Archive for the ‘Pensions’ Category

The rich get richer and the poor get poorer. It sucks, but that is the way of the world. At least that is what most of us assume, but data from the ONS out this week suggests this may be wrong.

Since the start of the economic downturn in 2007/8 the richest 20 per cent of households have seen disposable income fall by 6.8 per cent, the poorest 20 per cent have seen income rise by 6.9 per cent.

It is important that we point out what we mean by disposable income at this point – it’s after taxes and benefits. The ONS has included VAT in the equation, by the way.

In 2011/12 the richest 20 per cent – before taxes and benefits – enjoyed income of £78,300, which is 14 times greater than the poorest fifth, which had an average income of £5,400. That is a ratio of 14 to one.

But take into account taxes and benefits and things look different – very different. The top 20 per cent saw disposable income fall to £57,300, while the bottom 20 per cent saw it rise to £15,800. The ratio changes to just four to one.

So what a bunch of socialists the government of the last few years has been. Except they haven’t really.

For one thing, the data does not tell the full story. It does not tell us about average income in the top 1 per cent quartile.

Besides if you drill down, things look different. If you look over a much longer time period, say from 1977, a quite different picture emerges. Since 1977, disposable income for the bottom 20 per cent has risen by 1.93 per cent, and by 2.49 per cent for the top 20 per cent.

There is in any case a more noticeable gap between the top 20 per cent and the rest of the population.

Average disposable income for the second poorest 20 per cent was £21,373 in the last financial year, or 1.35 times more than the first 20 per cent. Average disposable income for the middle 20 per cent was £27,526, or 1.29 times the average for the second poorest. Average disposable income for the second richest 20 per cent was £34,437, or 1.25 times the average for the middle 20 per cent. And average disposable income for the richest 20 per cent was 1.66 times the second richest.

But then again, so what? Don’t the rules of numbers mean that the average of the top 20 per cent will always be much higher than everyone else for the simple reason there is no upper limit to the top 20 per cent. The lowest disposable income can be is zero, the highest is… well, it’s infinite. Instead let’s look at how things have changed.

Equivalised disposable income, by the way, means: “The total income of a household, after tax and other deductions, that is available for spending or saving, divided by the number of household members converted into equalised adults; household members are equalised or made equivalent by weighting each according to their age, using the so-called modified OECD equivalence scale.” See: Glossary: Equivalised disposable income

And by the way just one more point. The proportion of people in the bottom 20 per cent who are retired has fallen over this time period. . This is because retired households have seen incomes growing at a faster rate than those of non-retired households.

© Investment & Business News 2013

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As you know, we are ageing. We are all literally ageing, of course; there are no real life Benjamin Buttons out there. But as a country and as an economy we are ageing too, and that means there could be a pension problem in the future. The solution is obvious. We all have to save more, throw more money at our pensions. Or do we? A new report suggests that this approach may be flawed.

According to EuroFinUse: “Recent OECD statistics have cast a dark shadow over the aspirations of private pension savers. Over the last 5 years, real returns from private pension funds (after inflation) have been negative in many EU Member States. They have failed to hold their purchasing power, setting a gloomy outlook for tomorrow’s pensioners.”

In fact the real return (that’s after inflation) on five years’ pensions across Europe has been just 0.1 per cent over the last ten years and negative and minus 1.6 per cent over the last 5 years – at least that is what the OECD shows on the products and countries it covered.

EuroFinUse stated: “Despite such concerning results, the OECD still strongly recommends that citizens should make a greater contribution to personal pension provision. When advising people to save more, public authorities should bear in mind that pension saving products are in many cases destroying real value of citizens’ savings. This is why providers and public authorities should seek to protect the long-term purchasing power of savings, before advising citizens to increase those.” See: The Real Return of Private Pensions 

Actually, when you think about it, the report should not really come as a surprise. Many pension funds in an attempt to meet solvency laws, have been flocking to bonds, even though such bonds pay out lower percentage yields than inflation.

The truth is that many pension funds have been paralysed by the regulator into becoming so risk adverse that they threaten to bring down the economy. The economy needs risks; there is no such thing as risk free. The obsession with risk free in recent years has ironically created more risk.

That is why investing under your own steam, privately rather than via a pension fund is interesting.

And here is a thought to leave you with. A recent article in ‘Fortune’ magazine quoted London’s Tech City CEO Joanna Shields as saying that not so long ago her employees scoffed at stock options. They wanted pensions. She says that today that they all want to be the next Mark Zuckerberg. See: What London can teach Silicon Valley 

If you want a secure retirement, saving for a pension may be a partial answer, but stock options and investing directly, without the straitjacket of a pension fund and its requirements, may provide a better alternative

© Investment & Business News 2013

“The elderly are more likely to vote than the young.” That was what CityAM said this morning, in response to Ed Balls’ idea of increasing the retirement age.

Actually, Mr Balls was talking about ring fencing. The government is trying to make cuts, but certain areas are protected, will never be breached – never as in cross my heart hope to die, never.

So the NHS is safe. Education is safe, and state pensions are safe.

But maybe ring fences are a bit too solid, and never is too long a time frame. Part of the problem with the NHS is that the pendulum has swung too far to the other way since the bad old days of the 1970s. Back then doctors and nurses were grossly underpaid. Today many GPs are more like traffic police. They direct patient traffic to different specialists, but how much of what they do could be handled by well trained, experienced nurses?

As for nurses, maybe the entry level is too high. A better career progression path, with senior nurses taking on many of the tasks that used to be carried out by doctors is a good idea, but at the bottom end, maybe we need more SEN type nurses. So perhaps the NHS should be not so much be ring fenced, as have a new ring of confidence via a complete re-think on how it operates.

The NHS also needs a re-think in terms of the imminent retirement of the baby boomer generation, otherwise we have a nasty problem coming.

Talking of baby boomers retiring, did you hear the one about savings? It was told by Scottish Widows, and the story goes like this: one in five Brits are not saving at all; 40 per cent are not saving enough.

Is it right? Well, sort of.

It is true that the UK sits on a fault on the demographic tectonic plates, and the impending earthquake could be far more significant than anything fracking might bring. As things currently stand, the UK is heading towards a disaster of enormous proportions as the baby boomers retire, and find there isn’t enough money in the pot.

But what the UK really needs is a more dynamic economy, with more entrepreneurism. Greater savings may help if the money saved is used to fund investment and in promoting entrepreneurism. If, on the other hand, greater savings mean money sloshing around and lying idle, promoting consumer credit and mortgages, and pushing up house prices, then the catastrophe that is the imminent retirement of the baby boomers will be far more catastrophic.

As for ring fencing state pensions, Ed Balls actually said that the idea of cutting money spent on stage pensions in some way was being considered, but probably the result will be a rise in retirement age, rather than less pension income for those who are retired.

And on the topic of the UK fiscal deficit and government borrowing, it seems there is a choice: carry on borrowing and risk creating a massive debt burden for the younger generation, or impose austerity and risk deepening the downturn, imposing a massive burden on the younger generation trying to build a career.

Mr Balls is as populist as any of the politicians, and no more likely to advance unpopular policies that are in the common good, than anyone else, but at least Ed Balls’ new plan tries to deal with one of the problems.

The baby boomer generation makes up a large chunk of the electorate, however, which means they want higher house prices, higher pensions, a lower retirement age, and none of this talk about fiscal stimulus, for that will lead to more debt, which is immoral because that will leave a debt for future generations to pay.

For more see, Baby boomers: The tyranny of the Baby Boomers 

© Investment & Business News 2013

Uk Population

Here’s a chart for the UK population as of now with a line for the official projections 10 years hence.

As a tool for prediction this chart can be quite powerful; pictures speak a lot louder than words.  The way to use the chart is to imagine the blue and red lines being pulled across the page as we all move inexorably towards God’s waiting room on the right.

We’ll be pulled past 2 marks on the way. The left block shows where young people (16 – 24) might find themselves becoming employed and paying taxes – remember that 20% don’t though so the ‘new workers’ line is copied and shifted lower.

The next mark, for the retiring age for men, shows an ever increasing rate of retirees, after a very steep previous 10 years there will be another 7 million arriving during our 10 year look into the future. You might notice an almost mirror image of the lowered ‘new workers’ line but the unemployed are living off the state too, so there is another 1 million to be added to the line on the right if we want to balance workers vs. state supported.

Unfortunately, because the leading edge of retirees points up and the leading edge of new workers points down, things just get worse. While this demonstrates the ex-growth nature of the economy it is reassuring to compare the huge block of substantially employed people and the much smaller wedge shaped block of the already retired.

So it looks a lot less gloomy right now but as our 10 year view unfolds it builds to uncomfortable levels all the way up to and past the baby boomer’s peak in 15 years.

Note how the red projection line slumps after the retirement age. I’d like to think that this is not an early death syndrome but rather an indication that retired people like to head off to countries with blue skies and sunshine. As we have seen, the retiree level is really lower than the new workers level and that’s a significant first; it just gets progressively worse after this as the retirees line builds even steeper and the workers line pulls across a dip. Incidentally there are dips because WW1 and WW2 were one breeding cycle apart (27 years) and the resulting post war pulses have yet to die down.

If you are about 50 now you are at the population peak age. Births subsequently declined for 13 consecutive years, and that was another first, signalling the end of centuries of perpetual population growth. Because accounting practices, pension arrangements, government finance, and much more, all worked because growth conveniently forgave all sorts of silly thinking, there were, and still are, bound to be some serious consequences.  The way the world works has changed forever.

The workings of pension schemes are of particular interest. With perpetual growth there was always a bigger pool of funds to pay out the liabilities so nobody needed to be particularly efficient. That is no longer the case and you can be sure there will be a raft of pension scheme failures.

With such a huge pension liability arriving over the next 15 years the pension funds have to prepare by switching out of equities and into bonds and then progressively the bonds are then sold as net payouts increase. Logically we might expect weak equities and strong bonds eventually followed by weak bonds.  When the bond sell-off stage arrives one wonders how the Government finances will work – who will they sell bonds to then?

An ex growth world has some implications for equities. Shareholders have got used to accepting lower yields in exchange for corporate growth. As soon as the growth stops then a proper yield will be required. As an example a company yielding 2% and going ex-growth might have to yield 4% to remain attractive. So that means the share price would have to halve!  How likely is this scenario?

Well take a supermarket for example. As a footfall company, whose profits are directly linked to the traffic through the door, the impact of an ex-growth population will be severe. Actually the population is not quite ex-growth, it is just slowing down, but even so companies in this category are subject to massive falls as soon as their growth is seen to end. Just to be safe, sell all your growth stocks?

You can see why there was a property boom over recent decades as the only way the available housing stock grew was via owners dying or new houses being built. Looking back it seems so obvious that fewer old people (from a previously smaller population) supplying demand from a much bigger block of house seekers would result in big price rises.

The chart is giving a strong indication of a repeat performance. Note how there is a bulge moving into the first time buyers age groups and then compare that to the lower height of the chart where old people might shuffle off. Demand will clearly outstrip supply for a while and looking forward 10 years this is increased by immigration as can be seen by the way the bulge actually grows as it moves across. The low end of the housing market looks like a good bet and you can expect a rally in the house builders too.

All this is good for the economy with an added twist. The baby boomers already have a house and yet they are about to inherit their parents houses which can easily be sold on at today’s fairly substantial prices; an added boost to the economy for several years to come.

This last point reinforces the idea that retiring couples with windfall cash will head for the sun. That’s bullish for overseas holiday homes so get in while they are depressed.

Any negatives? Well the way the dotted red line sits above the blue line has implications for NHS services over the next 10 years. It doesn’t look much but in percentage terms there is a significant increase with a detrimental age bias to account for too. An already stretched service has a crisis looming.

The big bulge in the new adults group will all be driving cars for the first time; good for the motor industry but bad for traffic jams.

Conclusions:  No great dramas for the next 10 years but this is the lull before the storm. After 15 years the peak of the baby boomers will be at retirement age and from then on it is hard to see how the books stack up unless the, already brimming, country is filled with more foreigners.

The houses to buyers ratio is likely to top out, leading to a sustained bear market in house prices. The stock market will slump horribly as it goes absolutely ex-growth and the pension funds go into net draw down.  The Government will find it hard to fund the state pension burden and increased demands on public services. Borrowing to bridge the gap will be hard as traditional lenders, in the net draw-down scenario, have no need to buy bonds. Interest rates may well climb as a result and then the National debt financing costs spiral up. Pay more, borrow more, pay higher; sounds familiar.

A UK Government default before 2028?  Not so hard to imagine is it?

Data – The Office for National Statistics

Opinion – Patrick O’Connormist

According to data from the ONS, the number of people aged 65 or over in employment has risen from 890,000 in the first quarter of 2012 to just under a million in Q1 of this year.

According to a survey from NS&I, just under a third of Britain’s adults (31 per cent) do not know how they will finance their needs in later life, including such eventualities as long-term illness, nursing home or care fees and care of others, including partners, parents and siblings.

On the subject of retiring over 65, Nigel Green – who is the chief executive of the large IFA the deVere Group – said: “Naturally, it’s hugely positive if the over 65s who are working past the traditional retirement age are doing so because they choose to, but it’s totally different if they’re being forced to carry on working as they can’t afford to retire.” He said: “I suspect the majority are working because they have to.” He continued: “The ONS findings show once again that as a nation we’re simply not saving enough. There needs to be a radical shift in the savings culture.”

The NS&I research shows that “over a quarter of Britons (27 per cent) who have yet to consider financial planning in later life admit they do not want to think about such events. 23 per cent say they simply have not had time to think about their later life financial needs, and just under a fifth (19 per cent) prefer to take a short-term view of their finances and use the money they have for the present.

A further 12 per cent don’t consider that this situation will affect them in the near future and believe they will have plenty of time to consider such planning going forward, while 7 per cent of Britons do not consider later life financial planning as important.”

So what does that tell us?

Clearly we have to save more and we will, as the baby boomers wake up to their pension crisis in the making.

But if a large chunk of the UK populace starts to save more won’t that lead to recession? This is what happened in Japan 20 years ago, and we all know what happened next.

© Investment & Business News 2013

The data was revealed a week or so ago. It is pretty clear cut. According to the ECB, the median wealth of the Spanish is 183,000 euros, 172,000 euros for Italians, 75,000 for the Portuguese, and a stunning 267,000 euros in Cyprus. In contrast, median wealth in Germany is just 51,000 euros.

So that’s it then. The problem is not that the poor old Spanish and Cypriots are being pulverised by the vicious EU, which is being prompted by Germany into punishing them for mythical misdeeds. Instead, the real problem is that poverty stricken German households barely have two cents to rub together.

The solution is simple enough: tax ‘em. Have a wealth tax. And where will it end? Will the meat in your freezer – beef, horse or otherwise – be seen as wealth and subjected to tax?

There is an alternative take. Writing in the ‘FT’, Wolfgang Munchau argued that the ECB survey was in fact being taken out of context. For one thing, he said median wealth is a meaningless guide. He said: “If you want to compare across countries, it is better to take the mean.” Mr Munchau suggested that if we use mean wealth as the guide, then Germany’s does not lag behind troubled Europe as much as the quoted data suggests. It is not clear that Mr Munchau is right here, however. After all, median data is the better measure for telling us the position of most people, and is not distorted by a small number of people with massive wealth.

But Mr Munchau made a more substantive point. Actually the differences in wealth are a symptom of the euro – that is to say, a Cypriot euro has less value than a German euro, hence Cypriot assets appear to be worth more.

Others question the limitation of the ECB data, and say it does not take into account savings in pension schemes.

But there are other more important points. For one thing, the ECB survey relates to asset values from a couple of years ago. Asset prices across much of troubled Europe have crashed since.

Besides we all know that in Germany the housing market is seen as less important. The Germans do not celebrate house prices going up – they mourn.

The data does suggest an interesting idea though. Is the reason the savings ratio in Germany is relatively high, and thus consumption to income relatively low, because Germans have less wealth tied in the home, and after a period of rising house prices, appear to have less wealth?

©2013 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here

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As a species there is one thing we are lousy at. We think we are unique. We come up with an idea to solve a particular problem, and rarely does it occur to us that across the economy others are behaving in much the same way, and have come up with a similar idea.

Collective behaviour can have the effect of nullifying our actions; it can even have the opposite effect to what we had originally intended.

So that’s us. You and me. We are victims of this. It’s like a virus, and it has a name too – it is called the fallacy of composition. It has infected humanity since we came down from the trees. But you would expect more from regulators, wouldn’t you? Alas the regulator of the European pension industry – which goes by the snappy title of the European Insurance and Occupational Pensions Authority – has contracted a nasty dose of the fallacy of composition. It is one of the reasons why the economy can’t get out of the rut it has got itself into.

Back in 1997 it happened with Long Term Capital Management (LTCM). They came up with an algorithm that was a sure fire way to make money. It couldn’t fail, or at least the chances of failure were so minuscule that they were effectively ignored. What LTCM did not factor into account was what would happen if other investors applied a similar approach. The crisis that ensued was like an early preview of 2008, and nearly brought the global economy down to its knees. The IMF made a similar mistake. It congratulated the banking industry on the innovation called mortgage securitisation, and said that as a result of this the chances of banking crisis had reduced. It was a victim of the fallacy of composition. When the majority of mortgages were subjected to securitisation, the result was that –because banks took on more mortgages as a result – risk increased. You know what happened next.

We have an economic cycle for much the same reason. When market research shows demand is greater than supply in an industry, the company which commissioned the research increases output, but they rarely factor in competitors having access to similar research. Output rises, the industry sees boom, but then production exceeds demand and recession follows: companies cut production, demand exceeds supply, until research emerges showing demand is greater than supply.

So that’s the composition of fallacy. Across the economy it applies to savings. In a recession, companies and households reduce risk, save more, and the recession gets deeper as a result.

When banks reduce risk en masse, the result is less lending, the economy stumbles and the very thing banks were supposed to reduce, then rises. The fact is that all banks are insolvent. No bank can survive calls from all of its depositors to withdraw their money. If all banks collectively agreed to increase risk by lending more to wealth creators, the result would be a stronger economy and the chances of a banking crisis would fall.

If all pension funds put less money into ultra-safe, low yielding assets, and invested in infrastructure, and funded company investments by buying equities, the result would be an improving economic outlook, and pension funds would rise in value.

But under solvency II regulations, pension funds are required to reduce risk. So they have no choice but to pump more money into government bonds, and because government bonds pay out such incredibly low yields, they have to buy an awful lot of bonds in order to meet their commitments. That means they have to raise more money, and companies have to pump more profits into pension schemes and less into investment. The economy deteriorates as a result. And pension fund find they have an even bigger deficit.

The EU Commission wants to see European pension funds put money into infrastructure. The European Insurance and Occupational Pensions Authority has considered its request, and given the following statement: “Any preferential treatment of a certain asset class might result in a build-up of risk concentrations in the sector with the associated higher level of systemic risk.” In other words, they’ve said no. The irony in this statement is the use of the two words systemic risk. Actually, the fallacy of composition is the cause of systemic risk.

The National Association of Pension Funds (NAPF) has looked at the implications of forcing UK pension funds to follow solvency II rules and fears a £450 billion pension deficit will follow as a result.

Joanne Segars, chief executive of NAPF, said: “The EU plans for UK pensions come with a clear and unpalatable price tag. Businesses trying to run final salary pensions could be faced with bigger pension bills to plug an astonishing £450 billion funding gap. This would have a highly damaging effect for the retirement prospects of millions of UK workers.” She added: “This project has been conducted at breakneck speed due to the EC’s ludicrously tight timetable. This cannot be the basis for formulating a policy that could undermine the retirement plans of millions of people both in the UK and across Europe.”

She is right, but wrong about the problem. The problem is not that the European regulator is enforcing a “ludicrously tight timetable”, it is that it has fallen victim to the fallacy of composition.

©2013 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here