Inflation protection pension investment options?

michaels

So I am budgeting on my pension fund growing by inflation plus 2% after costs which based on the literature is the conservative side of average.

What I would really like would be a fund where I could lock in this type of return, sacrificing some of the slightly higher expected return on equities for reduced risk. Are there any such products available that I could put my DC pension pot into?

Thanks

Malthusian

You would be looking at either With Profits or a guaranteed drawdown arrangement. Both have significant drawbacks.

Inflation plus 2% plus costs is currently at least 5.5% for a low-cost pension with no advice (add another 1% for a more expensive arrangement) which is not conservative. It is slightly higher than the 5% the regulator considers a "medium" assumption of growth. No arrangement is going to guarantee you slightly higher than moderate growth year-on-year.

Are you in accumulation or decumulation - to translate, are you building up your pension in preparation for retirement or drawing down from it?

michaels

Malthusian wrote: »

You would be looking at either With Profits or a guaranteed drawdown arrangement. Both have significant drawbacks.

Inflation plus 2% plus costs is currently at least 5.5% for a low-cost pension with no advice (add another 1% for a more expensive arrangement) which is not conservative. It is slightly higher than the 5% the regulator considers a "medium" assumption of growth. No arrangement is going to guarantee you slightly higher than moderate growth year-on-year.

Are you in accumulation or decumulation - to translate, are you building up your pension in preparation for retirement or drawing down from it?

Thanks, currently building up, hopefully about 10 years to go. Would love to be able to put my current pot into index linked bonds paying cpi (or better rpi) +x%.

People on here quote the long term return on equities as being of order 5% in real terms so I thought asking for 2% in real terms would not be that greedy

Malthusian

If the UK government had to pay 2% plus inflation to persuade people to buy gilts then we would all have much bigger problems than our pension funds.

The fundamental problem is that investments don't increase at 5% above inflation or 2% above inflation but 20% one year, 10% the next, -20%, -25%, 20%, -2%, 15% and so on which when you look back over the right time period averages out at something like 7%.

Any non-cash investment that guarantees you a certain level of growth will eventually reach a point, no matter how modest the growth target, where the investments fall in value below the "guaranteed" amount. Any investment arrangement that allows you to withdraw from the policy based on a fund value of X when the underlying investments are actually only worth (1-Y)*X, where Y is the amount the investments have fallen in the current crash, is either going to be horrendously expensive and have strict restrictions on when you can actually benefit from the guarantee (guaranteed products) or will have a get-out clause (With Profits). That, or they do an Equitable Life.

In your position I see no reason to change your strategy. In five years time, if your investments have substantially outperformed inflation + 2% then it may be worth looking at reducing risk in the portfolio in the run up to retirement.

michaels

Malthusian wrote: »

If the UK government had to pay 2% plus inflation to persuade people to buy gilts then we would all have much bigger problems than our pension funds.

The fundamental problem is that investments don't increase at 5% above inflation or 2% above inflation but 20% one year, 10% the next, -20%, -25%, 20%, -2%, 15% and so on which when you look back over the right time period averages out at something like 7%.

Any non-cash investment that guarantees you a certain level of growth will eventually reach a point, no matter how modest the growth target, where the investments fall in value below the "guaranteed" amount. Any investment arrangement that allows you to withdraw from the policy based on a fund value of X when the underlying investments are actually only worth (1-Y)*X, where Y is the amount the investments have fallen in the current crash, is either going to be horrendously expensive and have strict restrictions on when you can actually benefit from the guarantee (guaranteed products) or will have a get-out clause (With Profits). That, or they do an Equitable Life.

In your position I see no reason to change your strategy. In five years time, if your investments have substantially outperformed inflation + 2% then it may be worth looking at reducing risk in the portfolio in the run up to retirement.

But in the past the govt did issue index linked gilts paying up to 4% above rpi so it would be nice to invest in a fund that held such assets but I bet their current value much exceeds the nominal value.

http://www.dmo.gov.uk/reportView.aspx?rptCode=D1D&rptName=57858161&reportpage=D1D

Malthusian

michaels wrote: »

But in the past the govt did issue index linked gilts paying up to 4% above rpi

Oh yes, those halcyon days when the base rate was 9.875% (June 1992 when the 2030 4&1/8% Index Linked Gilt was launched). This is what I meant when I said that if the UK government was offering gilts nowpaying 2% above inflation in today's economic conditions we'd all be in the skite.

You're exactly right, those gilts are currently priced at 3.6 times par value and the running yield is 1.1% according to HL (so they're only protection against inflation if you're willing to accept a 2.5% per annum real loss as the cost of letting HM Treasury look after your money).

If you'd actually bought those fresh new 2030 Index Linked Gilts in June 1992 and held them for 10 years, you'd only have made slightly more than if you'd just stuck the fund in cash (6.8%pa v 5.6%pa). So in another words, pretty much the same as now.

michaels

So what we are saying is that inflation protection is possible but rather than rpi+2% it is available at rpi-2.5% - which sort of stretches the definition of protection and using a top paying instant access savings account might well actually outperform.

bigadaj

michaels wrote: »

So what we are saying is that inflation protection is possible but rather than rpi+2% it is available at rpi-2.5% - which sort of stretches the definition of protection and using a top paying instant access savings account might well actually outperform.

Real interest rates on government debt is negative, they would be criticised for paying above the odds for money used to finance the national debt.

Fund managers and institutions can't use bank savings accounts, so utilise that as an advantage from an individual perspective.

The risk reward balance has been skewed for the last decade as a product of low and negative real interest rates compounded by quantitative easing. So high risk assets have returned large amounts and safe investments have effectively shrunk.

Investment is little different than betting whe it comes down to it, identifying a mismatch between odds and then allying that. Whether your successful will only be seen in hindsight.

Malthusian

michaels wrote: »

So what we are saying is that inflation protection is possible but rather than rpi+2% it is available at rpi-2.5% - which sort of stretches the definition of protection and using a top paying instant access savings account might well actually outperform.

It certainly should outperform given that top paying saving accounts are loss leaders and the interest is not a return on investment but a transfer of wealth from customers who can't be bothered to shop around to those who can.

Index-linked gilts are not like NS&I Index-Linked Certificates. The purpose of index-linked gilts is to raise money for the government, and like any borrower the government looks for the lowest rate it can get. The purpose of NS&I certificates is to spend that money on buying the votes of savers.

There is another form of inflation protection which doesn't cost 2.5% per annum. Investment in real assets which can be expected to increase with inflation (if sensibly diversified).

michaels

Malthusian wrote: »

It certainly should outperform given that top paying saving accounts are loss leaders and the interest is not a return on investment but a transfer of wealth from customers who can't be bothered to shop around to those who can.

Index-linked gilts are not like NS&I Index-Linked Certificates. The purpose of index-linked gilts is to raise money for the government, and like any borrower the government looks for the lowest rate it can get. The purpose of NS&I certificates is to spend that money on buying the votes of savers.

There is another form of inflation protection which doesn't cost 2.5% per annum. Investment in real assets which can be expected to increase with inflation (if sensibly diversified).

But whether purchased directly or in the form of some sort of fund offering if the underlying assets increase with inflation then dealing costs must mean an overall return of slightly below inflation - and if the strategy involves the ownership of real assets then the costs are likely to be non-negligible so back to rpi-x% scenarios

GDB2222

michaels wrote: »

But whether purchased directly or in the form of some sort of fund offering if the underlying assets increase with inflation then dealing costs must mean an overall return of slightly below inflation - and if the strategy involves the ownership of real assets then the costs are likely to be non-negligible so back to rpi-x% scenarios

In the long term equity dividends have grown at the inflation rate plus around 1%. Currently UK equities are priced at around 30 x dividends, so even if the dividends do continue to grow you are at risk of volatility if the pricing formula changes to say 15 x or 45 x.

And the other thing to worry about is that the P/E on the FTSE100 is around 30, which is historically very high. Dividend cover is only around 1.