UKH

Random question for the financial gurus (or even the slightly astute).

My 'chuff chart' shows I'm 81 months from when I'd like to retire. I have a few cash ISAs that have/will be maturing in the next few years.

Generally speaking, what's a relatively safe way to reinvest them, given the meagre below inflation rates on ISAs?

I do have a private pension with the Prudential I could put it in, which I believe is fairly secure, but remembering the raid on pensions by the government a few years back I'm reluctant to put all my funds in a single place.

I'm looking at something I could dip into as and when required after retirement, not a regular monthly payment, (all being well I'll have (almost) enough from a works pension to keep me afloat with living expenses (might need a bit more depending on fuel costs for heating).

I appreciate that it's a complex question with no right answers, just looking for some pointers.

ISA will always be a loss making place to store money. Banks will never pay you interest above inflation levels. 

Assuming you have paid off all debts, mortgage etc. I would look at overpayment into pensions, as a lump sum or increase salary sacrifice, (reducing your tax bill makes a lot of sense especially if you are in a higher bracket) and you get some say in the risk level you want.

Firms like Hargreaves lansdown are very user friendly for investing into a portfolio of stocks which reduces risk over investing in single or a few companies.

Thanks for that, much appreciated.

You could:

Use your tax-free pension allowance, and ideally salary sacrifice. Govt gives you your tax back, and possibly NI, and possibly employer's NI. Money is somewhat less available though, which goes against one of your requirements, but might work if you'd be ok with a lump sum and drip-feed money.

Put your ISA allowance and existing pot in a stocks and shares scheme (more risk but potentially more reward). Earnings are free of capital gains.

Look at a SIPP and toy with some gambling on higher risk options if you've a mind.

I would look at moving the cash ISAs into something better soon-ish. Mainly, get some quaified advice, and/or spend time and effort learning the ropes, preferably both.

Disclaimer: IANA professional

Thanks for that. In terms of learningthe ropes, could you recommend an unbiased source of information for a financial numpty?

Consider peer to peer lending which now has the “innovative financial services” ISA.  

I’ve been getting 5-6% APR with Ratesetter for almost a decade now.  I don’t keep a large fraction of my savings there as it’s more risky (not FSCS protected) but it’s earned that much more money over FSCS savings accounts that they could loose about 40% of my deposit and I’d still come out on top.  They’ve actually lost £0.00.

As a general rule, peer to peer lending is not recommended for more than a small proportion of your investment pot - i've been using p2p for a good few years too and seen some bad shit go down, have managed to avoid the worst of it so far but I shudder when I read about those that have lost five or six figures in poor investments. Takes a lot of work to do your due diligence. Ratesetter is a simpler platform where there's no specific loans to have to choose, true, but their rates are poorer now than they were last year, and their provision fund ratio has been gradually decreasing for some time too (increasing risk of losses). They dropped a considerable bollock when this happened too: http://i.imgur.com/DmsF87P.png. I'm reducing my Ratesetter investment due to the poor rates on offer in comparison with what I can make elsewhere.

I'm spread across many p2p platforms, my favourite is Ablrate (IFISA is offered, with good rates depending on loans chosen - the tax free wrapper makes a big difference to the interest you get to keep), but even then I do not invest more than I can afford to lose comfortably.

Back to the OP - stocks and shares ISA might be a good option for you, investing in a relatively low-risk fund would give instant diversification and a reasonably steady income/ROI. Vanguard's LifeStrategy fund might fit the bill (in one of its lower-risk variations), they do have some funds that are specifically tailored for retirement in 5/10/15 etc years time too, not looked into these myself in any detail but they might suit your circumstances well. There was a recent thread on S&S ISAs and I was pleased to see that a lot of other people rate Vanguard as well.

Here's a place to start: free basic advice and explanations from a government-sponsored source:

https://www.pensionwise.gov.uk/en

You’re only 81 months from retirement. At this stage your number one priority should therefore be to not lose what you have saved by taking unnecessary risks.

So if I were you I would stick to a form of savings account, products like Marcus give you up to 1.50% interest. Checks what it means tax wise for you because most of the time you’ll still be better of than with an isa.

But I would definitely avoid stock and shares like the pest, at 81 months from retirement it’s not the time to put your capital at significant risk. A stock market crash could well happen and the market will not have the time to recover by the time you retire.

I’ve also been taking this investment advice more seriously of late...

youtube.com/watch?v=qsMc-IswG3w&

Sound advice - canned food and shotguns! What could go wrong?

Don't forget that the scientists reckon we've only got about ten years (which is probably optimistic) to turn things around re climate change, part of which would mean changing our investment targets. Green funds?

......and don't keep putting off what you want to do in the future. Reducing costs can be as effective as increasing spending power.

No tin opener?

We started investing in green or ethical funds 16 years ago. The return is been impressive, even in the early days. Demand will probably boom now, which could in the short term over value them, but long term will be fine, it is just a question of avoiding unproven tech and any rags to riches schemes like the forest ones that were rattling around a few years ago. 

Of course folk shouldn't invest in things they don't understand without getting advice first. 

We agree!!

A managed fund in the last few years would be progressively moving funds out of shares and the like into more cash based assets/bonds, that give a lower return but are much safer. 

Nice post Summo : )

The R4 money programme did a show on ethical or green investments not so long ago. It covered the basics for those who have never considered before. 

Spot on. 

Spot on. 

Too risky at this late stage.

the op sounds to risk averse if they have not invested outside ISA a already

What are you invested in? And how have you invested?

Just curious as I've been looking at what to do with pensions also.

If you have cash in ISA's, you may be able to take the cash tax free when they mature and invest it in a SIPP. You get tax relief on the money you put in, so in effect get free cash from the gov. 

Once the money is in a SIPP, you could invest some of it in less risky bond fund ETFs, that pay more than a high street bank account. Some of them pay dividends monthly or quarterly, rather than annually which might come in handy. You could also invest some of it in broad market index ETF's i.e. ftse100, s&p500 etc to get a bit of 'action', as well as dividends, if you feel like a punt.

Obviously you'd need to talk to a grown up, in order to do it in a tax efficient way and to set the level of risk you're happy with. I'd also advise not taking advice from randoms on the internet...

nothing that can't be solved with a shotgun!

We been in this one for a long time, we also bought it for any nephews and God kids as presents. https://www.avanza.se/fonder/om-fonden.html/1871/swedbank-robur-ethica-glob...

We have also moved into a mutual fund with handelsbanken, but there is little that I've seen which can compete with that swedbank fund for a return. 

The problem with some ethical funds is what a fund manager might consider unethical is very subjective, so it's worth reading up. The swedbank fund is less harsh than handelsbanken on its criteria. But we now bank with handelsbanken so in some respects it's easier with them. 

I'm not a IFA, so this isn't advice, just observations.

1.  RomtheBear is right that the key priority is to not lose what you have at this rather important transition time.  Almost all schemes from big employers have some sort of life-cycle approach that progressively reduces risk in the 5 years or so before retirement.  Put another way, the core objective isn't to beat the market and get spectacular returns (that's called greed and speculation and should only be pursued if you have a high risk appetite and can afford significant losses as well as the time to repair damage should it happen).

2.  The key to risk management in anything other than cash deposit (where the key is protection) is spread.  Folk often underestimate how UN-spread indexes are (e.g. the FTSE 100).  Some FTSE 500, plus an all-world medium cap index, plus a broad US fund, plus some gilts plus some cash starts to get there.  As soon as you're into a single geography, sector, company or commodity you are waay too narrow.

3.  Traders lose... and 75% of the professionals don't beat the market.  Don't imagine you can stock-pick or call the price-impact of the next twist in Brexit.  Traders also lose because the transaction costs are high.  The professionals point is important because it goes back to #1.  "A rising market floats all boats".  If you're in equities you don't need to beat the market - just stay with it.  Managed funds are expensive (see earlier threads about why 1% fees are crippling) and you won't have enough info about how they manage down-turns.  You can buy ETFs or indices for <0.1%

4.  If it looks too good to be true, it is.  *All* the scams rely on greed - after all they have no other hook to offer - and higher *possible* returns rely on higher *definite* risk.  I wouldn't touch peer-to-peer lending - there's plenty of burnt fingers there.  Bubbles burst - bitcoin anyone?  Some legitimate offerings have very deep hidden flaws, often around liquidity - so you can invest and get an attractive return but what is the mechanism for selling/recovering your capital when you want it?  I know someone who is likely to own a bit of a wind farm in Italy for a long time.  The return is good - and does get paid - but there's almost no mechanism for selling the unlisted shares so he can't get his money out again.

5.  Take advice on specifics - and pay an agreed fee.  IFAs would prefer to provide "ongoing" advice" and charge a percentage (usually 1-3%) of the funds under direction.  That's a headwind your money can't aford... and you're in a transitional phase.  I'd suggest a one-off exercise to take stock; agree a trajectory to retirement in terms of mix; and the tactics of actually drawing pension (cash; timing; annuities or not; tax; etc.).  You can enact it yourself, you don't need to pay 2% next year and the year after (and the year after that...) in order to firm up a plan.

6.  If you beef up pension contributions be careful about the rules in the last 2? years pre-retirement.

Again - just stuff to consider.  I know nothing of your financial situation, but those are things you should think about.  https://www.unbiased.co.uk/ for IFAs and https://www.pensionwise.gov.uk/en are excellent.

Hi Summo

Why would you point someone that's a self-confessed beginner at a foreign-based fund where all the info is in Swedish, up to 30% of the fund is in swedish companies, is risk class 5 of 7, and the fees are 1.25% per year???  I know he asked what we invested in, but presumably you're a bit more spread than that?

What are those rules?

The question I presumed was referring to what ethical fund I had invested in from the beginning. I would hope no one invests purely on advice gained on a climbing forum. 

As per my original comment above if I want a safe return in 6-7 years then I would not be investing in any shares or high risk funds at all. 

I also said avoid rags to riches promises and get financial advice if you don't understand first.

Me, yeah diverse. Cash, isa type funds, low risk ftse tracker type funds, property and forest (the type I can physically see, not promised to exist elsewhere). 

Whilst it could be tempting to put more into said high risk fund, I'm older and wiser now than the impatient investor I was 20 years ago, so I'm content for a reasonable gain rather than throw all the eggs in one basket.

I think if you are going to do some hands on investing it's worth considering your own psychology, are so risk averse you'll never let it grow before selling up at ever down turn in the market, or the eternal optimist who'll be betting their house on black. 

I'm not a IFA! Something along the lines of only being able to carry forward 2? years allowances if you want to make an overpayment.  I think you also have to have been in a pension for those years, but don't know the detail.  That's why an IFA chat is generally needed.

Fair enough - I'd missed the specific request; the thread has morphed a bit form the original question.

Yes there is certainly risk out there. I was in a Morgan Grenfell PEP in mid 90s that was found guilty of mismanagement by the fsa. I did get adequate compensation eventually, but i would say I was lucky there. 

While I agree that the OP should go carefully, I'm not sure the above is helpful advice. Firstly, the OP has a pension already. He isn't proposing to put that at risk. The aim is to re-invest his cash deposits, and leave his pension gently accumulating. He only expects to have minor call on the funds under discussion, dipping into those for small needs after retirement.

Meanwhile, 81 months is nearly 7 years. Incredible though it may seem, since 1985 (the limit of the data I can access this instant) the FTSE 100 has returned a profit on a total return basis (including dividend payouts) over any 7 year period of investment. The market has crashed several times since 1985, including the greatest crash in history, yet, wherever you plot 7 years on the chart, the principal has always been recovered, usually with a hefty gain. Indeed the US stock market has "crashed" three times in the current 10 year bull market, falling 19% on each occasion and therefore just avoiding falling into a bear market. But it is up 400% over the 10 years. Many commentators believe it to be due another crash of course, but the point remains that a long enough horizon should always see the patient investor right.

Meanwhile cash deposits have under-performed inflation, ie they have lost money, every year of our lives and will continue to do so.

Moreover, the OP isn't confined to a 7 year deadline. As I understand the OP, these are funds that he expects to dip into in a moderate manner. That could be accommodated by allocating a portion to cash to cover 3 years, which would extend his investment horizon out to a more conservative 10 years.

To the OP

I don't know your exact circumstances so this is a broad generalisation, but I'd put as much as you are comfortable with in a Vanguard or iShares FTSE 100 ETF (Exchange Traded Fund) and keep the balance in a cash ISA to dip into. Leave the pension where it is. But only use the ETF for funds you are happy to lock away for 10 years. ETFs are easy to sell out of, unlike traditional investment funds, and you can take out/top up as much or as little as you like at any time. If you are cautious, you can invest a small portion each month so as to average out the cost of investing and enjoy any dips in the market. That might work to your advantage and could calm your nerves but the data does not support this more cautious approach. Gains on the FTSE in particular depend on dividend receipts and those only come with participation.

Thanks. You've pretty much nailed the situation. I have a workplace pension that will almost cover living costs if I retire at 60. There's private pension that I'd like to keep ticking over plus a slack handfull of maturing cash ISAs to reinvest. The mortgage is paid off due to overpaying, and once I get some work done on the property I aim to squirrel away what I would have been paying in mortgage repayments. I'm taking the pessimistic view there won't be a state pension when I hit 67.

I'm not really interested in having the same monthly income up to death. I'm looking at having a monthly income thats just enough to live on, then burning through the private pension pot and savings in around 20 to 25 years. At 80 and beyond spending will be pretty negligible, my Dad only had a state pension and in his last years had more money than he needed.

Thanks to all for some really good pointers, and we've even had summo and Rom agreeing with each other!

Not quite clear from your post but if you earn enough to pay higher rate tax, make sure that goes in to a pension - the tax benefits are huge.  It's less clear cut if you don't - you still get an effective 6% (from memory) tax relief however.

Thanks. Yes, I do pay higher rate.

Ho dear, that’s a classic rookie mistake. You can’t can’t find any 7 year period with negative returns in your historical data and therefore assume investing for 7 years is very safe, or at least that it tells you something about your expectation of returns.

As counter intuitive as it may be, this is a completely wrong conclusion. Traders know this fully well. The problem is that  the variance of returns for any 7 year period is driven almost entirely by unpredictable, extreme events. The nature of the distribution has severe statistical consequence. In such situations, by theorem in fact, the mean returns  cannot be estimated from your historical data. You therefore cannot make any prediction.

Put simply, it is a dangerous mistake to assume that because no 7 years period of negative returns has occurred, the probability of it occurring is low.  It’s a wrong conclusion to take.

Yes, absolutely true. 

But it’s a personal choice. You can put your money in something that has a risk that cannot be understood nor measured. Or you can lose a bit a but have the certainty to keep most of it.

It depends what important to you. I would assume that for most people at 10 years from retirement, the latter would most likely apply.

But it’s important that one gets the right information. Anybody who tells you that the stock market is safe over 7 years is safe because losses over any 7 year period never occurred is a charlatan.

“past performance is not indicative of future results”. They always put it on in the brochure !

You need phone music patience, once you get to speak to a human at Hmrc they seem uniformly helpful and will arrange for a tax refund on higher rate pension contributions 

Ring when it's not the end or start of years, nor close to any deadlines. Less waiting, more relaxed and helpful staff. 

The way I see it - if there’s ever a 7 year period where index linked stocks don’t rise, I am going to have much bigger problems than my index linked savings.  That’s unprecedented levels of financial disaster and I can’t see it happening without en external disaster that would be worse than the financial consequences (asteroid, super flu, mega war, a Corbyn government).   That’s definitely “canned food and shotguns” territory.

You appear to be assuming that the current point in history is “special” - that the increase in human productivity driven by increasing technology and infrastructure is going to stop.  There is nothing in science or technology to support that view.

You are right that future stock market performance can’t be predicted from past, but the future progress of humanity can be extrapolated. We are making our way up level 0 of the Kardaschev scale, and there is no evidence we are at a special point in history where that will stop.  The size of the economy and so the average growth of stocks is pretty tied to our energy supply as that is the multiplier over base human work and so defines productivity.  The future is great for energy.  The progress to decarbonising the grid in the UK is astounding.  You could argue that machines are the multiplier not energy, but over a long enough time scale energy is the driver.

The OP is smart enough to know the risks associated with stocks and shares.  Calling BnB a rookie charlatan for pointing out that there has never been a drop over a 7-year period is not appropriate.   He is pointing out facts, and the OP is smart enough to make their own decisions.  This is called “discussion”.  I on the other hand am making less justified, more predictive statements and again the OP is smart enough to recognise that and chose how much they let my perspective nudge their risk assessment on stocks and shares.  

Well it sounds like you are  a bit more financially savvy than your original post.

Why not split the money. Keep some in cash and some long term and untouched for 15/ 20 years in the stock market to allow it to grow and then drawdown when you need it as you get to early / mid 70s. 

And in your 8os you need to budget for care costs  unless you want your family to pay for it . So do not assume the state will pick up the tab .

Absolutely not.  You have not understood it. I am not assuming anything special from the current point in history. I am making the very optimistic assumption that the nature of the market stays exactly the same.

As I’ve said, almost all of the variance in your returns is driven by extreme, unpredictable events. Think about the consequences this has, statistically: the mean of the distribution will not correspond to the sample mean, and you also won’t be able to find typical “large moves”. Any such large move in your data isn’t typical and simply cannot be used as a guide for the future.

The good news is that although you cannot estimate the mean, you can still estimate parameters and run simulations. I suggest you do that and then we talk

Then etch it deep into your brain until it erases all other psychological bias. It’s very hard. I found it impossible to convince myself deeply of this until I looked into the maths of it.

I don't think it can, but if you believe that, then you can bet on that.

This has nothing to do with being smart or not smart. Most people who lose money on the stock market are very smart. Those who are really smart don’t use their money, but they are crooks.

I have no problem with his facts. I have a problem with the way he uses them. I am not saying he is a charlatan, on the contrary, I’m telling I’m him to beware charlatans.

My point is simply that looking at past returns to asses the risk of investing in the stock market is very wrong, and very, very misleading.

I sort of take your point.  It would be interesting to know if the Japanese markets has always had positive returns over 7 year periods, for example.  Ultimately however share prices are linked to economic growth.  If you make the (perhaps optimistic) assumption that this will continue, shares will be profitable long-term.  Quite what long-term is, is the question.

I agree with the observations about inability to predict specific events etc.

(Wintertree) You are right that future stock market performance can’t be predicted from past

I don’t have a problem keeping that in my brain, nor can maths convince me of its truth.  I understand statistical noise and measurement very well, including in highly non linear systems.  It is something I teach and the minimisation of which ultimately lies behind most of my work.  From this I understand that maths can tell me nothing about the future trend of the mean of the stock market.  

Maths can also never tell me anything about the probability of financial shocks much more severe than have been seen to date.  We have by definition never measured one and so we have a measurement problem - there is no data to allow maths to make any valid extrapolation as to their frequency or severity.  Maths is also blind to underlying drivers of stock growth - it doesn’t know if we’re at a technological dead end or just before a transformative breakthrough in knowledge.  We are nowhere near a dead end.  Breakthroughs, who knows.

By presenting them as they are and assuming - with good reason - that the OP is smart enough to recognise that?  

it’s actually even worse than simply a noise problem. Agree with all the rest.

Read his post, he clearly presented the fact that he couldn’t find any 7 year period with negative returns at the end as evidence of the safety of investing over 7 years. This is completely wrong, as we established. And this has nothing to do with being smart. BnB is very smart and nevertheless made that mistake. I’ll go as far to say that smart people make that mistake more often because smart people are better at looking for patterns. They therefore get caught out more often by false patterns. In my work I routinely see very senior people with several decades of finance experience making that mistake.

It’s worse, because you have path dependency. Even if over the long term, returns are positive, what matters to you or me is whether we are up or down when we have to exit. And that cannot be estimated, as we established.

But that’s fine, you can still invest in the stock market, as long as you’re happy living with the fact that you may lose your money.

Japan is a different story. That's why I specifically highlighted the FTSE100 because, unlike in most other developed markets, returns are dependant on dividends rather than capital growth. It is also the OP's home currency so avoids the complication and expense of hedging currency risk.

Many would be shocked to realise that the FTSE is barely higher today than it was 20 years ago. But the total return over that period has been in the region of 260%, thanks to dividends. Dividends are less volatile than share prices because major companies see distributions to shareholders as a vital commitment, to be maintained through thick and thin. Dividend cuts happen. Vodafone cut theirs yesterday. But it was for the first time in 20 years and the overriding trend amongst FTSE100 firms is for incremental annual increases to dividends. In fact it is these small annual increases which compound the already compounding effect of dividend re-investment to produce returns.

But what do I, a rookie charlatan, know?

I could do that.  But I would have no belief in what the results tell me, either about the mean or about the variance.  I would not let the undoubtedly complex and theory intensive nature of the model over ride my fundamental lack of belief in its predictive abilities - not least because the stock markets are a noisy emergent property of a more fundamental growth in human productivity energy, not a be all and end all.  I can see how people get drawn down this route, but it’s not for me.

Mind you, currently I have to save most of my skepticism for companies doing machine learning and AI drug discovery.

No I didn't. I presented the data to demonstrate the flaw in your argument that an imminent crash would likely ravage the OP's savings over the period to his retirement in 7-ish years. I can't use the future so had to rely on the past and was able to show that two of the most serious crashes of the last 100 years had not in fact had the impact you suggested.

I did say that "the point remains that a long enough horizon should always see the patient investor right". "Should" not "will", and I did not claim that 7 years was a safe investment horizon. Instead I demonstrated how he could extend that horizon in order to improve the odds of investment success.

I fully agree with that, the only reason I suggested it is that because if you run it, you’ll find that even with very naive and optimistic model assumptions, the probability of making positive returns in the simulation experiment will be a lot lower than most people expected. 

Fully agree. You’re preaching the converted here ! I find it incredible the amount of money invested in projects where AI/ML is actually guaranteed to give fallacious results.

This is true if one were to do the traditional thing of turning the pot into an annuity on the day you retire.   But, nowadays one can leave the pot invested and only remove money if one wants to or needs it to live on.

So, what to do depends quite a lot on one's wider circumstances.   If we're talking about a pot that one needn't dig deeply into, but could leave invested post-retirement, then the investment timescale is not the 7 years, but is more like 15 to 25 years (depending on how long you plan to live!).

On that sort of timescale I'd be heavily invested in shares, since in the long term they beat everything else by miles.

Edit to add: tl;dr version:  In the medium to long term, investing in shares wins -- stock-market falls only negate that if your circumstances compel you to sell near a trough.  

Sort of.  The total return will be much the same in different (similar) markets, whether it is limited capital growth+dividend, or just less limited capital growth.  Different ways of getting to the same point.

Again, that may be true, but path dependency is important, but the simple truth is that your money is at risk. So put in the stock market only money you are absolutely prepared to lose. Simples.

Obv its different with pension pots because of the massive tax advantage.

In a perfect world yes, you're right. But companies dispose of their dividends in an emotional way, sometimes to the detriment of their balance sheets, ie they borrow in order to keep the dividend growing. This tends to distort the comparison.

That is not to say that dividends beat capital growth. The UK's most respected fund manager, Terry Smith, invests mostly in stocks that pay low or no dividends. He'd rather that the firms invest the profits in more growth. But it does mean that dividend stocks smooth the curve.

Er...thanks, I think

Thats the sort of thing I'm looking at. Putting some of the current (and future) cash savings into a pension pot that could be used to draw down on would seem to be a good idea due to the tax benefits (although I accept that a limited amount of the 'pot' would be tax free on withdrawal.

I'm just wary of putting all my eggs in a single basket. Might discuss splitting between some into pension and some into ETFs.

No relatives, just me and Mrs Ridge. There's the equity in the house, (will probably downsize at some point), which could be utilised for that purpose.

In terms of when my own health starts to decline, I've seen the prolonged and unpleasant last years of a number of people, and take the view that a shotgun's not just for protected your tinned food stash*...

*Less messy options also available.

That is not by any stretch what I have said. I have said very clearly that in fact, one cannot say whether it is likely or not to happen. All I am saying is that the risk of losing your money cannot be measured from history alone.

That’s where you went wrong.

which is fine, but is irrelevant. As I’ve explained, this is no guide to the future because previous crashes are not typical. Put simply, there is no way to say whether previous crashes were big, or in fact, small. Most people don’t get that in this situation your variance is undefined.

May I point out this isn’t particularly obvious, this was demonstrated by Benoit Mandelbrot relatively recently, and it invalidated many of the models traders have used for years (and that some still continue to use...)

One cannot say whether it will improve your odds by any good margin. You’ve not demonstrated it. I repeat, again, that your historical data, user this way, is not a good guide in this situation.

Quite disconcerting, and confusing, I know. I suggest some reading : https://www.amazon.co.uk/Fractals-Scaling-Finance-Discontinuity-Concentrati...

I'll just say that I take both your points!

Probably not the same thing at all, but I spend a lot of time at work explaining that a probability of 1x10e-5 of something happening based on historical data and torturing numbers until they tell you the right answer doesn't mean it won't happen in the next 99999 years, and just because we've not had a disaster in the last 50 years doesn't mean there's not some unknown failure mode lurking and in reality we might narrowly miss armagedon every Thursday afternoon but are blissfully unaware of it.

My investments being obliterated/taking a severe hammering is unlikely based on existing knowledge, but there's a degree of uncertainly in current models and it'd be unwise to assume the risks are negligible and I need contingency planning. Is that about the size of it?

It’s in fact worse, it’s nothing to do with a degree of uncertainty in the current models, it’s more fundamental than this, in the type of model we are talking about, even a perfect fit on historical data will not work.

This does not mean that you can’t invest in the stock market, it just means that you need to be aware that there is a risk that you lose your money, and that you cannot quantify that risk by looking at history.

Obviously this depends on the type of investment, there are many financial products which do indeed lend themselves to modelling and do have a risk that can be understood, but typically FTSE isn’t one of those.

Why do you think that? Share prices are linked to the  value of companies.  Given the way humans and society works, short of say nuclear war, value will continue to be attached to companies that do all sorts of useful things, so the size of crashes will be limited.  You seem to be arguing that obscure mathematical models tell the world how to work, rather than describe the world imperfectly.

Good post.

However, note of caution on this:

an ETF tracker is not the same risk as a traditional tracker. The investment is a synthetic tracker fund made up of equity derivatives, You therefore have counterparty risk to Vanguard or iShares that you don't have in a standard tracker which buys the underlying stocks in equivalent weighting to the FSTE composition. 

In short, if there was a scandal or a big crash resulting in the failure of the financial counterparty (i.e. the next Lehmans) you could lose some of your investment. The trade off is lower fee. Worth knowing I'd have thought.

Just split it 1/3 cash, 1/3 pension and 1/3 EFT. Keep it simple otherwise imho you get lost... but remember the tax relief on pensions is a huge incentive and should be maximised.

I have always followed the rule of - dont be too clever on these things... unless you want to scan the financial press every day for a few hours.. Also try and  sure you have any shares 50/50 between UK and rest of the world, so you have spread the risk there.

It's always worth speaking to a couple of IFA's if you have a reasonable amount,when you find a good one they are excellent and worth paying for.They are useful in pointing out the obvious.

The shotgun maybe useful for you, but Mrs R may want to carry on living. When you have been through the care system with your parents for example it opens your eyes a bit as to what can happen.

Thats my take on it.

If you have a decent adviser or are good at these things you should get an anlaysis of which companies all your money is invested in so that you do not become too dependent on one company in your portfolio.

It doesn’t help if the variance of the value of a companies is also undefined. Which I would argue is also the case.

Unfortunately one cannot say with any certainty whether the size of crashes is limited, or where that limit is if there is one.

Your assessment is reasonable but it’s subjective one (as is the price of shares), and it carries a risk, which the investor must know he is taking. But it has the merit of being honest.

And that is absolutely fine. What is unacceptable is people drawing some line on an historical chart of ftse return and to make people believe there is low risk because it has never happened before. That’s pure BS.

The opposite, I’ve been arguing from the start that this type of thing does not lend itself to modelling.

This isn't about which companies you invest in, it's a more subtle point about the risk of ETF products. They mirror the market return on equities but have a very different risk profile because your money is not invested in buying equities. 

Very good point.

I’d also argue that the massive rise of trackers has amplified hidden risks in the markets. That is because few active investors are now driving huge volumes. This creates a massive feedback loop.

That should be a clue that the next crash could be bigger than any of the previous ones, and by a large margin.

You are, in a sense, right that the stock market could crash worse than it ever has, and then stay down.

But, if you're going to take into account such risks then all of the alternative investments are also risky.   Banks and governments have defaulted on debts before now. 

So long as companies overall in the economy are making money then their stock-market values are likely to behave in line with history (of which we have 150 years of experience now).  But if companies overall in the economy are *not* making money, and fail to do so over a decade or two, such that the stock market stays down, then any alternative home for your pension provision is likely to be in just as much trouble since the whole economy of the Western world will be over-turned.  No asset class would be safe, nor would hoarding bank notes, nor would hording gold coins.

So, the sensible thing to do with pensions is to use history as a guide to what is likely to happen and to invest accordingly.  That points to having a sensible fraction in the stock market (where what is "sensible" will depend on the individual's circumstances). 

Or, rather, invest in the stock market if: (1) you are investing for a reasonably long time (5 years or more), and (2) are unlikely to be a forced seller in a downturn.  In a very real sense, not doing so is "riskier" since not doing so will usually lead to a smaller pot at the end. 

Yes, that is perfectly true. But that’s not something you can do much about. I pretty much have to hold my cash in a bank. I understand that if that bank fails then I will lose my money. That’s fine.

Very true, but that’s not the problem. The problem, when you retire, is that you have path dependency. If the market crashes and erases all of your capital before you need it, then you are truly shafted, and it doesn’t matter if it recovers later on.

History is not a guide to what will happen when it comes to the stock market. Unfortunately.

This doesn’t mean you necessarily shouldn’t invest in stocks at any point !

It depends what you want. You can either take the risk of losing most of your capital, a risk that cannot easily be understood nor quantified accurately, or accept that inflation will certainly erode your capital.

It’s a choice but the important thing is to understand it.

Personally, I’m am not interested in retiring with fantastic riches, and more interested in making sure as much as possible that I have enough to live comfortably in my later years. So I’m perfectly happy with barely or even not beating inflation.

I still invest some money I am happy to lose, 10% or so, in very high risk stuff, mostly derivatives and some directly in various businesses, most of them owned by friends. So that I get the upside if there is one, and worst case scenario, I’ve helped a friend, which makes me happy anyway.

So my portfolio in the end has this funny property that it has the potential to profit greatly from these extreme, unpredictable events, but can be harmed only very little by them. Of course the downside is that the returns when nothing happens are poor. But this is something I am perfectly satisfied with.

True. That's why a cautious investor should start with one of Blackrock (iShares) or Vanguard, the two largest asset managers in the world, both much bigger than, say, Lloyds or RBScot. And their business lines are far less risky. They're not lenders or borrowers, they're custodians. In fact I'm looking at Blackrock's accounts on my screen right now. They have no debt. Meanwhile, retail banks borrow trillions on the wholesale market and that's where financial crises have their genesis. There's good reason why bank deposit accounts attract the state compensation scheme. Although that protection is one of the few good things about cash deposits.

Acknowledged nevertheless that no business is invulnerable.

Many quantitative analysts invest their own money in basic index trackers and leave it alone. This is on the basis that your chances of picking a fund that can outperform the market out of more than pure chance is small.

If you are interested in more detailed strategies for small investors, I recommend John Kay's "The Long and the Short of It"

But Blackrock and Vanguard are not underwriting that risk; it's diversified (hedged out) within the financial system, almost certainly with investment banks who undertake the commercial and retail lending you mention as being on the riskier end of the spectrum (albeit now with ring-fencing of retail depositors).  In the case of ETFs, they are absolutely not custodians in the sense that certain institutions (e.g. BONY Mellon) are the independent custodians of equities and bonds on behalf of asset managers.

Best analogy is the credit default swaps that were used to package securitised debt in the run up to the financial crash of 2007/2008.  There was an opaque and interconnected chain of derivative transactions between the large financial institutions and no one really understood who wore the ultimate credit risk. In the final reckoning, some of those counterparties came up short and couldn't meet their derivative obligations which led to the bail out of AIG and failure of specialist (a.k.a. monoline) insurers like Ambac, as well as losses on the investments themselves.

If you trust that investment managers and banks are adequately regulated and we can't ever have a financial crisis again, then OK,  go on believing that an ETF investment is the equivalent risk to holding equities.  

Some ETFs achieve exposure to the movements of an index by using derivatives to mimic the performance of the underlying index as you describe above. But the main products, like the iShares FTSE 100, actually closely reproduce the index by holding physical shares in appropriate proportion to the index weighting and to the demand for those shares from consumers through the ETF. In the industry terminology, its holdings are "physical" (actual shares) and "replicated" (an exact match). This factsheet confirms as much.

https://www.ishares.com/uk/individual/en/literature/fact-sheet/isf-ishares-...

There are issues with less liquid ETFs, but the main index trackers are also very liquid as well as much more like holding physical shares than you had assumed. You still have the counterparty risk of Blackrock or Vanguard of course. But you have that with with any bank deposit, don't you?

Regardless of whether they are well regulated, it seems to me these ETFs are actually a very bad thing to go into large quantities as an individual investor.

An individual investor is unlikely to know (or even have the means) to hedge for tail risk on such a product, but you should never buy something like this without hedging for tail risk. 

I see more and more people buying loads of these ETFs without even realising the risks they are taking...

Might be wise to just sit on the cash for a couple of months, could be a good time to buy if the markets think Corbyn will gain office in the next GE. 

Along with everyone else. Best not to try and predict these thingsz

You're just about the most risk-averse person around! Do you also have insurance against nuclear war or being struck by a meteorite?

Nope, I’m not risk averse, on the contrary, making sure that I cover myself from the threat of ruin by tail events, is what allows me to take very high risk elsewhere, and make very high returns when there is an upside, without worrying about losing everything.

And no, I’m not insured for nuclear war, because insurances typically exclude specifically this type of thing in what they cover in their contracts. If you read the small prints you’ll see that your home is not covered in case of war, nuclear disaster, etc etc...

Insurers are not stupid you see, they give you cover only for the risks they can measure, and they understand risk a lot better than asset managers !

Your are right, the i-Shares one is very like an index tracker fund, and will have a similar risk profile. Would be interesting to see the fee on it, not spotted on the factsheet.

There are ETFs which are fully synthetic (using derivative options only). If you are feeling punchy there are ETFs that give 2X or 3X the return on the FTSE, or even the inverse return (gains when the markets fall). Guess it's a case of looking at the detail of each. 

Let us keep this simple, never mind tail risks etc etc. Do not put all your eggs in one basket.

Hardly rocket science.

Although generally speaking a good advice, this is often interpreted by people as the reason to put all of their pensions and savings in so called “balanced” and “diversified” portfolio.

In reality what this means is that if the market crashes they have nothing else left.

The total fee is 0.07%. Your agent or custodian will make a charge as well. But they charge for holding funds and equities of course. It's likely no different.

You seem to fretting about an event that has never happened - all shares and bonds and other assets in a balanced portfolio simultaneously dropping to a minimal amount.  Even in the two worst crashes ever, a balanced portfolio would have lost  less than 50%.  Even US shares lost "only" 90% in the 1930s.  The chances of having nothing left in an even vaguely balanced portfolio aren't worth worrying about.  If it happens, the cash worth will be least of your worries.

Are you not over-exaggerating a tad, Rom? A typical balanced or diversified portfolio consists of 50% bonds (mostly boring) and 50% equities (risky but potentially rewarding). Most posters don't have the benefit of your experience in finance so forgive me for an over-simplification as I attempt to explain. I realise you already grasp all this so you can skip the next two paragraphs.

In a market crash so severe as to halve the value of all equities, I'm modelling that the small allocation to riskier bonds would also fall somewhat and the large portion of government bonds would actually grow to keep up the bond half of the "50". Therefore, this portfolio would still retain 75% of its value. That's a lot more than "nothing else left".

The balance however would now be 67% bonds and 33% equities. A good portfolio manager would then re-balance (sell bonds, buy equities to get back to 50/50) to capture the upside of a recovery in equities so that when the market eventually recovers its former level, the portfolio would show a gain instead of returning to its previous value, at which point the manager sells equities and buys bonds to return to 50/50, with a profit. It's a proven strategy (the rebalancing is more of a continual process in reality but I did say this was a simplified explanation).

There's no guarantee that a market will ever return to its former level of course, but there's considerably greater probability than there is of finding "nothing left" after a crash. Absent a nuclear war of course.