Inflation

[Chrysalis]

TJH wrote: “I can't easily put a value on the pensions, as only one of them arose from an annuity purchase.”

I use a multiplier of the annual payment to put a capital value on the pensions. I don’t have much by way of pensions in payment but have a large SIPP (I took the PCLS some years ago) which continues to grow. Although there are arguments against this I bought an extra £25 per week state pension and continue to defer taking payment of the state pension as it increases at 10.4% helping me build my inflation proofed income. (I think discussion of the benefits or otherwise of deferring the state pension should be on another thread if anyone wants to discuss this. It’s a complex issue and I’m well aware of John Kay’s modelling and analysis).

So, I receive a small inflation proofed pension each year and add what I would receive (but defer from the state) and multiply by 25 for the capital value. 25 is historic and I really should look at this number but this whole part of my spreadsheet is a small and obscure byway which might become more significant if inflation kicks off.

Best wishes,

Steve

For other readers who might not be aware - deferring state pension is now about half as good a deal as it used to be (about 5% increase per year). Combined with higher state pension age I am not sure many would consider it likely that they would live long enough to break even.

[Wuffle]

A rare occasion when being a professional failure works in my favour.
I am resigned to work past the state pension age with all the inflation protection that brings.
The OH is a decade younger than me so it brings a natural balance to our lives as well.

W.

[hiriskpaul]

TJH wrote: “I can't easily put a value on the pensions, as only one of them arose from an annuity purchase.”

I use a multiplier of the annual payment to put a capital value on the pensions. I don’t have much by way of pensions in payment but have a large SIPP (I took the PCLS some years ago) which continues to grow. Although there are arguments against this I bought an extra £25 per week state pension and continue to defer taking payment of the state pension as it increases at 10.4% helping me build my inflation proofed income. (I think discussion of the benefits or otherwise of deferring the state pension should be on another thread if anyone wants to discuss this. It’s a complex issue and I’m well aware of John Kay’s modelling and analysis).

So, I receive a small inflation proofed pension each year and add what I would receive (but defer from the state) and multiply by 25 for the capital value. 25 is historic and I really should look at this number but this whole part of my spreadsheet is a small and obscure byway which might become more significant if inflation kicks off.

Best wishes,

Steve

For other readers who might not be aware - deferring state pension is now about half as good a deal as it used to be (about 5% increase per year). Combined with higher state pension age I am not sure many would consider it likely that they would live long enough to break even.

For me, I would consider deferring as longevity insurance. It would not matter if I failed to break even, but might matter if I lived into my 90s.

If you don't break even on house insurance, is that money wasted?

[hiriskpaul]

As you know, I'm not a believer in asset allocation models. My personal situation is that we have a house, which is paid for, I have three pensions (state, and 2 occupational) which escalate in different ways, a portfolio of shares and a modest cash holding. I can't easily put a value on the pensions, as only one of them arose from an annuity purchase. Property valuation is only tentative, because of the lack of local yardsticks. It is currently about 50/50 equities and property, plus about 6% cash. Last year the income from dividends and pensions was comparable, in the ratio of 41/59, so the pensions (which equate to fixed interest) are a little more than one third, if one assumes that the yields from the underlying assets are similar.

In the current year, it looks probable that the income from equities may be only 2/3rds of the previous years. For me, that is no hardship.

TJH

Sounds like you are in a fortunate position. If your investment income halved and stayed that way for a decade, your income would only drop by about 30%. Would that cause hardship? If not then you can afford to take significant risk with your investment income. For many people, especially those with a much lower proportion of their income protected, a halving of investment income could be painful, or at the very least life changing and consequently may prefer to dial down their investment risk.

[1nvest]

Look at the prices available in the real world and you get the real loss of purchasing power.....

The matter hinges on using ‘purchasing power’ as an illustration of the effect of ‘inflation’.

Since 1980 the US$ has declined at a annualised rate of 2.8% relative to gold. Since 1972 the £ has declined at a annualised rate of -1.4%. In both cases that is sporadic/volatile. That broadly implies US inflation of 2.8% and UK inflation rates of 4.2% ... in terms of gold. Gold can maintain its purchase power over long periods, but again in a very sporadic manner. A Roman soldier might have bought a nice suit for a 1 ounce gold coin, as might a modern day man buy a nice suit for around a 1 ounce coin.

If your home value is £ and around a third of your total wealth, holding US stock and gold in 50/50 has you diversified across each of £, $ (primary reserve currency) and gold (global currency). Along with being land, stock, commodity asset diversified. The first chart above shows the make up of the total yearly gains from such a 50/50 US stock/gold (in £ adjusted total return terms) portfolio.

Excepting if you can reliably predict and rotate into which (£, primary reserve currency, global currency) will be the better performing over a period of time, then its reasonable to diversify across all three in around equal amounts. Which helps to reduce overall volatility (risk). That wont have you at the best, but equally nor the worst ... but the middle road is usually 'good enough'.

[1nvest]

Property valuation is ... currently about 50/50 equities and property, plus about 6% cash. Last year the income from dividends and pensions was comparable

Sounds like you are in a fortunate position. If your investment income halved and stayed that way for a decade, your income would only drop by about 30%.

Looks to me (thanks for sharing Terry) more like a overall asset allocation of the order 10% cash/reserves, rest split equally three ways of home, stock, pensions (bond equivalent, where pension and stock income are around comparable, so if stock income halved that's 25% less relative to combined stock and 'bonds' (pensions). Factor in home imputed rent benefit (liability matched rent, rather than renting and having to find/pay rent) ... and sitting sweet Value 'rent' at the same as 'bonds' or stock income and stock income halving equates to a relatively mild 16% "hit".

Descent inflation linked occupational pensions are (were) great. I pity those coming behind (next gen) whom will have to rely on being able to accumulate enough in SIPP's and find investments for those SIPP's to potentially provide a stable/safe inflation adjusted income uplift. Healthcare is going a similar way, more reliant upon individuals being able to fund their own rather than a collective insurance. Both IMO are significant backward steps, this gen not leaving a better but a worse world for the next gen.

For many people, especially those with a much lower proportion of their income protected, a halving of investment income could be painful, or at the very least life changing and consequently may prefer to dial down their investment risk.

I'm turning 60 with a reasonable index linked occupational pension soon to be received. At mid 66 I'll also receive a further £9K/year in state pension. Own a home, hold a reasonable amount of liquid wealth/assets, so could now do very much similar to Terry, as the combined imputed rent and pensions would be 'enough' alone. I did stop working in my mid 40's (redundancy offer that was too good to pass on), primarily to become a carer, and since 2005 have more or less had to rely upon investments for my regular 'wage' to supplement care allowance and some odd jobs low £ value irregular work. So I could go against the grain and actually increase liquid wealth to being nearly all-in on stocks as-enter/in retirement, but after so many years of playing defensive I guess I have a in-built fear of such.

[AJC5001]

So, I receive a small inflation proofed pension each year and add what I would receive (but defer from the state) and multiply by 25 for the capital value. 25 is historic and I really should look at this number but this whole part of my spreadsheet is a small and obscure byway which might become more significant if inflation kicks off.

Best wishes,

Steve

I too have a few rows in a much larger spreadsheet where I attempt to calculate the capital value of my pensions. The SIPP row just contains the current value of the SIPP. The rows for my BD pensions contains the current annualised Gross monthly pension payment multiplied by 20. The annualised state pension is also multiplied by 20.

The multiplier of 20 comes from the way DB pensions are revalued when calculating the amount of Lifetime Allowance, as far as I recall from when I set it up a few years ago when I first received my DB pensions. From https://www.pensionsadvisoryservice.org.uk/content/publications-files/uploads/Spotlight_Lifetime_Allowance.pdf :-

"Defined Benefit (DB)

A Defined Benefit (DB) pension, an example of which is a “final salary” pension, is a pension which
provides you with a guaranteed income in retirement based on how long you were a member of the
scheme and the salary you earned during this time. When you start to draw your DB pension you may
automatically receive a tax-free lump sum, or you can commute (‘give up’) some of your pension for a
tax-free lump sum (known as a pension commencement lump sum).
When you start to draw your benefits, your DB pension is multiplied by 20 to provide the value which is
to be tested against the LTA."

However, I note that further down that linked document there is :-

"What if I took a pension benefit before 6 April 2006?

The Lifetime Allowance was introduced from 6 April 2006. If you took any of your pension benefits before
this date, then your Lifetime Allowance will be reduced
At your first BCE after 6 April 2006, any pension you are receiving will be multiplied by 25 to work out
how much your Lifetime Allowance should be reduced by."

which may be the source of your multiplier of 25.

I've never attempted to understand how the Lifetime Allowance and BCE's work as I'm nowhere near the allowance, so using the multiplier of 20 was just a convenience. I suggest any more discussion of this should be on the Pensions board.

Afrian

[tjh290633]

OK you wiseacres.

I've been drawing my pensions for 22 years now. What value should I get?

TJH

[Hariseldon58]

@johnw

I can see the inflation linked bond has caused some confusion, about the degree of protection and at present, the certainty of loss in real terms at maturity.

It might be worth thinking of this as a product that provides a small income, that increases with inflation and at maturity, the capital Is returned with inflation protection. Except that the demand for this bond is so high that it sells above the ‘par’ price and consequently a real loss will occur at maturity.

This might not seem a good thing to buy, except that should we have a period of poor or negative growth and high inflation it may seem a whole lot better than regular bonds or equities....

My personal take is that they real yield of ILG is too negative and that the £ has a poor record against other currencies in bad times.

US Treasury Inflation Protected securities are my choice , alongside regular US Treasuries, plus premium bonds for a ten year comfortable income backstop. In real terms all of these are likely to return a slightly negative ’real’ yield but they provide at least 10 years income in case the equity portfolio (5+ X the size) has a really bad time.

This the small negative real yield on 15% of the portfolio is a modest insurance cost.

[Steveam]

OK you wiseacres.

I've been drawing my pensions for 22 years now. What value should I get?

TJH

Although I’ve not really given this a lot of thought as it’s a fairly irrelevant issue I’d suggest revaluing the various pensions at what it would cost you to buy them at the revaluation date. The value of the pension would decline as one ages which seems right.

The only reason I went down this rabbit hole was that some years ago I “spent” about £25k on buying extra state pension (£25/week) and realised that my spreadsheet now had me £25k poorer which didn’t feel right as I’d just bought an asset at a bargain price. Deferring my state pension (which as someone above mentioned I see as insurance against longevity) added to the misrepresentation. At the end of the day “worth” is a side issue as I live on income and this discussion is about the inflation prospects and impacts.

Best wishes,

Steve

[tjh290633]

OK you wiseacres.

I've been drawing my pensions for 22 years now. What value should I get?

TJH

Although I’ve not really given this a lot of thought as it’s a fairly irrelevant issue I’d suggest revaluing the various pensions at what it would cost you to buy them at the revaluation date. The value of the pension would decline as one ages which seems right.

I suppose the correct route would be to see what an annuity for my life expectancy might cost. Unfortunately the tables which I have found only go up to 75, which is not a lot of help. A life expectancy calculator suggests that I have 5 years left. I wonder if a multiplier of 6 is realistic?

TJH

[JohnW]

@johnw

It might be worth thinking of this as a product that provides a small income, that increases with inflation and at maturity, the capital Is returned with inflation protection. Except that the demand for this bond is so high that it sells above the ‘par’ price and consequently a real loss will occur at maturity.

Nice summary. I'll poke my neck out in a room full of bond wizards, for the sake of any complete bond neophytes, to clarify that 'your capital is returned with inflation protection' is actually 'the bond's (adjusted) face value, not the price you pay for it, is returned with inflation protection'. I think, as usual.

My personal take is that they real yield of ILG is too negative and that the £ has a poor record against other currencies in bad times.

US Treasury Inflation Protected securities are my choice , alongside regular US Treasuries, plus premium bonds for a ten year comfortable income backstop. In real terms all of these are likely to return a slightly negative ’real’ yield but they provide at least 10 years income in case the equity portfolio (5+ X the size) has a really bad time.

The choice of UK linkers or US TIPs might depend a lot on whether one is a UK or US investor. A problem I see with UK investors buying individual US bonds is the currency exchange rate fluctuation risk. If you guess it right, good; but exchange rates can move adversely further than the size of the bond yield, thus potentially damaging the value of that bond as an investment. Secondly, for inflation protection, a UK investor getting protection from US inflation rates might not be as helpful as getting protection from UK inflation rates. But if the foreign bond has a much better yield to maturity than the local bond, I could be tempted. Bond funds are a different kettle of fish, somewhat.

[Hariseldon58]

@johnw

1) Yes the inflation protection is to the par (face) value NOT the price you paid.

2) The US bonds are held through an ETF not individually and exchange rate movements may be considerably greater than the yield, currency movements can be adverse but over time the £ tends to sink...

My mix is regular US bonds, inflation protected and U.K. sterling premium bonds, it covers most bases.

Fair points about the difference between U.K. and US inflation rates but I have much greater faith in the dollar over time. ( Higher U.K. inflation than US inflation will not be covered but the £ is likely to weaken and you’ll probably make back the difference in relative currency movements)

There are technical differences with the workings of us and U.K. inflation protected bonds as well.

You can get U.K. hedged versions of US bonds but I do not believe them to be attractive.

Predicting currency movements is not easy...

[Wuffle]

Is it fair to say that it is bloody complicated and you should let one of the UK investment trusts that specialise in this kind of thing do it for you?

W.

[scrumpyjack]

Also don't forget any nominal gain on US indexed securities is subject to cgt in a taxable account whilst uk linkers are not

[JohnW]

....you should let one of the UK investment trusts that specialise in this kind of thing do it for you?

That sure makes it simpler, but you still have to decide which country’s bonds you want, which type, short or long term, currency hedged or not. Then there are fund fees. An advantage of a fund is the diversification you get, reducing default risk; but if it’s only UK/US government bonds a default is unlikely, and a one country fund might not reduce that risk anyway.
An obvious role for individual government bonds is to meet known spending needs in the future. You buy one or a series of bonds with maturities to match your spending needs. This gives a very predictable outcome (income, actually), but yields are low now. A bond fund might not meet that need so precisely because its maturity it always being pushed out into the future, as bonds mature or are sold and then replaced with similar ones, and so its value is sensitive to interest rate changes whereas single bonds held to maturity just sail on unflustered.

[NeilW]

Resulting from printing money, and even with the forecast high unemployment and falling wages. some say we are heading for general inflation.

Not sure how they get that given the high level of savings necessarily implied by the level of Gilt issues. Somebody has to want to save not spend if those are to be sold.

Very difficult to get inflation without excess spending.

There's been high levels of "printing money" in Japan for 30 years. Betting on inflation there has become known as the "Widowmaker trade"

[Wuffle]

JohnW,

It is my heart.
I know it better than anyone.
I have read a book on heart surgery.
Yes, it is definitely best if I operate on myself.
Control is great.... Up to a point.

W.

[Bubblesofearth]

Is it fair to say that it is bloody complicated and you should let one of the UK investment trusts that specialise in this kind of thing do it for you?

W.

The motto of the financial industry.

BoE

[tjh290633]

Is it fair to say that it is bloody complicated and you should let one of the UK investment trusts that specialise in this kind of thing do it for you?

W.

The motto of the financial industry.

BoE

It always used to be said that it was far better to invest in gilts directly, rather than pay somebody to do it for you. I cannot see that the situation has changed to any extent.

Not that I would be touching fixed interest securities with my own or anybody else's bargepole at this time.

TJH