Thoughts on the current market bubble

I know as passive investors you try to accept the ups and downs fatalistically, and avoid trying to improve things because timing's difficult to do.

I'm not a passive investor, and not an index investor, for the most part, so I am used to going beyond a regular steady-buying approach. I know I need to look at what I am buying and owning.

(I should clarify that I'm not a trader. I want to buy and hold very long-term, much like an index investing approach. I just try to use research to buy better profit-makers than the index average.)

By many measures, current prices are crazy.

To quantify that, let's look at risk and reward. The reward is the cashflow the shares (or index funds of shares) give. If an investor reasonably wants a 10% annual return, that suggests a fair price of 10x earnings. By that measure the market is priced at about double what it should be.

At that, it contains some risk. And it is competing - a savvy investor will be looking at this subdued reward (down to 5%) and comparing it to the risk-free option. For a lot of people that is short-term US treasury bonds, and they're giving 4.3%. That's very nearly the same return, for no risk.

That risk has some impact on the value of these investment opportunities, and in the normal course of things 4% for no risk and 10% for risk sounds about balanced. Right now we're way out of balance.

This means that at some point a pin is going to burst the bubble, and prices will normalise. We're in a market that's priced at double what it should be.

Will it crash? Maybe, or it could stagnate, with prices remaining fairly static over a long period whilst earnings catch up.

When will it crash? No-one knows. And I am not nearly smart enough to try to make a prediction. It could continue motoring along for a couple more years, I have no idea.

What to do about it?

Because no-one honestly knows *when* a correction will happen, it's more tempting to take the passive, fatalistic approach and just ride it out.

In my own case it's harder to bury my head in the sand. I don't have the arms-length comfort of an index fund - I'm mostly in Berkshire Hathaway shares, so I can easily see their earnings and am very aware of their value. $40 of earnings for a $500 share means an 8% return. Less overblown than the market in general, but it's still lower than usual, and making me wary. When markets fall, they drag everyone along with them.

I am at the point of topslicing a little and keeping some cash for a rainy day. New contributions will add to that cash. If/when I can buy again at sensible prices I'll do so.

As to making risk predictions, I think the new US administration has made things worse. Their pro-business reputation gave stock prices a further bump up, meaning prices got further out of line with earnings, and then there's the pinprick factor. The market becomes febrile and we're one pinprick away from an event which triggers a loss of confidence and a crash tends to follow. I think most of us would agree that this administration is less competent than others, so I wonder if they will screw it up. Both US government debt and the debt of American financial institutions has been allowed to rise to risky levels, and I wonder if that will be the flashpoint.

Another risk, closer to the cause of the bubble, is AI. The market-dominating companies are pouring their earnings into their scramble for AI capability, rather than feeding them to investors. If confidence in that should falter, and investors retreat, that could be the trigger too.

I'm not suggesting you do anything; just airing my thoughts and looking for opinions, so that we can make more informed choices together.

If you're interested, here's someone else's similar take on this: https://www.youtube.com/watch?v=DDY_MACVvlI

Just How Much Do I Need To Save For Retirement?

 I'm planning to look at three scenarios in this post.

1, How much does automatic enrolment get you?

2, How much do you need to save to top up your state pension to a comfortable retirement?

3, How much do you need for a comfortable early retirement?

Nest

A recent interview with an executive from Nest (the government workplace pension company) prompted this idea. He said that they aim to turn the current contributions for automatic enrolment into half the top-up from state pension to the retirement you'd want.

Now, I dislike how Nest approach investment. For my taste, they force people into low performing investments because people will be scared of volatility. I don't agree with their logic. 90% of their customers never log in or look at their investment pot, so I doubt they're going to be all that scared when they don't know what's happening! For the first five years they put people into low performing assets, so that they don't become scared. And in the final fifteen years they "lifestyle" them into - you guessed it - low performing assets so that there are no upsets.

This strikes me as a case of "planning to fail". Many of Nest's customers are lower earners, who can ill afford pension contributions, but by the same token they need a good top-up from this pension to boost their state pension. If Nest know that their strategy will fall short of customer needs, wouldn't that sway them to use a less cautious approach?

Anyway, enough of that particular soapbox. Nest's approach inspired me to wonder what someone would achieve if, with a willing employer, they instead put the same contributions into a SIPP and practised low-cost global index fund investing.

The Auto Enrolment Plan

In my head, auto enrolment means 5% contribution from the employee and 3% from the employer, making 8% of wages going into the pension.

Only, it's not! It only applies to people aged 22 or older, earning £10k or more (from a single job). Then the first £6,240 of earnings doesn't have any pension contribution taken off. 

So let's take a typical person and work out what would happen to them. Meet Geoff, he's 30 and earns minimum wage (£12.21/hr) working 37.5 hour week (9-5 with a half hour lunch break), about £458 per week or £23,924 per year. The 8% of contributions will come from (£23,924-£6,240)=£17,684 of earnings, giving £1,414 per year.

Note that this is pre-tax money, so when putting it into a SIPP it already includes any pension credit top-up.

Time to fire up the Compound Interest Calculator. I'm going to keep all figures in today's pounds, so that we can see the spending power of this pension pot. I'll use a growth rate of 7%, which I think is a good long-term average for a global equities fund, net of inflation.

I'll break things down into monthly contributions too. That's £1,414 /12 = £117.83pm. Geoff should get his state pension at 68 perhaps? Who knows how the politicians will tweak things by then, but let's figure on 38 years of contributions and growth.

Running the numbers, this gives a total pot at the end of £266,354. The real figure when Geoff retires should be far higher, but we've stripped inflation out to give us today's pounds. A relatively safe 4% annual drawdown from that pot would give Geoff £10,654 on top of his £11,973 state pension, for a total of £22,627. 

That's before Income Tax. He'd get a taxfree personal allowance of £12,570, and 25% of his personal pension withdrawal would also be taxfree, so I think he would pay about £1,478 tax, leaving him £21,149.

I came into this with a figure in my head, for a comfortable retirement of about £20k. It turns out that my scenarios 1 and 2 are the same - auto enrolment, properly invested, is just about enough to top up your state pension to give a comfortable retirement. Yay!

Early Retirement

And how about my other scenario? How much would Geoff need to contribute in order to retire early?

The first problem is, how long's a piece of string? What do we call "early" retirement? We want something significantly earlier than age 68, so let's just pick an easy example which still allows the personal pension to fund retirement: the personal pension should be accessible ten years before state pension age, so let's try age 58.

The maths isn't quite as simple as firing up the calculator and plugging in some bigger numbers. Geoff will now have two stages to retirement. From age 58 the personal pension will do all of the lifting, and then at age 68 his state pension will kick in.

From age 58 we want to draw about £20k after tax. Let's use those figures from above and aim for £22,627 gross. The 25% taxfree element will be a little different, but not enough to matter. 

Then from age 68 the spending from our pot reduces because state pension is covering part of the spending. We'll want to draw £10,654 as above.

I can cheat a little bit here and save myself some donkey work. Instead of working out both of these stages, I'll instead just shoot for that £266,354 figure at age 68, leaving part two as it was above.

My quick-and-dirty approach to this is to plug in some best-guess numbers and then adjust until I get the desired result. Then I can read off the input figures.

I want to know a total Geoff needs at start of his age 58 retirement, in order to draw down £22,627 per year for ten years and leave £266,354 remaining. So my calculation is for 10 years pulling £1,885.58 per month out. 

Note that I'm not trying to account for lumpy returns or adjust for a fully safe plan here, I'm just trying to estimate what is most likely to happen to Geoff's money.

After four tries, I ended up with a starting pot size of £295,000 needed to give Geoff £266,484 left at 68. So Geoff needs to get to £295k by 58. Back to the calculator...

Inputs: Age 30 to age 58 is 28 years. Same 7% growth rate. Striking for an end figure of £295,000.

£284 per month is the total amount Geoff needs to contribute to reach £294,987 at age 58.

How does £284 per month relate to Geoff's earnings of £23,924? Well, his employer contributions will be unchanged, so he'll have a further (284*12=£3,408-£1,414)=£1,994 to add, or £166.17 per month. When he pays this into his SIPP he only needs to contribute 80% of this, as this is from tax-paid money and the tax will be claimed back automatically by the SIPP. Meaning he should throw £132.93 per month at his SIPP on top of his work contributions.

Conclusions

Instead of the 8% contribution from auto-enrolment, including 5% gross contribution from Geoff, for a ten year earlier retirement he needs to hike his contributions to 14.2%. Or add 7.6% of his net pay to put him on a trajectory to buy an extra ten years of retirement.

Many of us are starting later than Geoff, so we often have to throw everything at it that we possibly can. But for someone starting at age 30, spending a modest 7.6% of your take-home pay to buy ten years of extra freedom seems a good deal.

And for someone simply aiming to retire at state pension age, all they have to do to achieve a comfortable retirement is to turn that stodgy default-fund workplace pension into one in the equivalent of a global index fund.

Which Platform Would You Choose?

When choosing an investing platform I'd prefer to keep it simple and have accounts with just one company. I'm happy that my investments are safe, so grouping things together makes my life easier and often means economies of scale, ie lower fees.

What are the important factors?

In fact, lower fees are probably my primary concern. I do expect some fees, since I know they're providing me with a valuable service, but I don't want to pay over the top.

The service is important. I want a good range of investments to be available, and I want to get a reply to my questions.

Stability is also rather critical. I don't want to be doing business with someone who is here short-term and then selling my business on next year - I'm here for the long haul and don't want to be messed about.

All Purpose Platforms

If I need a platform to host the normal accounts - ISA, SIPP, and GIA - then these are my picks.

Starting out: Vanguard or Hargreaves Lansdown

From £10k invested: Vanguard

From £100k invested: Interactive Investor

Here's my reasoning for these choices. Vanguard and II are both decent platforms. Vanguard work out cheaper when you have a smaller pot invested, with their 0.15% annual platform charge, and from about the £100k mark II with their flat monthly subscription fee become cheaper than the percentage charge.

For small pots below about £10k, HL may work out a bit cheaper than Vanguard. They charge 0.45% annually, while Vanguard have a minimum fee of £4 per month. So you could save a little bit by going with HL initially.

But if you're going to reach the region of £10k pretty quickly, you may not think it worthwhile to chop and change, so you may prefer to set up with Vanguard in the first place.

Then there's InvestEngine, the plucky little startup offering accounts free of platform fees. For me, this fails to pass muster on the aforementioned stability test. It's a loss-making startup, so as it stands offering accounts for free isn't sustainable. There is a real admin overhead, particularly in offering SIPPs, so it remains to be seen how these guys will work out. Will they introduce fees? Will they get out of this market and sell your business on? Will they squeeze a profit from the buy and sell prices when you trade? But if you want to use them in the meantime, you'd save a few quid.

Note that if you want this SIPP to receive your workplace pension contributions, that rules out Vanguard, who only accept these contributions if you're one of the company directors. Annoying. 

LISAs

For lifetime ISAs, there's a much more limited market. The regular faces like Vanguard and Interactive Investor don't offer them.

Perhaps this is because the contribution limit of £4k per year, along with the limited band of ages during which you can contrbute, means they stay as relatively small accounts - and small accounts are hard for platforms to make a profit on. 

The two familiar-name platforms offering them are:

Hargreaves Lansdown - fees 0.25% with a cap of £45. Dealing funds: no charge.

AJ Bell - fees 0.25% but with no cap on fund fees. Dealing funds: £1.50.

HL edges it for the win.

Junior ISAs and SIPPs

Fidelity don't charge a platform fee on Junior accounts, though they charge £1.50 dealing fee for regular monthly trades and £7.50 for other trades.

Vanguard charge 0.15% annual platform fee then no trading charges. Although they're in the process of introducing a minimum £4/month fee, it doesn't appear that this will apply to junior accounts.

If you have under £12,000 in there, and are investing on a monthly basis, Vanguard are cheaper.

If you have over £12,000, or are making a one-off investment for your kids, or are contributing less than monthly, then Fidelity wins.

Freebies

Another factor which can shift the balance if you're comparing the costs is whether they offer any freebies. Some platforms like to entice new customers to join or transfer their business over with some sort of introductory offer. I wouldn't let this sway your decision unduly, but if you are going to a particular platform anyway then do be sure to check out what offers you quality for.

Vanguard never do this.

Interactive Investor almost always have an offer on the go. If you need a referral code, here's mine. Full disclosure, if you use it, I get a reward too. 

How Do You Solve A Problem Like A GIA?

Apologies to any Sound of Music fans for the cheesy misquote in the article title!

This article is about how to manage a General Investment Account. Lots of people are a bit scared of them, as they're Taxable. But the tax is pretty straightforward, and usually quite low, so let's dive in and look at how it all works. 

A “General Investment Account” is an account in which you can buy, own, and sell shares or funds. There’s no limit to how much you can add or withdraw, but your activity in them is subject to tax in a couple of ways.

You would normally use an ISA first, as they are free of all taxes. Also consider using a SIPP before a GIA, unless you need the money before the age of about 60. 

Even GIAs get a couple of tax breaks!

· You are allowed to earn £500 in dividends per tax year before they are taxed. Any dividends above that figure are taxed at 8.75% (for basic rate taxpayers).

· You are allowed to earn £3,000 in capital gains per tax year before you pay Capital Gains Tax. You can control when you make these gains, as it is counted as the date upon which you sell the shares or funds. Any gains above that figure are taxed at 18% (for basic rate taxpayers). Note that this is on gains. If you have a fund which has doubled in price, when you sell £2000 that is only £1000 of gain.

It is your responsibility to keep track of these earnings and report them for tax purposes if any tax becomes due.

Note that the taxable event is when you sell assets, not when you withdraw any cash from the account. So if you sell some of one fund and use the money to buy a different fund, there was still a taxable event. (Some people use this to “harvest” capital gains, using up their CGT allowance and getting rid of some CGT liability.) If you sell a fund and then rebuy the same fund soon after, there are rules on what counts as a disposal, so do check.

To make keeping track of dividends much easier, it is suggested that you hold the “income” and not the “accumulation” versions of any funds. (In Accumulation funds, dividends from the companies still pay out into the fund, but they are used to buy more shares, and the fund unit price goes up accordingly. The taxman still considers you to have benefited from these dividends, and dividend tax is due. But you can’t easily see how much you have had.)

· Note that dividends and capital gains count toward your earnings total for calculation of which tax band you are in. If you are a basic rate taxpayer close to the higher rate limit of £50,270, some of your capital gains and dividends may cross over the line and be taxed at higher rates.

· A sale which results in a loss also counts, and you can use this loss to subtract from your overall CGT bill for the year.

Reporting the tax

You only need to report and pay CGT and dividends on a yearly basis.

Gains made in the 2024-2025 tax year (ie ending 5th April 2025) need to be reported by 31st December 2025 and paid by 31st January 2026.

You can report gains either by filling in a Self Assessment (tax return), or by using HMRC’s Capital Gains Tax service. Or in the first instance you could just phone them for guidance.

Reporting for dividends is similar. If you don’t already fill in a Self Assessment, you must report for the year ended by the following 5th October. If your dividends are up to £10,000, you can either have your tax code amended so that the tax is taken from your wages or pension, or you can talk to HMRC by phone. If your dividends are over £10k then you need to fill in a Self Assessment.

Example

You buy £40,000 of the Vanguard FTSE Global All-Cap Inc fund.

It goes up in price to be worth £50,000.

You want to sell some of it. You sell £25,000. You’re going to use £20k of it to use up this year’s ISA allowance, and the balance after any tax will buy a holiday.

80% of your fund is original capital and 20% is profit.

This means that 20% of your £25,000 sale is gains, or £5,000. The first £3,000 is covered by your taxfree allowance, so £2,000 gets taxed at 18% - there’s £360 in CGT to pay.

In terms of dividends, this fund has been paying out about 1.47% in dividends. In the above example, your £50,000 fund may be paying £735 in dividends.

The first £500 uses up your dividend allowance, and the remaining £235 is taxed at 8.75%, so there’s £20.56 tax to pay.

You’ve pulled £25,735 from your GIA with £380.56 in tax. That’s a tax rate of 1.5% on everything you’ve taken from the GIA, or 6.6% on your gains from using the GIA.

Are GIAs better than a high interest account or premium bonds?

Yes!

Many people fill their ISAs and SIPPs, and then sit holding cash waiting for new allowances to come along in April. If this is money you want to invest, and are just held up by allowances, invest it now using a GIA.

You can hold over £30k in a GIA using a typical global index fund before the dividends get taxed.

The same goes for CGT - if your fund hasn’t risen by more than 15% whilst it was parked in the GIA, you could pull £20k out to fill your ISA without having more than £3,000 in gains.

And you are in control of when you sell, so you can go more slowly to stay within CGT taxfree limits if you want to.

How much did we win by?

At the time of writing, the best cash savings rates are about 5%. Typical returns on shares are about 10%.

Even paying tax on investing in shares, we keep about 93% of their earnings in the above example. So we’re on 9.3% from shares versus 5% on cash.

 

Links

www.gov.uk/report-and-pay-your-capital-gains-tax

www.gov.uk/tax-on-dividends