Compound Interest - HL Lifestime ISA

TJB24

Hi All,

I've recently opened a Lifetime ISA to use as an added retirement vehicle. I am already a homeowner, 24 years old and have a Civil Service pension plan. I also currently save £800 a month into stock investments towards more immediate life goals, such as a more family-appropriate home.

My LISA is with Hargeaves Lansdown; I have £200 deposited and a direct debit of £50 pcm (62.50 with the 25% Gov top-up).

Currently my investment instruction is 50/50 into the two following funds:

Franklin Templeton Global Total Return Bond (Class W, Income) - 0.79% OCF and pays 8.65% quarterly interest.

Lindsell Train Global Equity (Class D, Income) - 0.52% OCF, very small dividend but 140% five year growth return.

My question really is one of mathematics. I'll be paying in to my LISA for another 26 years, and will grow a further 10 years before I can access tax-free at age 60. I plan to reinvest all income.

Over the long term, which investment style is likely to return more? The cumulative growth of an equity fund, or the compound interest of a high-income fund?

I am considering moving to the Templeton Emerging Markets Bond (Class W, Hedged), which pays out 11.27% interest but has a slightly higher OCF and hasn't performed as well on it's capital return.

Obviously the best method is to always diversify. Greatful for any and all comments.

Bravepants

I'm not in a position to comment about your choice of funds, BUT your £800 stock investment would be better saved rather than invested if you have immediate life goals like buying a house etc.



Is your Civil Service Pension the Alpha scheme? If so you might consider buying Added Pension too.

jimjames

I would suspect that any investment where you are relying on interest is likely to do less well than an investment where you are getting dividend income and capital growth. Interest would suggest bond type products which probably long term grow less than equities

Bravepants

...also, if I was 24 years old and drip feeding only £50 a month into some fund or other I would probably choose a single globally diversified fund like Vanguard FTSE Global All Cap index, at least until I was 40 or so.

dunstonh

Over the long term, which investment style is likely to return more? The cumulative growth of an equity fund, or the compound interest of a high-income fund?

You would expect the investment to be significantly higher than interest over the long term. Although there will be short term periods of losses or nothing years which in isolation of the positive years will see returns lower or negative. It is the averaging out of the good years, bad years and nothing years that matters.

I am considering moving to the Templeton Emerging Markets Bond (Class W, Hedged), which pays out 11.27% interest but has a slightly higher OCF and hasn't performed as well on it's capital return.

The yield is not the full story. That is a high-risk fund which could lose more than the yield in a few months. High yield funds tend to have lower growth on the unit price. It is mainly supply and demand with them that influences as there is virtually no real growth.

If your purpose is for the next house, then investing may not be a sensible thing to do.

TJB24

Bravepants wrote: »

I'm not in a position to comment about your choice of funds, BUT your £800 stock investment would be better saved rather than invested if you have immediate life goals like buying a house etc.

Is your Civil Service Pension the Alpha scheme? If so you might consider buying Added Pension too.

Thanks for the reply, I already own a £190k flat with a mortgage. I'm not intending to make the next big move for at least another four years, and while I don't have dependents and the ability to save a lot each month, I feel I can take the risk/reward of the market. Cash saving interest, whilst secure, is incredibly low, and my savings are greater than the 5% incentive thresholds will allow. I am on the Alpha pension but I don't want to put all my eggs in one basket; it's also taxable and I can't access it without penalty until age 67.

jimjames wrote: »

I would suspect that any investment where you are relying on interest is likely to do less well than an investment where you are getting dividend income and capital growth. Interest would suggest bond type products which probably long term grow less than equities

Yes, the Templeton products quoted are all invested in emergening market bonds. I'm interested in the maths behind wether capital growth exceeds compound interest from income.

bowlhead99

TJB24 wrote: »

My question really is one of mathematics. I'll be paying in to my LISA for another 26 years, and will grow a further 10 years before I can access tax-free at age 60. I plan to reinvest all income.

Over the long term, which investment style is likely to return more? The cumulative growth of an equity fund, or the compound interest of a high-income fund?

I am considering moving to the Templeton Emerging Markets Bond (Class W, Hedged), which pays out 11.27% interest but has a slightly higher OCF and hasn't performed as well on it's capital return.

Obviously the best method is to always diversify. Greatful for any and all comments.

Yes, diversifying rather than holding just one fund for 36 years will be a good thing to do.

However, over a long period - you are looking at a third of a century - one would expect greater returns from company equities (virtually unlimited upside) than from fixed income (the fixed returns paid by companies before the rest of the profits are given to the equity holders).

Investors in equities demand greater returns than investors in fixed interest, to compensate for the greater uncertainty of return from year to year. Over the long term, those higher returns should be more valuable.

Bravepants

TJB24 wrote: »

Thanks for the reply, I already own a £190k flat with a mortgage. I'm not intending to make the next big move for at least another four years, and while I don't have dependents and the ability to save a lot each month, I feel I can take the risk/reward of the market. Cash saving interest, whilst secure, is incredibly low, and my savings are greater than the 5% incentive thresholds will allow. I am on the Alpha pension but I don't want to put all my eggs in one basket; it's also taxable and I can't access it without penalty until age 67.

Four years is a very short time over which to invest and hope that you get a return! You say you are not able to save much a month, but £800 is a fair chunk, almost £10k per year - or close to £40k over the 4 years.


Suppose in 4 years your fund is worth only £20k, how will you feel, will you still cash in your investments (crystallising the loss) and buy a house?



You can get fixed rate accounts paying close to inflation level interest these days. Investec do several fixed rate accounts. I know it's not much, but I seriously think you need to re-consider your risk tolerance over 4 years.

TJB24

bowlhead99 wrote: »

Investors in equities demand greater returns than investors in fixed interest, to compensate for the greater uncertainty of return from year to year. Over the long term, those higher returns should be more valuable.

Thank you, good point indeed.

Bravepants wrote: »

Suppose in 4 years your fund is worth only £20k, how will you feel, will you still cash in your investments (crystallising the loss) and buy a house?

You can get fixed rate accounts paying close to inflation level interest these days. Investec do several fixed rate accounts. I know it's not much, but I seriously think you need to re-consider your risk tolerance over 4 years.

I think, touching wood, that a 50% capital loss is pretty unlikely in any scenario. I invest over eight different funds, which spreads my savings into well over 100 different companies, with a global focus and a mix of currencies and bonds as well..

I had a quick lesson on the highs and lows of the market; I invested lump sum in July/August and almost immediately had a paper loss of -8.5% in November following global market turmoil. This has since recovered to -2.5% as of yesterday, with most funds back in profit.

Historically, market pullbacks and corrections repair themselves in 3-6 months on average. I already have 50% equity in my home, and when I come to seriously house hunt I won't be under pressure to sell off any holdings that are performing badly at that time. Pound cost averaging also helps. My partner also has a stock portfolio but is mostly saving into cash, so between us I think we're in a good place.

Ultimately it is a riskier strategy, but Lindsell Train Global Equity, even with recent turmoil, has made a 140% five-year return, with my other funds in a similar position. That's versus 5% AER on cash. Personally I think it's a risk worth taking.

bowlhead99

TJB24 wrote: »

Historically, market pullbacks and corrections repair themselves in 3-6 months on average.

Arguably a pullback or correction doesn't need to be 'repaired' because the correction is itself a 'repair' (or, as they say, 'correction') of the price which is too high. So a drop of 20% might not get fixed because it itself is the fix to get the market back to the place it deserves to be.

If you look at the factsheets for a major global index such as the FTSE All-World (3000+ major international shares, currently with market capitalisation of over $45 trillion), you can see that the biggest peak-to-trough drawdown in the last twelve years was from the last couple of months of 2007 to March 2009. In that period, the market fell 57.9% in USD terms (total return, i.e. even including dividends reinvested at falling prices)

Of course, if you grab FTSE's equivalent latest factsheet from December 2018 it says the largest drawdown in the last ten years was only 26%, because looking back only ten years misses the nasty 'credit crunch' which was coming to an end in early 2009 and perhaps gives you a false sense of security.

Also, just because the last couple of major crashes (2000 to 2003, 2007 to 2009) recovered within only a few years, it doesn't mean that next time you'll get an equivalently-quick recovery. Last time, all global governments just dropped interest rates to the floor (or took them negative) and did a load of quantitative easing. But as interest rates are already low and the last round of QE hasn't unwound yet, it's not clear that could be a solution again. We might see a drop and a long drawn out flatline before things improve.

Further back in history the "great depression" was a decade or so, but "fortunately" the world war came along and stimulated economic activity

Basically if you are holding investments to meet a short term need (5 years or less), the fact you're drip feeding won't necessarily cushion the impact enough. Depending on the severity of the drop, and time to recover, could be a painful process.

No denying the returns on equity in your LISA for a 36-year hold are a 'risk worth taking'. But worth considering/ sense-checking that the money destined for home improvements or property purchase should really have major stock market exposure.