How to Fund the Life You Want: a review
Robin Powell and Jonathan Hollow’s new book on financial planning isn’t afraid to spell out the right and wrong ways to invest
What is the point of saving for the future? — it’s too complicated, and I have left it too late. I may as well as well enjoy life now by spending whatever I earn, and rely on the state pension when the time comes…
How to Fund the Life You Want by Robin Powell and Jonathan Hollow, a Business Book Awards winner, takes the concerns of very many would-be savers seriously, and seeks to show there is still time to build savings that will go a good part of the way towards securing a comfortable retirement.
Much financial planning literature has a somewhat moralistic tone, preaching the wisdom of foregoing current pleasures for the sake of future financial stability. Powell and Hollow’s message is more subtle, recognising that while there is indeed a common tendency to pay too little attention to needs of one’s older self, the present matters as well as the future. Today should not simply be sacrificed to an ideal future that may never come: ‘There are two people you need to think about as you read through these pages … and they are both yourself! … these two selves can and should come to a mutually beneficial understanding.’ The needs of both should be held in tension. The ‘purpose of money is to support the life you want’: now, as well as in the future.
How to Fund the Life You Want is an ambitious book aiming to guide the reader through every aspect of financial planning, encompassing investment strategy, portfolio design, tax law, day-to-day money management, social care provision, and the merits of financial advisers. It includes access to a downloadable workbook to help readers think through and apply the often dense advice given in its pages to their particular circumstances. This review focuses on that element of the book with which my blog is concerned: the most effective way by which the majority of investors can accumulate savings.
A window opens
Powell and Hollow’s recommended investment strategy is shaped by the fundamental changes in UK pension law that came into effect in 2015, the implications of which have still not fully permeated the investing public’s consciousness. The old rules obliged savers to cash in their entire pension pot as soon as they reached retirement age in exchange for an annuity, a guaranteed inflation-proofed income. But now investors can access their savings from the age of 55 (the threshold will rise to 57 from 2028) and simply use them as they please, opening the possibility of continuing to grow them well beyond the formal date of retirement.
For those concerned they have not saved enough through their working lives the change is transformative, opening up time for a good many more years of accumulation. When they feel they are ready savers can draw down a percentage of their money each year, rather than spending it all at once on an annuity. To use one the book’s illustrations, a 65-year-old spending £250,000 to buy an inflation-linked annuity might expect to get around £6,500 a year guaranteed income for the rest of their life. But under the 2015 rules they now have the option to invest the £250,000 and spend a percentage each year: 3.3%, for example, would allow £8,250 a year. Or they might decide to take a part-time job for a few years to allow their capital to build up, untouched, until such a time as they consider it sufficient to draw upon. In brief, the strict division between saving during one’s working years and spending during the years of retirement has been dissolved, removing that sense of an impending deadline that weighs so heavily upon those who know they need to save more.
But the new freedoms bring new responsibilities, notably the ongoing requirement to pay attention to one’s portfolio for longer, to stay in invested in the market well into retirement, and to make fine judgements, year after year, regarding the percentage of the pot that can be draw down. As Powell and Hollow put it: ‘Those wanting to retire as early as the law allows must switch from blissful ignorance aged 54 to being a successful manager of a portfolio of investments from the day of their 55th birthday … How can people turn on this sixpence and turn into capable money managers, if they have hardly considered how their pension is being invested for the whole time money has been going in?’
Prioritising equities
That is one of the fundamental questions the book seeks to answer. Financial planning books often provide superficial treatments of the crucial subject of investment strategy, presenting a brief overview of the different kinds of investment funds on the market with a recommendation to consult a financial adviser for details. But Powell and Hollow make it central, and take a very firm line on the investment strategy most suitable for ordinary investors.
It has two essential elements: equities are the fuel that drive long term returns, and low cost passive investment funds offer the best means of securing a fair share of those returns. The history of markets is volatile, punctured with booms and busts. But its lesson is that over time shares earn higher returns than all other assets. The book quotes the well known research by Elroy Dimson, Paul Marsh and Mike Staunton in their 2002 study Triumph of the Optimists showing that over the past century US equities returned an average of 6.7% each year after inflation, and UK equities 5.4%. Those returns sound modest, but over time they compound powerfully.
Certainly, the authors insist — against much received opinion in the UK — that equities offer a surer path to wealth than property. They are simpler: with property ‘there are always bills to pay, jobs that need doing, contractors to find and, for landlords, the prospect, or reality, of awkward tenants’, but investing in shares ‘is a simple as setting up automatic monthly payments into an index fund.’ Equities offer a much broader platform for the generation of wealth: to put one’s faith in the markets is simply to trust that ‘as throughout history, the spirit of human enterprise will prove resilient so market-based economies will continue to prosper.’
Passive > Active
Having established the case for equities, the book goes on to present the fullest treatment of the critical active versus passive debate that I’ve read in a financial planning guide, coming down — emphatically — on the passive side. For Powell and Hollow index funds ‘are the best innovation in asset management since investment funds were invented in the 1770s’, ensuring that investors benefit from the collective wealth generated by the world’s markets, and, crucially, the star performers — accounting for less than 5% of the market — that drive the bulk of equity returns.
And they are easy to manage: investors need only start paying into one of the many off-the-shelf products as soon as they can, and, somewhat harder, resist the siren calls of the financial industry claiming active managers can consistently beat the market. Powell and Hollow marshall a battery of facts and figures in support of their case, including sobering research showing that over a 10-year period only 1% of 516 UK active funds outperformed. The law of averages means there will always be short-term winners, but in the long run active funds must fail: collectively investors must earn the market return, so as many active funds must lose as win. And once the significantly higher fees charged by active funds are factored in it logically follows that they must underperform low cost index funds.
For John Bogle, whose Vanguard corporation launched the first index fund back in the 1970s, and something of a hero to the authors, ‘the relentless rules of humble arithmetic’ mean that ‘[G]ross returns in the financial markets minus the costs of financial intermediation equal the net returns actually delivered to investors.’ Powell and Hollow present a particularly stark example. If a £1m pension pot grows 2.5% each year, an owner whose policy is to take the growth only, leaving the main body of the pension in tact, would withdraw £25,000. Not bad. But after a seemingly modest fee of 1.2% they would be entitled to no more than £13,000. Financial intermediaries would have helped themselves to the remaining £12,000, 48% of the income generated that year. Because accumulated savings are likely to grow only by a few percentage points each year it is critical to keep fees as low as possible.
For Powell and Hollow ‘most investors, and indeed many advisers and investment journalists, are simply unaware of the impact of compounded investment fees and charges over the long term.’ They urge investors to ignore the counsel of ‘sharks and soothsayers’ in the asset management industry proclaiming the capacity of various alternative investments to outperform simple index funds, even after costs. The evidence is simply not there. Private equity is frequently claimed as a useful diversifier, but when public equities fall in value private companies tend to follow. Hedge funds can undoubtedly draw upon considerably ingenuity to secure short term outperformance, but any gains tend to be blown away by very high fees. Thematic funds present a more subtle temptation, sold on the basis of ostensibly appealing promises to follow emerging economic and technological trends. But the facts show that they too have trailed wider indices, despite their availability in the low cost ETF format.
Nor should investors be taken in by industry claims that the rising popularity of index funds is undermining the market’s capacity to identify and price value. For Powell and Hollow the visceral and abiding desire of many investors to secure outperformance will ensure a fruitful dynamic between active and passive management for any foreseeable future. There are and always will be professional traders and wealthier investors ready to devote the time and money necessary to chase higher returns. Ordinary investors should stick to tracking the market.
The authors do, however, recognise that active funds may be useful for pursuing investment objectives that do not simply prioritise returns. Investors wishing to dedicate a portion of their portfolio to ESG objectives, for example, might well believe that certain active funds can more precisely target the companies they wish to support than the many ESG-screened passive products. In this special case extra fees are fully acknowledged as a price worth paying.
Portfolio design
How, then, should passive-oriented portfolios be designed? The right mix of assets will differ according to each investor’s circumstances, notably temperament, and their proximity to retirement. Those who have built up funds they deem sufficient might be advised to hold a defensive portfolio, sheltered so far as possible from the market downturns that erode savings investors will soon need to call upon. But those still in the accumulation phase, with more time to weather losses, should consider a relatively ambitious portfolio, perhaps a mix of 80% equities and 20% fixed income. Investors can construct appropriate portfolios themselves using low cost index funds and ETFs as building blocks, but might consider one of the various ready made products (like me Powell and Hollow are admirers of the Vanguard LifeStrategy range) that take care of the periodic rebalancing necessary to ensure exposure to changing market conditions, and can be easily adjusted take account of the investor’s stage in their journey.
Once they have made their decision savers should simply be patient and get on with their lives, allowing their fund to quietly accumulate, avoiding the temptation to meddle: research indicates that the least active investors typically do considerably better than the most active. Patience means staying the course through cycles of boom and bust. Markets can dip alarmingly — as they have over the past 18 months — but history shows that over time the market always recovers, and sometimes very quickly. Powell and Hollow and include a chapter summarising the growing literature on investment psychology, but, in the end, perhaps, one thing is needful: to draw up a well considered plan and stick with it.
Clarity
As noted, this is an ambitious book ranging well beyond investment strategy, from which I learned much. The unambiguous advice given regarding the correct strategy to pursue will raise some eyebrows, and provoke some hostility (the authors already have some enemies through membership of various initiatives campaigning for greater industry transparency, and their maintenance of blogs such as The Evidence Based Investor.
But that clarity is the book’s strength. The evidence is quite clear regarding the benefits of low cost index funds: Powell and Hollow simply present it. As they acknowledge investors may well need to consult an investment adviser on the complexities of matters such as tax, inheritance and social care. But all the essential information today’s intelligent investor needs is in the book. A highly recommended read.
How to Fund the Life You Want by Robin Powell and Jonathan Hollow is published by Bloomsbury. Image by Jonas Weckschmied on Unsplash.
