Free Asset Allocator Website

I am running my entire retirement investing strategy including expected annual returns and projected retirement dates from an excel spreadsheet. Today though, I stumbled upon a nice little tool that looks to be written by Morningstar which provides a quick way of mixing up simple asset allocations to project expected returns. Additionally if you enter the portfolio value, annual investments, desired years to retirement or similar and your total financial goal it provides a probability of reaching the goal. Link here.

The website states “Asset Allocator helps you assess the likelihood of meeting your financial goals based on your current financial situation. If you find that you are not on track to meet your goals you can adjust certain criteria and immediately see the effect of your portfolio's growth potential.”

I entered my retirement investing strategy into the site which included a Portfolio Value which is currently at 40% of my Financial Goal. My Annual Investments were based on me investing around 60% of my gross annual earnings and I entered my time to retirement (Years) as 7 years. Asset Mix was entered as my Desired Low Charge Portfolio as I describe regularly on the site including here.

The Expected Return was provided as 8.99% with a 3 year standard deviation of 13.18. An Expected Return of 8.99% seems a little bullish for my tastes. Using my models I have a current expected annual return after inflation of 4.2%. The UK arithmetic mean of the retail prices index (RPI) since 1987 is 3.5%. Totally these would give an expected return of around 7.7% before inflation which is a variation of 1.29%.

What is also provided by the website is a Probability of [reaching my] Goal. In my case this was provided as 91%. I’ll take those odds...

As always DYOR.

Tax efficient investing – Individual Savings Accounts (ISA’s)

To ensure that I maximise the annual return on my retirement investing strategy I am constantly focused on three key elements:
1. Ensure I have the right asset allocation in place
2. Minimise the fees that I pay by buying index linked investments wherever possible
3. Minimise the tax that I pay

To minimise the tax that I pay I use one tax friendly investment and two tax wrappers.
I have written in the past about the tax friendly investment I use to help me minimise tax – Index Linked Savings Certificates.

Today I’m going to talk about one of the tax wrappers I use which is Individual Savings Accounts (ISA’s). The other tax wrapper I use is a personal pension which I will discuss in the not too distant future.

I’m not going to go into great detail about how ISA’s work as most people are aware of them and you can find plenty of information on the internet including here.

My current retirement investing strategy holds around 9.7% of its assets in Stocks and Shares ISA’s. I do not use Cash ISA’s at this point in time. Providing that you find a Stocks and Shares ISA provider that does not have any fees for the privilege of using the ISA tax wrapper I cannot find any negatives to using them. At the very worst you are break even and neither better nor worse off.

For me the Stocks and Shares ISA is performing a powerful function. To minimise fees for some of my asset classes I am buying offshore based exchange traded funds (ETF’s) which are categorised as non-distributing funds by HM Revenue & Customs. In very crude terms if I was not holding these within the ISA and I chose to sell to rebalance my portfolio the capital gain would be taxed as income rather than as a capital gain. This also means that I could not use my capital gains tax allowance either. As all income (dividends and interest) and all capital gains are tax-free within an ISA I am sheltered from this problem.

As always DYOR.

The Bank of England holds the Official Bank Rate at 0.5%

The Bank of England made two decisions today.

Firstly the bank decided to stop quantitative easing as they were happy with the £200 billion of government bonds that they already own. What is now going to be interesting to watch is what happens to government gilt prices and yields now that the government have lost a key buyer of their debt. In December alone the UK government needed to borrow £15.7 billion and I look forward to seeing where the buyers of all this debt are going to come from. The other thing that I look forward to is seeing if the Bank of England is ever going to be able to sell the government debt that they have already bought.

Secondly the bank decided to keep the official bank rate on hold at 0.5% for the twelfth month in a row as I suggested they would on Tuesday. This is the lowest rates have been even if I look back to the year 1694. Even during the Great Depression the Bank Rate only went as low as 2%. My chart today shows the relationship between the official bank rate, the consumer price index (CPI) and the retail prices index (RPI). Normally, as you would expect, the correlation between the official bank rate and inflation is quite high. However currently the bank seem to have lost all interest in controlling inflation so while it heads skyward the bank rate flat lines. I’d really like to know their justification for this when the Monetary Policy Framework under which they operate includes “...Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment.” I guess we’ll know Mervyn King’s thoughts when he writes a letter to Alistair Darling next month following the CPI heading over 3%.

UK Mortgage Approvals – February 2010 Update

On Saturday I discussed why I might have been early in my call that we had potentially reached the ‘Return to “normal”’ phase of the UK house market. I would like to revisit this again as I continue seeing data that is potentially starting to point towards a further housing market correction.

The first chart is a repeat of that shown on Saturday. I described how the new interest rates secured on dwellings are still very low at 4.5% compared to the peak of 6.3% and have likely had a big effect on the market. What is of interest however is that this 4.5% increase is 7% more than the low of June 2009 and is trending in an upwards direction with no assistance from the Bank of England.

The second chart today also shows another interesting piece of data. The olive line is the most interesting which shows seasonally adjusted monthly mortgage approvals decreasing for the first time in 13 months dropping from 60,045 to 59,023 in December which is a decrease of 2%.

Rising mortgage interest rates will put pressure on those who have variable rates or are coming off fixed rates. It will also decrease the level of borrowing possible for a new person trying to enter the housing market. Additionally falling mortgage approvals suggests less competition in the market for each house that is for sale.

Could the rules of supply and demand finally start to work in the near future?

A tale of two Central Banks – Reserve Bank of Australia vs Bank of England

The Reserve Bank of Australia (RBA) announced today that they were keeping interest rates on hold at 3.75% after raising rates by 0.25% a month for 3 months in a row. According to the Financial Times this surprised most economists.

In my opinion the RBA seem to have timed their increases well. In September of 2009 the Australian Consumer Price Index (CPI) saw a low in this cycle of 1.26% and even though this was the case they started raising rates in October. We have now seen the RBA increase rates by 20% from their lows. It doesn’t seem unreasonable to me for them to take a pause to see what effect this is having given CPI is still only 2.1% and given the inflation target for the RBA is as follows:

“The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.”

This target was introduced in mid 2003 and since that time the arithmetic average has been 2.7% so to me as a simple Average Joe they seem to be doing a reasonable job.

Now to the contrast which is the Bank of England. They have kept the Official Bank Rate at a record low of 0.5% now since March 2009. The Bank of England also saw the UK Consumer Price Index (CPI) reach a low in this cycle in September of 2009 at a rate of 1.1%. However instead of following the lead of the RBA they have sat on their hands allowing CPI to reach 1.5% in October, 1.9% in November and we now have the CPI at 2.9% (with last month being the largest month on month increase in history) and the Retail Prices Index (RPI) at 2.4%. I can’t see how they can allow this to occur given the Monetary Policy Framework under which they operate includes:

“The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government's inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.”

I think the Bank of England have now shown their hand and think they can control the inflation genie and allow “just a little bit of inflation”. I’m backing that they don’t raise interest rates this week. I guess only time will tell.

Australian Property Market – February 2010 Update

I intend to keep a close eye on Australian house prices as I build my retirement portfolio. This is because Australia is a very likely retirement possibility (if not sooner) for me.

The first chart shows the quarterly Real (adjusted for the Consumer Price Index) Brisbane and Real (again adjusted for CPI) Australian Eight Cities (Sydney, Melbourne, Brisbane, Adelaide, Perth, Hobart, Darwin & Canberra) House Price Index with data taken from the Australian Bureau of Statistics catalogue 6416.0 since 1991. This Index was reset in 2003/2004 and so I have “corrected” pre March 2002 data by taking the ratio’s of the pre and post September 2003 to June 2004 data as a multiplier. This chart carries data only until December 2010 and clearly shows a nice dip at the start of 2009 before the latest data point has taken house prices to new record real highs.

My second chart shows Real Annual Changes in price from 1995 to present. In Real terms over this period Brisbane has seen average increases of 5.3% (up from an average of 5.2% last quarter) and the Australian Eight Cities has seen average increases of 4.9% (up from an average of 4.8% last quarter). Unfortunately for me though the trend lines (particularly for Brisbane) continue to head upwards.

In non-inflation adjusted terms over the period Brisbane prices have seen average increases of 8.1% and the Australian Eight Cities prices have seen average increases of 7.8% (up from an average 7.6% last quarter). Unfortunately if you don’t already own a property you continue to be priced out when compared with average earnings. Using the Australian Bureau of Statistics catalogue 6302.0 (extrapolating the last quarter as the data is not released to the 25 February) which looks at average weekly earnings shows that while house prices have had their long run averages increase this quarter, Total Weekly Earnings have stagnated at a yearly 3.8% and Total Full Time Adult Earnings at 4.3%.

My third chart shows what happens when house prices continue to rise at a rate greater than salaries. Over this period affordability of Brisbane houses when compared to Adult Full Time Weekly Earnings has gone from a low of 0.063 to 0.121 meaning affordability has halved and the Median Eight Cities houses have gone from a low of 0.064 to 0.112 which is a huge reduction. This type of shift is just not sustainable but when/if will the market return to a more sustainable equilibrium.

Looking at the big increases this quarter I can’t help wonder if the data is ‘reliable’ and I would like to see how the histograms have changed since 2008. This is because the government has brought forward demand and changed the dynamic in the market by offering first home buyer grants with changing values depending on the date. If I had have bought before 14 October 2008 I would have received $7,000. Using this as a 5% deposit would mean I could borrow $140,000. If I had have bought a new house between 14 October 2008 and 30 September 2009 I would have received $21,000 which again with a 5% deposit would mean I could borrow $420,000. That has to change the supply and demand dynamic in the market. This ‘stimulus’ has now been gradually withdrawn with first new home buyers being reduced to $14,000 between 01 October 2009 to 31 December 2009. Finally, since 01 January 2010 first home buyers are back to $7,000 meaning we’re back to that $140,000.

So if I was a first home buyer I would have bought between October and September with first home buyer stragglers buying also in October to December. I would now be out of the market. I think the Housing Industry Association (HIA) may have seen in this when they reported that new home sales are down 4.6% in December 2009.

It will be very interesting to see what happens next. Australia has rising interest rates and if supply and demand works (assuming no government intervention) second home buyers may now struggle to sell without reducing prices as their pool of buyers has been reduced, along with the pool that remains having smaller deposits. This should reduce prices going forward. This should then flow through the rest of the market. Interesting times ahead...

My allocation to international equities

Tim Hale in his book ‘Smarter Investing : Simpler Decisions For Better Results’ states that ‘investing in a range of developed equity markets such as those in North America, the European Union, Japan and Australasia, provides the potential to deliver comparable returns, given similar levels of risk, long term rates of economic growth and reasonably comparable levels of governance, law, political stability and capitalist economics...’

However, he also mentions that investing in developed international equity markets can expose you to economic cycles / pressures that are out of sync and currency exchange rates. These types of effects can be clearly seen by looking at the chart above which has been prepared using the Yahoo Finance website. The period used is December 1989 to the present day with the red line being the S&P 500 (USA), the blue line being the FTSE 100 (United Kingdom) and the green line being the Nikkei 225 (Japan).

It is these types of effects that I am looking to take advantage of in my retirement investing strategy by regularly balancing back to my desired regional allocation within my international equities allocation. This is exactly the same principle I am using with my total low charge portfolio allowing me to buy when the market is low and sell when the market is high.

When choosing what regions to invest in I wanted to also ensure that my allocations were large enough to make a difference within my total low charge portfolio. For example my nominal allocation (before allowing for corrections in line with PE10 ratios) to international equities is 15%. If within my international equities I have an allocation to a region at 20% then this will affect 3% of the total portfolio which matters. If I went down as low as 5% then the total affect would be only 0.75%. A 10% swing in stock market prices in this region would then only make a difference of 0.075% to the total portfolio which in my opinion is insignificant.

So what regions am I allocating to my international equities asset allocation? I’ve kept it really simple with desired allocations of:
- 40% United States
- 40% Developed Europe (France, Germany, Italy, Spain, Netherlands, Switzerland etc)
- 20% Japan

My current asset allocation is:
- 38% United States
- 38% Developed Europe
- 21% Japan
- 3% Other

Others include South & Central America, Emerging Europe, Middle East & Africa and Developed Asia. These other regions have not been deliberately chosen but are merely the by product of buying low cost funds that cover a little more than the regions I am interested in.
Sectors within these regions include energy, materials, industrials, consumer discretionary, consumer staples, health care, financials and information technology.

As always DYOR.

UK Property Market – January 2010 Update

I am yet to buy myself a flat or house even though the ownership of one is important to my retirement investing strategy in the longer term. The reason for this is that in my opinion UK house prices are still overvalued by a huge margin. Yesterday the Nationwide reported that average house prices had risen from £162,103 to £163,481, a rise of 0.8%, in a single month pushing house prices to yet more highs of un-affordability.

Chart 1 shows the Nationwide Historical House Prices in Real (ie inflation adjusted) terms. The Real increase is much less than that reported by the Nationwide with prices rising from only £163,140 to £163,481 as the UK Retail Prices Index (RPI) also increased by a high of 0.6% in a single month.

This chart also demonstrates that compared to average earnings property is very expensive when a ratio is created of the Nationwide Historical House Prices to the Average Earnings Index (LNMM) and it is for this reason I have yet to buy. In 1996 this ratio was as low as 607 and today the ratio stands at 1,172. If we were to return to that number the average house using the Nationwide Index would be £84,670. Will we ever get that low again?

Last month I questioned whether we may have been at the point of the ‘Return to “normal”’ phase kicking in. Chart 2 today highlights why I may have been early in my call. The red line shows the monthly average of UK resident banks interest rate of new loans secured on dwellings to households. I have taken the average of five data sets which are the floating rate, fixation <=1year, fixation >1year<=5years, fixation >5year<=10years and the fixation >10years. This interest rate had been as high as 6.3% in September 2008 (before the Bank of England panicked and lowered the Official Bank Rate to a record low of 0.5%) and then had reduced to a low of 4.2% by June 2009.

This has meant for new loans the average interest payable has reduced by a 1/3. So when a typical person walks in to a bank and asks for the maximum they can borrow the low interest rate is going to mean they can borrow more principle which will then push up house prices. The good news however is that even though the Bank of England has not moved, the Official Bank Rate the interest paid on loans is starting to increase from the low of 4.2% to 4.5% in November 2009. This will reduce affordability which unless peoples earnings start to increase should start to push house prices back down again and there is little the Bank of England can do unless they completely ignore inflation and drop interest rates even further or perform more Quantitative Easing. They clearly won’t be able to do this without risking a bond strike or hyperinflation however personally I do think they won’t raise interest rates even though inflation is rising quickly when they meet in a few days.

Chart 3 shows the annual change in Nationwide property prices and compares this with the change in the average earnings index extrapolated a couple of months to match the Nationwide time period as LNMM is still only released to November 2009. It shows that the annual change in earnings is now around 1.4% which is significantly less than the Retail Prices Index (RPI) and the increases being seen in house prices.

So in summary house prices are increasing in nominal and to a lesser extent in Real inflation adjusted terms. However in my opinion I suggest that these increases will be short lived. Salaries are increasing at a rate which is less than both inflation and house prices. Bank mortgage rates are starting to increase from their lows which will reduce the level of principle that can be borrowed. The Bank of England and government are powerless to do anything about it without risking the country as a whole. The only fear I have now is that the Bank of England holds interest rates allowing inflation to rise quickly (I think they will) resulting in nominal house price increases but stagnation in Real inflation adjusted house prices. This will be dependent on whether salaries start to increase in line with inflation. The private sector doesn’t seem in a position to do this however while government borrowing is at record highs I fear the government will listen to the Unions requests for big increases as they have an election win to try and buy.

For now I’m staying out of the housing market.

As always DYOR

Assumptions:
LNMM data is extrapolated for December ’09 and January ’10.

How can banks be back to big profits and big bonuses so quickly?

One method the banks are clearly using is to widen the margin between what they borrow at compared to what they lend at as can be clearly seen in my chart today. This means that any interest earning cash that I am holding as part of my retirement investing strategy is losing out over the potential interest rate that I could have once expected with the extra hair cut being used for banks earnings and bonuses.

The blue line shows the monthly average of UK resident banks interest rates of new time deposits with a fixed original maturity from households. I have taken the average of three data sets which are the maturity <=1year, maturity >1year<=2years and the maturity >2years.

The red line shows the monthly average of UK resident banks interest rate of new loans secured on dwellings to households. I have taken the average of five data sets which are the floating rate, fixation <=1year, fixation >1year<=5years, fixation >5year<=10years and the fixation >10years.

The average interest rate paid to households between 2004 and 2007 was 4.81% with the average borrowing rate being 5.47%. That gave the banks a margin of 0.67%. In the last year the average rate paid has been 3.13% with the average borrowing rate being 4.53%. The banks have widened their margin to 1.41%. Finally, in the last month of the data set (November 2009) the banks have been able to further widen their margin to 1.69% with the average rate paid to households being a low 2.84%.

Bank of England datasets used:
Time deposits – CFMBI84, CFMBI85, CFMBI86
Loans – CFMBJ39, CFMBJ42, CFMBJ43, CFMBJ44, CFMBJ45

How to Make a Million UK Pounds

According to the Camelot Group around 70% of the adult population regularly play The National Lottery. Personally, I find that number worryingly high. So while I suspect 70% of the population think that this is one method to make a million I personally don’t like the odds with around a 1 in 14,000,000 chance of hitting the big one.

I’m going to propose an alternate method for UK residents. Unfortunately my method is not as instantaneous and involves a lot of dedication. However I think my method has much better odds.

So how does it work?

The first thing I need is a stocks and shares ISA. These are a great product as once your money is invested in one all returns are tax free. I have to be careful though and ensure my stocks and shares ISA does not charge me an annual fee. As of the 6th April 2010 every UK saver will be able to invest up to £10,200. For my method I’m going to suggest I stay very focused and invest the full £10,200.

The next thing to do is to decide what stocks and shares to buy within my ISA. Tim Hale in his book “Smarter Investing : Simpler Decisions for Better Results” suggests that the arithmetic average for UK real (after inflation) equity returns could be 7.0%. He also suggests UK real (after inflation) bond average returns could be 2.3%. So I’ll take these two building blocks and build a basic portfolio that consists of 60% UK equities and 40% UK bonds. I then decide to rebalance this asset allocation regularly. This could give me an average real return of around 5.1%.

Now I need to buy those equities and bonds. With a bit of shopping around I should be able to find exchange traded funds (ETF’s) for both UK equities and UK bonds to buy within my ISA with fees of less than 0.5% per annum. I’ll be conservative and assume I spend the whole 0.5% meaning my average expected return is now 5.1% - 0.5% = 4.9%.
Now of course the UK government always wants a bit of inflation. Since 1988 the average of the Retail Prices Index (RPI) has been around 3.5%. So I’ll add the inflation on 4.9% + 3.5% = 8.1% to give an average expected annual return.

Now I’m going to let the magic of compound interest go to work.

After 5 years I’ve invested £51,000 of my own money and assuming straight line average returns I might have around £65,000.

After 15 years I’ve invested £153,000 of my own money and compound interest has started working for me as I might have around £302,000.

After 25 years I’ve invested £255,000 of my own money and I might have around £821,000.
Finally, after 28 years I’ve invested £285,600 of my own money and I might have around $1,073,000. I’m a millionaire.

Of course in 28 years my one million pounds won’t have the buying power of today. Assuming the 3.5% inflation I mentioned above means my £1,000,000 would be worth around £587,000 today. That however is still a lot of money.

As always DYOR.

Stagflation and the UK Q4 GDP Numbers

Firstly, some quotes to think about:
1. "Now in Britain, we are saying, as you know, that inflation is low, interest rates are low and we expect there to be growth.” – Gordon Brown, 2008
2. "We have a strong economy, its momentum will carry us through." – Alistair Darling, 2007
3. "I think the choice is becoming pretty clear. Between a government that is determined at all times to maintain the stability and growth of the British economy. “ – Gordon Brown,2007
4. “...a weak currency arises from a weak economy which in turn is the result of a weak Government.” – Gordon Brown, 1992

So the UK today emerged from recession. What an excellent [sic] job the current government and the Bank of England has done managing the UK economy over the business cycle. Today we find that the UK economy (GDP) has grown by 0.1% in the final three months of 2009. To get these outstanding [sic] results they’ve only had to lower VAT to 15%, lower the Official Bank Rate to 0.5% (the lowest rate in the history of the Bank of England), quantitative ease to the tune of £200 billion and introduce a car scrappage scheme to name but four.

This has all resulted in:
- house prices that are within 13% of record peaks. Of course that’s great news if you’re a “hard working family”, sorry, hard working politician with multiple houses partly paid for by the tax payer.
- a heavily devalued (weak) pound.
- low returns from bank deposits / bonds for those people trying to live on savings or save for retirement.

To go with this we have the Consumer Price Index (CPI) increasing at a rate of 2.9% including the largest month on month in history and a Retail Prices Index (RPI) increasing at a rate of 2.4%.

Now I’m going to get my crystal ball out and predict how the Bank of England is going to respond. I’m betting that they will leave the Official Bank Rate on hold at 0.5%. This in turn will lead to the next big issue for UK PLC. Firstly inflation will take off, then salary inflation will start as the public sector unions negotiate first just before the election and then others join the band wagon. This will then lead to built in inflation which the Bank of England will struggle to get back in hand.

I have one word for where I think the UK economy is headed – stagflation.

To conclude I’m going to modify the four quotes above a little. “Inflation is not low”, “we do not have a strong economy”, “we do not have stability and growth” however we do have “a weak currency”.