Tuesday 7 September 2010

Should retirees look to the stockmarket for income?

Adapted from my advice to a client this weekend:

Price inflation is not uniform or universal. Food and fuel have risen in cost recently, but State Pension benefits are linked to a cost of living index and should therefore approximately keep pace with increases in the price of basic needs.

In other areas (e.g. cars, cruises) prices have remained stable or even fallen. During what I suspect will turn out to be a long, Japan-style recession, it may be that the price of luxury goods and services will not inflate greatly, except perhaps for the luxuries of the very wealthiest.

Other than cash, what other ways could you invest?

First, one could look at deposits that link to inflation indices. Unfortunately, NS&I recently withdrew their index-linked savings certificates, the first time they have done so in 35 years. National Counties Building Society has an RPI-linked cash ISA (available until 30 September) but this is for a fixed amount (£5,100), runs for a fixed 5 year term and does not permit earlier withdrawals, so it may not fit in with your requirements.

If the government issues new index-linked gilts, these provide income and capital growth in line with RPI. The initial income may be low, however. For further details, please see the website of the Debt Management Office or a stockbroker. Generally, I would not now strongly recommend government bonds on the second-hand market, because the demand for them has become so high in these troubled times that the yield (ratio of income to traded price) is very low. If public finances unravel and interest rates rise, the effect on the capital value of bonds would be very depressing. As it is, the UK is struggling to maintain its official AAA rating and the implied credit rating on the credit default insurance market is actually rather lower already.**

Residential property appears still to be overpriced in historical terms. I think the only reason prices haven’t fallen much further is that interest rates are very low, which allows homeowners to maintain their mortgage payments on large loans. As the budget cuts begin to take effect, I think we will also see a depression in commercial real estate.

The stock market is also in a bubble, I believe. The ratio of price to earnings is still very high and the earnings may not truly reflect the forward position*. Companies are reportedly maintaining some degree of profitability by running down stocks, closing sites and laying off staff, but there is only so far they can go down this road. Many leading companies derive a significant part of their earnings overseas, but world trade is so interconnected these days that a slowdown in Western consumption will also impact on Eastern production.

The general picture appears to be deflationary, and although governments would like to stimulate further inflation in the way they have done over the past 30 years, there are respected economic and investment commentators who say we are now saturated with debt and unless we see outright defaults by sovereign nations (which could still happen), we will have to go through a long and painful process of retrenchment and paying-off debt.

Others look beyond deflation and think that it will ultimately force governments to find some way to increase the monetary base and devalue their currency. It may be significant that both Russia and China have made substantial purchases of gold in the last few months, and China has announced its intention of increasing her holding from c. 1,000 tonnes to six or ten times that amount in the next decade. But here we are in the realms of financial speculation, and the inflation speculators are already buying into agricultural commodities, precious metals, oil etc.

However, extreme or unconventional government strategies to deal with deflation don’t seem imminent and so I think that over the next couple of years, cash savings are likely to be a good way to build up funds for your envisaged discretionary expenditure***. Should there appear to be a major policy change, then we may have to look at investments that could protect against high inflation.

* Albert Edwards at SocGen expects a major reversal, the FT reports today.

** Though CMA DataVision have raised the UK from aa to aa+ in their Q2 report.

*** "There are no longer any “defensive” securities on the planet. The old asset allocation models and the diversification models don’t and won’t work any more and they haven’t for over a decade. I can’t believe that prominent asset managers are still using this approach." - Steven Bauer

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.


Don't have one said...

Glad you posted this. I've said before I'm a layperson, the day to day details and mechanics of investing aren't something I have a great deal of time to understand. I moved my pension entirely into cash the first quarter more out of a combination of intuition and what to me - based on my reading - seemed common sense. I don't think I've gained from that decision but given the uncertainties I see I do at the moment feel comfortable with it.

A year ago at my pension review I looked at the 5/8 percent growth projections without thinking and as a given. I don't see where that's coming from now. It's easy to get pessimistic though - at least I have a pension plan!

Paddington said...

I was tempted to put all of my extra cash into cases of whiskey and vodka, for trade goods, antiseptic, and anaesthetic.

Sackerson said...

Myopia: in deflation, expect your cash to become worth more without being subject to income/capital gains taxes. Which is why the govt hates it. But they're stuck, at the moment.

Padders: sound good to me. Do you read "Whiskey and Gunpowder"?

Steven_L said...

Not being funny, you're saying 'Don't invest in anything' - what use is that to anyone?

I disagree that stocks are expensive. Some stocks are expensive, some are cheap IMHO.

It's just a question of trying to find the cheap ones. If you don't want to lose your money, you might as well just sit back in bank deposits and let Mervyn King redistribute it to people with big mortgages.

Not for me, I'd rather make long term stockpicks. But then I'm 30 and not looking to retire for a while yet :)

Paddington said...

I am 53, but have an 8-year-old, so I'm on the WTID* program.

* Work 'til I Die

Sackerson said...

Hi Steven

"'Don't invest in anything' - what use is that to anyone?"

I was saying it in 1999 and for those who listened it saved them a packet. Cash was the best asset class by far over 2000-2010. Yes, you could have made more by hopping in and out of the market at the right times - assisted by the crystal ball.

I don't recommend individual stocks because I'm not a stockbroker. But I agree that at your age, you have time to recover from mistakes.

However, sometimes, doing nothing is the best thing to do. Overtrading almost guarantees losses. We are not in a "normal" cyclical downturn - bits are flying off the machine.

Sackerson said...

Sorry, correction: "Cash was the best asset class by far" - I went too far there. I mean it was far better than equities in general.

Have a look a Mish today - if he's right, we're on for serious deflation, in which case cash is definitely King.