  3. Invesco Perpetual High Income Acc
    4 star | none | 5% | 1.52%
  4. JPM Natural Resources A Acc
    2 star | bronze | 3% | 1.68%
  5. M+G Global Basics X Acc
    2 star | neutral | 0% | 1.68%
  6. M&G Recovery X Acc
    2 star | gold | 0% | 1.65%
  7. M&G Strategic Corporate Bond A
    4 star | gold | 3% | 1.16%
  8. Neptune US Opportunities Acc
    3 star | bronze | 5% | 1.65%
  9. Troy Trojan Acc
    2 star | none | 5% | 1.57%
  10. Troy Trojan Income Acc
    2 star | none | 5% | 1.57%

A few observations

The number of funds out-performing the market is identical to those under-performing it.

I paid an average of 3.79% across all funds to just get started.  That reduced my initial £65K pot down to £62.5K on day one.

Adjusted for inflation, the equivalent buying power of £65K in 2007 is £82K today.  My pension pot has just about kept up with inflation. According to this calculator, my average compound growth rate has been a measly 2.21%.

Taking an average total fund value over the years of £71.5K, I’ve been paying an average of 1.45% in management fees pa – a little over £1,000. That’s ignoring Old Mutual Wealth’s platform fees too.

Over the 7 years I’ve owned this fund, I could have saved the £2.5K of entry fees and reduced the management fees by about 60% by using a low-cost index tracker fund.

If I had done this, I’d be up approximately £7,000 – enough to bring the current pension pot value to £85,000 – ahead of inflation.

What’s more, taking the FTSE All Share Index as an example, over the same period, my £65K would have grown to around £90K.  Not phenomenal – but better than than this expensive-to-enter and expensively-managed collection of funds has produced.

As soon as I know what I’m going, I’ll be transferring this pension pot into a low-cost tracker fund.

Basis points (bps)

1 basis point = 1/100th of 1%.  BPS is used to denote the change in interest rates, equity indexes and the yield of a fixed-income security. The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points, and 0.01% = 1 basis point. So, a bond whose yield increases from 5% to 5.5% is said to increase by 50 basis points; or interest rates that have risen 1% are said to have increased by 100 basis points.

No-load Mutual fund

A mutual fund in which shares are sold without a commission or sales charge. This is the opposite of a load fund, which charges a commission at the time of the fund’s purchase, at the time of its sale, or as a “level-load” for as long as the investor holds the fund.

Because there is no transaction cost to purchase a no-load fund, all of the money invested is working for the investor. For example, if you purchase £10,000 worth of a no-load mutual fund, all £10,000 will be invested into the fund.

If you buy a load fund that charges a front-end load (sales commission) of 5%, the amount actually invested in the fund is only £9,500. If the load is back-ended, when shares of the fund are sold, the £500 sales commission comes out of the proceeds. If the level-load fee is 1%, your fund balance will be charged £100 annually for as long as you own the fund.

In reality, there are other fees which take a chunk out of owning any mutual fund.  The no-load name only applies to transaction costs.  The book does a good job of listing the potential fees on page 113.

2.1 The $13T Lie

big liarChapter Overview

Most mutual funds won’t beat a low-cost index fund over time

Morning Star

Based in Chicago, Morningstar, Inc. is a provider of independent investment research in North America, Europe, Australia, and Asia. There’s a UK site for Morning Star. One of the research products they have is rating mutual funds.

Five star rating

Morning Star’s five-star-rating system takes a bit of investigating as they also have an Analyst rating system (gold, silver, bronze).

This document explains that the Analyst rating system is a forward-looking assessment of a fund and the star system is an assessment of past performance.

So, a fund with the best past performance and a bright future would have a gold shield and 5-star rating.

Being speculative about future performance, the Analyst rating is just that – speculative. The star rating, however, is purely quantitative – but past performance doesn’t always tally with future potential.

Morning Star offers a lot of tools for UK investors – many of them free. This page is a good place to start.

$13T AUM

AUM is short for Assets Under Management, sometimes called funds under management (FUM). It is a measure of the total market value of all the financial assets within a specific fund or collection of funds. It’s a crude measure of popularity and fund size – but fund size and its performance may not correlate at all.

The book quotes that US mutual funds collectively boast $13T AUM, which, given that the recommendation for most people to avoid mutual funds and invest in low-cost index funds, implies that a lot of money is being invested in a sub-optimal way.

This industry survey at the end of 2013 suggests that there was £5T (approx $8T) AUM in mutual funds in the UK. On the face of it, perhaps the UK has smarter investors?

However with a UK population roughly 20% of the US population, maybe a more comparable UK AUM would be $ invested per person.

On that basis, a UK investor is 3X more likely invested in a mutual fund than their US counterpart. A crude metric, admittedly, but maybe the UK has even greater need of the advice contained in this book?

Hedge fund

In the US, hedge funds – unlike mutual funds – are unregulated because they’re geared towards sophisticated investors. They typically require a very large initial minimum investment and the money is locked in the fund for at least one year. Hedge funds are similar to mutual funds – but for the super-rich.

Clearly, I don’t need to worry about knowing too much more ..

Fund manager

Pretty-self explanatory – but I researched it just in case. A fund manager can be an individual or a group of people who manage a (hedge or mutual) fund.

All-weather portfolio
Here’s a quick video about how Ray Dalio and Bridgewater Associates invented the All-weather portfolio – also available as a pdf document.

Basically, it’s an investment strategy designed, on the whole, to perform well in all financial environments – all weathers.

While investing with Bridgewater isn’t available to mere mortals like me, the principles they use to construct a robust and diversified portfolio are detailed later in the book.  The UK Morning Star web site also has some tools which might come in handy later ..

2.0 Shattering the nine financial myths

shattering mythsOverview

This chapter is an intro to the nine financial myths and uses two specific terms for the first time

What is a Mutual Fund?

This section hints at the problems associated with an actively managed mutual fund – high fees. By definition, a Mutual fund is professionally managed – an investment programme funded by shareholders that trades in diversified holdings.

So the ‘mutual’ part is me plus the other people who invest in the fund. There’s a good description here on The highlights are:

  • The entirety of the mutual fund’s portfolio is referred to as assets under management.
  • An average expense ratio for a managed mutual fund is around 1 to 1.5 percent.
  • Most mutual funds are open-ended, allowing new investors to join in.
  • Mutual funds make money via dividends, capital gains, and growth of the securities within the fund.
  • The alternative to a mutual fund is an index fund (Chapters 1.1 and 1.2) which isn’t actively managed and has lower fees (0.5%)

What is a broker?

Investopedia has a whole page about this. The book uses the term in a way that suggest that they don’t have a fiduciary responsibility to you or me. They may be more interested in the upside for themselves or the company they represent.

Generally, a broker in the US executes buy and sell orders for their clients. Full service brokers might also offer buying and selling recommendations and other financial advice, while discount brokers simply act on the instructions of their clients.

The London Stock Exchange has a stockbroker search and lists different types of broker which seem to tally roughly with the US equivalents:

  • Full service = Advisory
  • Discount = Execution only

More importantly,  do brokers have a fiduciary responsibility to their clients?

This WSJ article of April 2014 suggests that they currently don’t act in that capacity in the US – although it may be in the pipeline.

This article about fiduciary duties in the UK of June 2014 suggests that the US is, in fact, leading the way in fiduciary regulation.

The long and short of it is that the book recommends low-fee index funds over actively managed mutual funds – which makes the whole broker fiduciary responsibility question a non-issue.

Once again, my action plan is to choose a good IFA (Chapter 1.1).