I absolutely love being able to provide free, impartial and efficient access to financial strategies that you can take advantage of right now – today – without spending your hard earned cash at the outset. For the Canadian version of this article go here.
It took me nothing short of sixteen years to completely decode how investing works, where it spectacularly doesn’t work, what the risks are, and how I can cut out the thousands of advisers and middlemen who sit between me and the market. Now I get an above-average return for myself and my family. Even more important: I understand what I am invested in.
So how can you actually retire 13 years earlier? I will give you a basic example: let’s imagine you have £50,000 in investments today and get a 3% real rate of return for 30 years. Real rate of return means, after inflation and taxes. You deposit £200 every month in the account and you re-invest the income. After 30 years you have a balance of £239,680 in today’s money. Not bad[i].
How much do you have if you take that same £50,000 in investments, but get a 5% real rate of return (by reducing fees and getting slightly better investment performance as per the below) Same £200 monthly deposits. The result is significantly higher: £390,532.
It actually takes you a full 43 years in the first example to get £390.5k at a 3% real growth rate. So 13 years longer working! Ouch.
Minimising fees and slightly increasing performance has a dramatic impact on your finances in the long term. If I can provide guidance that gets you there in 10 minutes, or a few days or weeks of your time, then we’ve won together and set you on the path to financial independence.
Current Situation in the United Kingdom
According to the Financial Conduct Authority (FCA) the forecast real rate of return for a blended portfolio of stocks and bonds is 3.5% to 5.5%, and adjusting for weak-ish government bond yields they arrive at 3% to 5%. In plain English, that means pensions are forecast to grow (after inflation and costs) within that range in real terms (i.e. how much you would really have with today’s spending power).
That being said there are positives. The U.K. has been hammered by Brexit and equity returns long term are expected to be robust. In addition, British shares trade at historically low valuations and have high dividend yields. This is well correlated with higher future returns on a 10 year basis. See here for the ‘Home Base’ portfolio that recommends how to tap into that income.
We expect to enter a more challenging economic environment, as interest rates rise and government policy looks to restrict the easy-money policies of the last decade. As a result, fees are really going to matter. The average pension fees in private pensions in the UK are high: they sit between 1.85-2.0% per year.
In other words: your money may grow by 3% to 5% per year, and behind the scenes one of the main drags on your return is fees. Let’s get to work and find a way to improve performance!
What can you do about it?
Relying on the government to fund your retirement is generally not sufficient. If it were up to the government, in order to account for poor investment returns and people living longer, as a millennial you will probably be working until 72-75 by the time you retire. To avoid that fate you need to ensure that you are maxing out on your employer pension contributions and taking advantage of the tax policies that support saving for retirement.
In the UK opening a retirement account and making regular Self-Invested Pension (SIPP) contributions is essential, especially if you’re a higher rate tax earner. In addition open a Stocks and Shares ISA to build a war-chest of tax free savings once you hit the annual limits. You are going to need to tap into both approaches in order to retire comfortably.
If you want to retire at 67 with an annual pension of £40,000 per year, then given that the state pension is £168.70 per week (£8767 per annum), you’ve got a £31,232 income gap to fill! You need investments that generate that much outside of the state pension. Using the 25x rule that means you require a pension pot of £780,820 to sustainably give you a £31,232 income after retirement (provided you receive maximum state benefits, which will more likely be less by the time you retire).
What’s an efficient way to get there without burning excessive cash on investment management services, fund and ETF fees? How do you get great investment performance without going through your government and employer pension plans?
Vanguard LifeStrategy 80 – Asset Allocation Funds
Vanguard UK has an excellent solution: they have created a single pension-like product that you can buy using an investment account (SIPP or ISA). Exactly like a pension. Even better: they have built 5 separate offerings that are tailored to your risk appetite and you can choose from any of them.
What Vanguard have done is fully automate the various fragmented ETF investments that people had been using to create their own sustainable investing strategies. This single fund does a lot of the work for you, so instead of purchasing, say, 10 ETF’s and line-balancing money between them, you just buy one product on a monthly basis and it automatically allocates your money to those 10 ETF’s, which in turn buy thousands of diverse equities and stocks across the globe. Remarkably simple and exactly like the funds you see in your pension statements (if you ever read them!)
Self-investing in stocks and equities is much safer than, say, crypto-currencies like Bitcoin, and what you invest in is covered by all of the major banks and backed by the government itself. Whereas every crypto-currency exchange out there can go bankrupt and leave you with nothing. For a full breakdown on what the Financial Services Compensation Scheme (FSCS) is and how the government protects you up to £85,000 please read here.
Let’s have a look below:
Vanguard LifeStrategy 80 Equity Fund A Acc
This product aims to achieve your investing objectives by allocating your capital to various equity and fixed income securities on a global and balanced basis. And it includes fixed income. Just like a pension fund. In fact, it is scary how much this has automated the job of a pension fund.
According to independent fund rating website Morningstar this fund has achieved their coveted 5* Gold rating. Very few funds do.
In principle all you need to do is to open an account through a major bank or provider (AJ Bell, Hargreaves Landsdown, Interactive Investor, Vanguard UK all offer stocks and shares accounts) and fund it. I will do a separate article on how this works.
The funds are eligible for SIPPs or ISAs and non-registered accounts. Beyond my workplace pension, the key benefit here is that you can self-invest through either a SIPP or an ISA with only the minor inconvenience of having to place the trades yourself. In fact with AJ Bell you can automate it so that it buys the funds itself each month.
The major advantage here is on fees. The all-in cost of these ETF’s is 0.22% per year. Compared to the average private pension in the UK, which charges close to 2% per year, that’s a cool saving of about 1.78% in fees. This adds up over time: it could mean you retiring 10-15 years earlier if the Vanguard product has the same performance of a standard pension.
If you open an account with AJ Bell (I use them personally) buying the Vanguard LifeStrategy fund costs £1.50 per trade plus a 0.25% annual management fee. Remember to factor this in: it means that if you planned to invest only say £2000 per year, then in year one you’d be paying an extra 1.2% in fees (12 trades per year at £1.5 plus £5 for management). For that reason self-investing in a SIPP or ISA is better suited to £4,000 – £8,000+ accounts and a pool of your investments. The more you have over £8,000 the lower the trades are as a % of your wealth, until it becomes next to nothing.
Here is what the Vanguard LifeStrategy 80% Equity Fund is invested in:
The ETF is pretty much exactly split between 80% equities and 20% income securities. It is geographically diversified with key holdings in the US Total Market (not just S&P 500, but mid-cap and small-cap exposure), FTSE All-Share index, and the developed world across the EMEA, alongside a smaller exposure to Japan and Emerging Market economies. There is a lot of science behind the scenes as to why geographically diversified portfolio’s perform better, and this fits the bill.
The 1-year return for the Vanguard LifeStrategy 80% Equity Fund is 9.94% as of the end of October 2019. This is within touching distance of the 1-year return on the FTSE All-Share index which is 10.77% over the same period. Remember that these are not real rates of return and 2019 has been an above-average year.
Returns over the 1 year, 3 year and 5 year time horizons have been excellent and well ahead of the FTSE All Share:
|Time Period||Performance Vanguard 80||FTSE All Share|
The approximate performance excluding fees is 9.2% return per year since 2011, and a very healthy 16.88% return year to date in 2019. After fees and inflation the adjusted average real return would be about 6.49% – that works out to higher than the FCA forecasts and will out-strip most private pensions because it is inclusive of fees, which are extremely low. I wouldn’t expect this high a return over the next 10 years however it is performing better than the FTSE All Share.
The internal dividend on the Vanguard 80% Equity Fund is 1.67%. This is the only thing I don’t like about the fund: the dividend yield is low because it has a heavy weighting towards the American market, where the S&P 500 and Dow Jones have historically low dividend rates because of soaring stock prices.
As I describe here you could consider adding heavier weighting to the UK and Europe to gain a much higher dividend yield following the Home Base portfolio.
This means that your desired rate of capital growth is just under 5%, to give you that healthy real return after inflation of approximately 6.49% (inflation is running at 2.48% and fees 0.22%). I think you’ll likely get closer to 5% real return over the next 10-15 years. If you follow the example at the start of this article, then moving from a 3% real rate of return to a 5% real rate of return allows you to retire 13 years earlier! That’s after adjusting down this fund’s performance from 6.49% to 5% to account for slower future growth.
For further information on the Vanguard LifeStrategy 80% Equity Fund please see here. Frugal Investors is not affiliated with Vanguard and we don’t receive any compensation for recommending them. This is simply a great product that the Frugalist Investor (i.e. me) invests in for the purposes of automating my investments and receiving great after-tax returns in a well-balanced portfolio.
Asset Allocation – Picking a Risk Profile
For further reading on how to choose an appropriate asset allocation strategy for your age and financial situation, have a look at our Risk Profile article here. Vanguard’s website has plenty of information on what the asset allocation strategy is and how to choose the right fund.
I encourage you to truly understand what
you are invested in and why, and to pick a strategy that allows you to sleep at
night. Happy investing and please do comment and ask any questions below!
 Vanguard LifeStrategy 80 Equity Fund A Acc information available
through Morningstar.co.uk. We are not affiliated with Morningstar or Vanguard
UK and this doesn’t constitute investing advice [https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F00000MLUQ]
[i] I arrived at these figures using a compound annual interest calculator here: [https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php]