News

Irregular Roundup, 15th July 2024

by Mike Rawson · July 15, 2024

We begin today’s Irregular Roundup with chilling.

Contents

Chill not FIRE
Consumer preferences
One factor model
DIY vs advised
IHT
Quick Links

Chill not FIRE

When I started this blog almost ten years ago, one of the 7 Circles after which it was named was “FIRE and Frugal”.

The FIRE movement wasn’t very well known at that point, but by now I would expect that most readers know that the acronym stands for Financial Independence, Retire Early.

Both aspects of FIRE appealed to me, and indeed, I had already FIRE’d before I started the blog.

But a lot of the UK finance bloggers at that time were working towards FIRE, and it was a topic I was interested in.

Unfortunately, there isn’t a lot to say about fire. The process goes as follows:

Work out how much you need to live on
Multiply this by between 25 and 33 (depending on which SWR – safe withdrawal rate – you believe in) to come up with a pot size that will allow you to retire
Work backwards from that pot to work out what level of contributions you need to make to get to that number by your target age (and divide that by your income to come up with you’re savings rate)
Save for many years and hey presto! You’ve fired.

I ran out of things to say, and several other FIRE bloggers who were around then have also quit since they hit their number.

The sooner you want to FIRE, the more aggressive your savings rate has to be – some people aim for 60% to 70% of income.

I only worked for 25 years, which according to Mr. Money Mustache’s “simple maths” means I must have saved 33% of my income.

I’m not sure I managed that, but the point I was going to make is that there has been a backlash against high savings rates, and “sacrifice” in general.

The latest salvo was fired by Andrew Oxlade of Fidelity in This Is Money.

He says that he’s starting a new anti-FIRE movement called CHILL.

CHILL stands for Career Happiness Inspires Longer Lives.

That’s a tall order for many – the quality of careers has declined considerably since I started.

Andrew thinks that social media fosters the idea that money is what’s needed for happiness.

Maybe it does – Reddit and Twitter were the only platforms that I ever liked, and they have both fallen a long way from their peak.

More money indeed has diminishing returns, but that depends on how you define enough.

If you look at income, then clearly £200K of income is not worth double what £100K is.

But in FIRE, the surplus just brings forward the date of your financial independence, so money scales more linearly until you reach your goal.

That might look weird to someone who isn’t interested in FI, or who thinks that it’s unattainable – but it’s not.

I always saw FIRE as being about regaining control of your time.

I hated my job and 90%+ of the more than fifty managers I had during my career.

I was also bored at work, and find retirement more stimulating (though when you quit a decade or more before your peers, you do lose some social contact).

My partner enjoys her job and is likely to continue for as long as she is offered interesting work (and her health permits).

I enjoy not having a job, but instead having the time to devote to whatever hobby or passion currently interests me.

Everybody has to decide for themselves on the RE part, though there are few jobs that I can see 70-year-olds enjoying.

FI, not so much – I can’t see why anyone wouldn’t want to be financially independent.

FI means freedom.

Consumer preferences

Joachim Klement wrote about whether consumers take notice of firms’ profits and ESG credentials.

Except for weirdos like me who are totally into investing as a hobby or profession, I have never seen anyone read a financial report or an ESG report. I wonder how anyone could have missed that before sending outquestionnaires to tens of thousands of unsuspecting Americans.

As you might imagine, people are interested in quality and price, not profitability and ESG credentials.

And their key information sources are friends and family and customer reviews.

Financial and ESG reports are used by less than 10% of people.

Which I guess is simply the share of people who checked every possible answer because they didn’t pay attention to the survey plus the few weirdos that have investing as a hobby or profession. ESG reports only have an effect on consumers who have been prompted to actually read them, but these effects are small and short-lived.

When they were asked after the experiment why they didn’t care about ESG and profits, the number one reason was that they couldn’t remember.

Shocking, huh?

One factor model

In a second article, Joachim wrote about a one-factor model to explain asset returns.

The problem with most finance models and theories is that they have been developed by people trained in economics and finance, which is to say by people without a proper education in maths and statistics.

Joachim is a trained mathematician and physicist and doesn’t rate his colleagues in finance.

In particular, he’s not a fan of linear models, even though they sometimes make money.

Financial markets are complex dynamic stochastic systems and trying to describe a complex dynamic system with a linear model is inevitably going to fail no matter how many parameters you use to ‘fit’ the model to reality.

Most importantly, practitioners and academics alike insist on using fundamental variables like valuation or profitability to explain market behaviour.

Way back in 2009, Joachim wrote a paper explaining how to use a Fourier filter to profit from market cycles.

I thought that was an incredibly simple model that performed extremely well, but I met a lot of resistance because the model did not rely on fundamentals, but instead used combinations of sine and cosine functions to identify cycles without ‘explaining’ what drives these cycles.

The new paper is similar, using fourth-order polynomials.

This nonlinear model makes all known factor models redundant. It created sizeable outperformance and matched the actual returns of asset classes very well. [The] model outperformed existing factor models in almost all cases for forecast periods of 6 months.

Despite this, Joachim is not optimistic that the new model will be widely adopted.

It doesn’t use fundamentals to explain share price returns. And that means to most practitioners and academics it has no meaning.

But you know who doesn’t care about ‘having meaning’ or using polynomials to understand and forecast asset returns? AI. And hedge funds don’t care whether their model uses fundamental variables. They just want to make money.

I don’t care either, so I hope that someone will use AI to make the model available to regular private investors.

DIY vs advised

For FT Adviser, Alina Khan reported that 79% of over 55s prefer the DIY route to taking advice from an IFA.

The data comes from Canada Life, which reported a few more findings:

39 per cent p are experiencing the retirement they dreamed of
29 per cent are not
11 per cent did not anticipate just how much money they would need in retirement and are finding life after work more difficult than they expected
36 per cent said they had experienced unexpected health challenges
27 per cent said they were still happy even if they were not living the retirement they had planned

Canada Life MD Tom Evans said:

People’s experiences of retirement vary quite widely. While a lack of retirement funds, and the impact of rising costs are clearly issues facing the current generation of retirees, unexpected health issues trump both of those, and the dreams of many have been shattered.

Planning your retirement and ensuring it is flexible enough to navigate the many challenges you will face is vital to feel in control to enjoy your later years.

Engaging the services of a qualified financial adviser early on is a fundamental part of that process. An adviser will not only be able to help with product choice, investment selection and tax, but will help you navigate any unexpected bumps in the road along the way.

I agree about the need for a flexible plan, but many people should be able to put one together without professional help, and many others won’t have the funds to justify paying for (expensive) advice.

IHT

For the FT, Emma Agyemang reported on calls from think-tank Demos for government action on IHT.

A freedom of information request found that 68 estates, each with business assets of more than £5M, were able to shelter £1.8bn of their assets from IHT.

HMRC data shows that 3,380 estates in 2020-2021 claimed the tax break on assets worth a total of £3.2 bn.

So the Demos families mad up 2% of claims, but owned 57% of the sheltered assets.

Business relief was introduced in 1976 and was originally targeted at company firms, but was later extended to AIM stocks.

Since then, a cottage industry of wealth managers offering IHT portfolios of safe AIM stocks has grown up.

To save even more money, you can run such a portfolio on a DIY basis (since most AIM stocks qualify) – as I did for my mother-in-law.

Dan Gross of Demos said:

It is quite shocking that over half of the relief goes to 68 estates. It’s a very small number of the wealthiest benefiting from the vast majority of the relief. Business relief is being used as a way to reduce tax bills for those estates at the very top.

The inclusion of AIM stocks makes no sense from an IHT perspective, but it makes more sense from the angle of supporting small growth stocks (as with VCT and EIS).

This argument is somewhat undermined by the low quality of the typical AIM stock, but with some joined-up thinking from the government, this might be fixed.

I think it’s more likely that Labour will do away with the relief (for AIM stocks at least) as IHT seems to be one of the taxes they are planning to raise more revenue from.