Continuing with the frequently asked questions that came up during the recording of season 14 of the MeaningfulMoney podcast.
Bond Funds for Balance
Most people understand that equities are where the growth is, but when using bonds as a diversifier and volatility reducer, it can be harder for investors to find a bond fund than an equity fund.
Part of the problem is that bonds are such a broad church, from junk bonds issued by tiny companies to UK Gilts. If you’re not really planning to make money with this money, but it’s purely a diversifier, then your main goal is to prevent a loss.
Right now, sovereign debt in developed markets, including Gilts, US treasuries and so on, are at record low yields, we’re talking 400-year low yields. Yields are the inverse of prices, as you know, so that means they are more highly priced than they ever been. That’s doesn’t mean they’ll definitely go down further, but it’s quite likely.
In my interview with investments expert Lars Kroijer, he essentially suggested buying a global tracker and then if you wanted to diversify, buy government bonds in your local jurisdiction, which for the UK means buying Gilts. You could always buy those gilts directly from the Debt Management Office.
You’re not buying a fund; you’re buying the asset itself. For most of us, a fund is the easiest way to go. Look in the UK Gilt sector as a starting point to finding Gilts, but you’re going to need a log-in to dig about.
For instance, I did a very quick filter using Morningstar to find 1st quartile funds in the UK Gilts sector over one, three and five. This whittled things down to six funds, with not too much between them over five years’ performance.
But when I brought in, out of interest, the Vanguard LifeStrategy 60% Equity fund, and compared the volatility of that, which has 60% in shares and the rest in bonds, I compared it to the Gilt funds, the LifeStrategy fund was LESS volatile than the gilt funds! Most Gilt tracker funds track the whole gilt market, so they tend towards longer-dated gilts, which are volatile.
Gilts are IOUs, so the shorter the date, the nearer the time to redemption, so prices are much less volatile at the short end of the scale. You’re going to need to really dig into the data to find a fund that you’re happy with to balance out the equities. They’re not going to provide you with any money, but they do reduce portfolio volatility.
This is such an unprecedented time in the history of Gilt prices that I’m not sure there’s an answer to this right now. But, short-dated gilt funds are likely to be the least volatile option and should offer something near the capital preservation which is the whole point of the exercise.
Does it Make Sense to Pay in More Than Your Employer Match Contribution?
My basic answer is that you should, if you are employed, invest as much into your pension to maximise the free money match from your employer, and anything else can go into ISAs when you’re starting out.
But, if you find that you’re paying in more than the employer match, you may wonder if you should be redirecting the extra money into an ISA instead, particularly if you want your ISA to bridge the gap between semi-retirement and taking benefits from your direct contributions payments.
Not to put too fine a point on it, but if you’re in the position to contribute more than your employer’s match contribution, then planning is likely to be a bigger factor for you than if you’re just starting out.
For most of us, the answer to whether we should divert ‘extra’ pension contributions will depend on our individual plans. Take that away, and the maths will always favour pensions due to the tax relief on the way in. You have more money to compound as a result, and the fund will be larger than the equivalent ISA fund at any given point, assuming identical charges and investment profile. The free money grows quicker, so you’ll end up with a bigger fund.
Yes, ISAs are tax-free and pensions are taxed. Pensions are incredibly flexible though, at least under current rules and you can draw a ton of money tax free from a pension, particularly if you have no other income at the time, for instance before your state or other secured pensions kick in.
Right now, with the personal allowance at £12,500, you could draw £16,666 from a DC pension fund without paying any tax. One quarter of that is tax free cash and the other three-quarters would fall in the personal allowance, assuming you had no other income.
So, if your plans suggest you’d like a larger ISA fund, then get your employer match into your pension and redirect everything else into ISAs, but in the absence of a clear plan, favour pensions.