Pension Shortfall – Reality Sets In

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A recent report from the Financial Services agency is causing quite a stir in the Japanese media after it detailed a shortfall in pension provision for retirees. It’s estimated that a quarter of Japanese 60 year olds will live until 95 and will need an extra 20 million yen for a 30 year retirement. (article here)

Of course the Japanese are known for their world-leading life expectancy, but the issue highlights another Japanese trait: saving money in cash instead of investing. A news report I watched this morning estimates that the average Japanese family has over half of their assets in cash, which of course earns next to nothing in the bank and is eroded by creeping inflation. This unwillingness to take risk could come back to haunt them in later life as they age and run out of money.

The political leadership are adamantly defending the credibility of Japan’s public pension system, but the reality of a pension shortfall has been known for some time. It seems a little unfair to only now be telling an aging public that they need to invest more.

Certainly there is a lesson here for everyone: Improved lifestyle, technology and advances in healthcare mean many of us will live longer than we perhaps once thought. With a noticeable reduction in the number of defined benefit pensions these days, we all need to save and invest more for the future.

It’s particularly important for younger people to realise this now and not wait too long to get started saving for retirement. Here is a useful calculator to help you understand if you are looking at a retirement surplus or shortfall.

If you are looking at a potential shortfall, you may want to review this section on retirement planning.

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

Investment Fees – Am I Paying Too Much?

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I came across an interesting article this week – see here. JP Morgan are launching a US Equity ETF with a fee of just 0.02%. That makes it the lowest fee ETF available at the moment, beating Vanguard, Schwab, and iShares on cost.

This is great news for long term investors, as long as they make money. Now why wouldn’t they make money with a fee of only 0.02% you ask? With the rise of ETFs, there’s a lot of talk these days about how much investors are paying. Fund managers and financial advisers are frequently criticised for charging too much.

But here’s the thing: it doesn’t matter how cheap your investment is if you buy it when the market is doing well and then sell it during a downturn. You are going to lose money!

Here are a couple of excerpts from Tony Robbins’ “Money Master the Game” book:

For the 20 year period from December 31,1993, to December 31 2013, the S&P returned 9.2% annually. However the average mutual fund investor averaged just over 2.5%, barely beating inflation. They would have been better off in US Treasuries.

Another fascinating example is that of the Fidelity Magellan mutual fund. The fund was managed by Peter Lynch, who delivered an astonishing 29% average annual return between 1977 and 1990. However Fidelity found that the average Magellan investor actually lost money over the same time period. How can that be? Well, quite simply, they bought and sold the fund at the wrong time!

So what can we learn from this? Simply that if you focus too hard on fees, be careful not to lose sight of the big picture. If you are prone to making emotional investment decisions when markets are swaying, maybe it’s worth paying for a good adviser who can help you make sound decisions?

If you are able to buy that JP Morgan ETF, hold it forever, and add to it when markets are bleeding, then good for you! You are going to be very happy with the result over the long run.

If watching your investment value go up and down makes you nervous, maybe you are better off paying for a diversified managed fund with a blend of asset classes that is adjusted tactically by the manager. Then you don’t have to worry about buying and selling at the wrong time.

I guess what I am saying is; if you are a disciplined investor you should absolutely be conscious of fees, and minimise them where possible for best results. If discipline is an issue for you, or you simply don’t have the time, it may be worth paying for some help.

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

Japan Inflation Watch

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It’s been a long time coming… 27 years in the case of a well known soft drinks company. Japan’s top Coca-Cola distributor recently announced that they will be increasing prices by between 6% and 10% as soon as April this year. (article here) They are certainly not the only ones, as spring will see price increases in many of your favourite restaurants, as well as on specific foods such as instant ramen, canned mackerel and even ice cream! Coupled with the planned October increase in sales tax from 8-10% this means that your yen isn’t going to go as far as it has for the last three decades.

This will come as a shock to the Japanese public and long-time Japan residents. We’ve all got used to the size of food and drink portions getting incrementally smaller, so called “shrinkflation”, but it’s really quite a jolt to see the actual price of things going up. Even my barber is raising his prices from next month!

What is this going to mean for us all financially? Well, put simply, the massive debt bubble created by the Bank of Japan means we are unlikely to see a rise in interest rates any time soon. So, money languishing in our Japanese bank accounts is going to be losing spending power. I have talked about base currency over and over, but it still bears repeating: If you are planning to spend the money you make in Japan in the UK, then UK inflation is your minimum benchmark for investments. Holding cash in JPY at zero interest in this case means you are not only losing spending power in your base currency, but taking currency risk as well. Up until now, if you were planning to spend the money in Japan, then holding JPY cash was both safe, and good enough to at least preserve your spending power. Regardless of what government inflation statistics might say, this is clearly no longer the case.

So what action should Japan residents be taking here? Here are a few things you can do:

  1. Review your base currency / currencies – if you are saving to pay for your kids education overseas, or your retirement abroad, you should be saving and investing in the currency you are planning to spend the money in. JPY cash is not the place to be.
  2. That said, if you live and work in Japan, your emergency cash reserve should be in JPY. (unless losing your job would mean leaving Japan immediately)
  3. If you have a future need for JPY as a base currency, you are going to lose spending power in JPY cash / bonds – this means you will have to take some risk with some of your money.
  4. One way to do this would be to look for dividend paying stocks / ETFs. Here is an interesting list of dividend paying ETFs in Japan. Google translate does a pretty good job on this. Remember that you should be looking at the Japan stocks / REITS – anything that invests in overseas assets, like emerging market bonds, carry currency risk that could wipe out your actual return.
  5. You could also consider a diversified Japan fund manager. I invest part of my NISA in Rheos Hifumi Plus, which is one of the most popular NISA investment funds in Japan. (this is not a sales pitch – just what I do)

I hope this helps. Please do get in touch with any interesting price increases you notice here in Japan.

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

Diversifying Through Crypto – How Digital Assets Could Change Your Retirement Plan

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Sticking with the theme of cryptocurrency this week, I came across this fascinating research paper  on the role that digital assets can play in asset allocation. While I recommend you read the report yourself, I appreciate that not everyone is enraptured by talk of efficient frontiers and Sharpe ratios, so I will attempt to summarise the main points of the paper into something more easily digestible.

First of all, here’s a post I wrote previously about asset allocation, which may be a good refresher. As noted there, modern portfolio theory is about diversification, specifically, blending various asset classes to produce good returns with the lowest possible risk. Over the long term it is possible to estimate the future behaviour of various asset classes and blend them to together to create an efficient frontier portfolio, whereby the return is optimized to the level of risk.

Efficient frontier
https://grayscale.co/a-new-frontier-research-paper/

What makes the development of a new digital asset class so interesting is the opportunity to add it into the mix and create an allocation that is more diversified than traditional portfolios. A well diversified portfolio contains a blend of assets which are not strongly correlated to each other. So the key to success is not necessarily finding better performing assets, but properly combining uncorrelated assets. In short, to widen the net and capture a better return without greatly increasing the risk.

The graphic below shows a simple simulation of how this could work. It takes a typical portfolio that is 60% global stocks and 40% global bonds, (Global 60/40) and shows how the performance and risk characteristics change by simply adding an allocation to bitcoin:

Figure 5
https://grayscale.co/a-new-frontier-research-paper/

As you can see, a 1% allocation to Bitcoin increases the return over the time period without greatly affecting the level of risk. A 5% allocation to bitcoin moves the risk needle a little more, but the cumulative return is almost double that of the Global 60/40.

This can then be taken a step further by adding a blend of digital assets rather than just bitcoin:

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https://grayscale.co/a-new-frontier-research-paper/

It seems that the extra diversification achieved through a range of digital assets has a significant positive impact on the risk/return profile of this portfolio. This can be attributed to the fact that although digital assets appear to go up and down together, they are not perfectly correlated.

I’m not going to get into Sharpe ratios in this post but you can get a definition here. From a financial planning perspective I do think it is worth a look at Figure 12 and Figure 13 in the paper, which give an interesting simulation of how someone saving for retirement could benefit from an allocation to digital assets over time:

grayscale_fig12
https://grayscale.co/a-new-frontier-research-paper/

Assuming $100,000 in starting capital and an annual contribution of $18,500, this gives us an idea of how adding a 5% allocation to a blend of digital assets to the Global 60/40 can affect risk/return results over time. Although the increase in annualised return is only 0.3% for a similar level of risk, the effect of compound interest over the years turns this into a meaningful dollar figure at the end:

grayscale_fig13
https://grayscale.co/a-new-frontier-research-paper/

Now this is, of course, a simulation and there is no guarantee of achieving these returns over time, but it certainly makes for a compelling argument for allocating a small portion of long term investments to digital assets. Having said that, we are still some way from being able to click a button and add a 5% allocation to crypto to a retirement plan, which means investors currently have to figure out how to buy and store these assets safely themselves. However, there is already talk of bitcoin ETFs, and crypto funds that are accessible to retail investors are starting to appear. It looks like making an allocation to digital assets as part of your long term investment strategy is about to get easier.

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

Saving for Retirement in your 30’s

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Twitter storms are a daily occurrence, but it’s fairly rare to see one erupt around the subject of financial planning. However, that’s exactly what happened last week as this MarketWatch article suddenly got the full treatment from angry (and witty) thirty-somethings on social media.

The anger was mainly directed at the idea, from Fidelity Investments, that by age 35 you should have twice your salary saved. Obviously this is meant as a general guideline, but it met with a considerable amount of vitriol from people claiming it is out of touch and unrealistic for many people, with the 2008 financial crisis, crippling student debt, and low-paying jobs cited as the factors making it difficult.

So how useful is this guideline? Are young people under too much pressure to prepare for the future, when they are struggling to live day to day?

If you are 35 today and planning to retire at 65, you have 30 years in which to save. Assuming you wish to replace 50% of your income in retirement you need to save 15% of your income per year. If you’ve already been saving and have a head start, then hitting your long-term target is going to be significantly easier.

Of course, these days many people are running up large amounts of debt just to complete their education. The first 10 years of work are often spent paying that off and getting into a position to start saving for the future. So if you are 35 and don’t have a big chunk of money saved you are not alone, and it is by no means too late. That said, if you are 25 and have the ability to save even a small percentage of your income for retirement you should seriously consider doing so. Even if the amount seems trivial, the extra 10 years of saving will make a significant difference by the time you are 65. The charts in this article do a good job of illustrating the benefit of starting saving early.

Remember that saving for retirement is one of three basics you should be looking to cover as soon as possible, along with building an emergency cash reserve and arranging basic insurance. It’s probably better to focus on accomplishing these three things, rather than trying to hit a specific number by age 35.

Inflation – The Evil Twin

 

Inflation erosion

We touched on the subject of inflation before in a previous post on benchmarking, but I would like to return to it briefly just to stress how important it is in your planning.

In the short term, inflation can seem harmless enough. If you leave $100 under your mattress and the rate of inflation is 3%, then next year your $100 will buy 3% less goods and services. In other words, in order to buy the same amount of goods and services you now need $103. When you extend this to 10 years you may think that you now need $130, but the effects of compounding mean that you actually need $134.39. Yes, as wonderful as compound interest is when working in your favor, compound inflation, it’s evil twin, is working against you over time.

So how can inflation affect your long term financial planning? Well first of all it will affect the targets you set. Let’s take an example of someone who wants to have an income of $50,000 per year in retirement in 25 years time:

If you can find a miracle low risk product that generates a 10% annual return, then you need $500,000 in capital at retirement. Then you can live off the interest without spending your capital and it doesn’t matter how long you live.

If we are more realistic and think in terms of a 5% return, then you need $1,000,000 in order to generate $50,000 per year.

What if you can only get 2.5% in retirement? Well then you need $2,000,000.

The problem is that all of these numbers are in today’s money. The table above tells us that over 25 years at 3% inflation, our spending power will more than halve. (it actually goes to 46.70% but let’s keep the numbers simple) That means that with a 5% return we actually need $2,000,000. And with a 2.5% return we need $4,000,000.

This is why it’s important to start saving and investing early. If we are not taking advantage of compound interest on our savings, our nest egg will be getting eaten away by its evil twin inflation!

The Power of Compounding

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I’m a keen golfer. How about we bet on a game of golf? Say 10 cents a hole? How about we double that every hole? It wouldn’t be for big money right?

Let’s take a look hole by hole:

  1. $0.10
  2. $0.20
  3. $0.40
  4. $0.80
  5. $1.60
  6. $3.20
  7. $6.40
  8. $12.80
  9. $25.60
  10. $51.20
  11. $102.40
  12. $204.80
  13. $409.60
  14. $819.20
  15. $1,638.40
  16. $3,276.80
  17. $6,553.60
  18. $13,107.20!

Well, as they say…that escalated quickly!

 

(Credit to Tony Robbins Wealth Mastery for this one)