Key Post "I am 65 – where should I invest my life savings? "

I am often asked this question, so I have put together a Key Post on the topic and look forward to the counter arguments.

• My wife and I are both 67 and in good health.
  
• We own our house outright – we have no mortgage or other borrowings. It’s probably worth around €300,000.
  
• We get the state contributory pension of €460 per week.
  
• I have a pension of around €10,000 a year from my former employer.
  
• We have savings of €100,000 in the Post Office. Where should we put it to get maximum safety and maximum return?
  
• At the moment, we live within our means. The two pensions are enough to keep us going and we don't expect to have to eat into our savings for the next few years

Summary and recommendation

• If you keep your savings in the Post Office or in a deposit account, it will be slowly but surely eroded by inflation
• Keep €10,000 in cash for emergencies
• Buy a portfolio of shares directly with the balance
• This is the least risky long term option
• This is the option most likely to yield the highest return
• It is important to buy shares directly, and not buy a fund or equity-linked product of some sort.

What are your financial objectives and what term are you investing for?



As healthy 67 year olds you have a life expectancy of around 20 to 30 years. So the question you should be asking is where will you get the best and safest return over the next tweny years?


If you have some other plans, for example to spend all the money on a world cruise in the next few years, then the recommendation would be different.



If you had invested in shares 30 years ago …
If you had put €100,000 in the Post Office, in February 2004, it would be worth €100,000 today.

If you had put €100,000 in the Irish stock exchange in February 1984, it would be worth about €850,000 today. This is despite the collapse in the share price of big companies like AIB, BoI, Anglo etc.

You would have also earned far more in dividends from these shares than you would have earned in interest from the Post Office

If you had put €100,000 in the Iris Stock Exchange in February 1994 – 20 years ago, it would be worth €250,000 today.

If you had put €100,000 in the Irish Stock Exchange in February 2004 (10 years ago) it would have fallen in value to €96,000 today.

If you had put €100,000 in the ISE in February 2007 ( 7 years ago) it would have fallen in value to €50,000 today.

If you had put €100,000 in the ISE in March 2009 (5 years ago) it would be worth €250,000 today



The biggest threat to your savings is inflation
Inflation gradually erodes the real purchasing value of your money.

Your €100,000 will buy a lot less in twenty years time that it will buy today.

The best protection against inflation is investing in shares or property which will probably increase in value by more than inflation.

Some expect that we will have price deflation over the next few years. If so, then deposits may perform better than shares.

The other threat is that the euro, the state or the banks may collapse and your money could become worthless overnight.
This is a small risk and is a lot less today that it was two years ago, but it’s still a risk. The people of Cyprus lost a big part of their deposits overnight.
Although the risk is small, the effects on you would be catastrophic. As you receive a pension from the state, this could also be at risk. You should diversify your income and investments as much as possible. Avoid state investments such as the Post Office, or state backed investments such as deposit accounts in banks.

There is no risk-free place to invest your money
Deposits will probably be eroded by inflation and may be wiped out by a bank or state bankruptcy.

Shares could go into a sustained long-term decline

The stockmarket is the least risky, long-term investment
People argue that with stockmarket investment, you get higher rewards, but you also take higher risks. That is just not correct. Stockmarkets are a lot less risky than deposit accounts, in the long-term.

The problem is that stockmarkets fluctuate a lot. You could invest your €100,000 in a diversified portfolio of stocks today and it could drop to €70,000 by this time next year.

The pros and cons of investing in residential property
Many people feel that there are some great bargains to be had in the current (February 2014) property market. The rent is good. Investing in bricks and mortar is seen as safe. And some people feel comfortable with property as they think that they know the market.

Investing in residential property without the need to borrow is probably better than putting money on deposit. Over the longer term, property prices tend to rise.

But there are many reasons for you to avoid property
· You already have an exposure to property as you have €300,000 invested in your own home. If property prices do well, you will benefit.

· Property requires a lot of management – getting tenants, collecting the rent, maintaining the property, complying with the PRTB, etc.

· If you get bad tenants, you will have a nightmare. Most tenants are fine, but some wreck the place, pay no rent and refuse to leave. It will take at least a year to get them out and although they will owe you money, there is no realistic way of getting it from them.

· Property is risky. It’s not a one way upward only movement. It does fall in value, as many recent investors have found out.

· It’s not a very liquid investment. If you need money in a hurry, you won’t be able to sell your property and get your hands on the cash. With an investment in shares, you will be able to sell some or all of them and get cash within a week.

Reasons why people avoid investing in the stockmarket

"I know nothing about it"

You don't need to. Buy a portfolio of 10 blue chip stocks and hold onto them. Neither, you nor anyone else, can predict which ones will do well. By buying a portfolio, you will be hoping that the winners will compensate for the losers.

"I lost a lot of money on eircom"

Investing in only one share is very risky. Buying a portfolio of 10 spreads the risk.

This issue is debated more thoroughly in this Key Post: "Should the elderly be less conservative investors?"

It is better to buy shares directly than to buy a fund of some sort

The advantages of funds

• simplicity - you only have one investment to worry about
• diversification - a fund will have many different shares

But these advantages are outweighed by the disadvantages

• Costs - you will be charged management fees which can have seriously damage your overall return
• Taxation - direct investment is more tax efficient

I believe that a portfolio of 10 shares provides adequate diversification. But I am in a minority on this view. Is ten shares enough?

Taxation

When you cash your fund, the profits are taxed at 41%
Dividends received directly on shares are taxed at your marginal rate of tax which could be as high as 55%
However Capital Gains are taxed at 33% and the first €1,270 is tax-free every year.
When you die, there is no CGT on the gains in your portfolio.

Brendan Burgess said:

We have savings of €100,000 in the Post Office. Where should we put it to get maximum safety and maximum return?

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I know you were speaking loosely but the straight answer is that these are contradictory aspirations. It is like going into a car dealer and asking for his sportiest and most economic car.

Advice should be tailored to the personal circumstances. In this case we are talking 100K and whilst I accept most of your statements I do not accept the conclusion. Instinctively I would say "stick with the post office" and my narrative would go as follows.

Narrative:

"First thing to note is I have no silver bullets, sorry, I know you thought because I have a Nobel Prize in Economics this would be a no brainer for me.

Let's think 5 years ahead, just to get some focus, unless you prefer some other time horizon.

If you stick with the Post Office you will still have your 100K and another 10K. I know, I know, baked beanz will cost another few cents, but all the financial markets expect the low inflation we have had for the last 20 years to continue for maybe the next 20 years.

Obviously you will be afraid of a bout of hyperinflation but there is no insurance against that, not even equities. If it came from a surge in oil prices or a collapse in a currency or a geopolitical mega crisis equities would suffer too, at least on that time horizon. Equities have proved good hedges against steady inflation coming from slow depreciation of the currency simply because they represent real assets. I don't want to get too technical with you but actually cash is a better insurance against deflation than equities and there are some who actually think deflation is a bigger risk these days than inflation.

If you invest in the stockmarket in some shape or form the outcome in pure euro terms is much more uncertain. On average you might expect to do slightly better than the Post Office, maybe another 5K. And there is no doubt you could make maybe as much as 50K in the next 5 years, I certainly can't tell you. But you can't dismiss the possibility that you would lose 20K or even more. How would you feel about that?"

Of course I would have different advice for a 30 year old saving for a pension.

Duke of Marmalade said:

Let's think 5 years ahead, just to get some focus, unless you prefer some other time horizon.

.

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But why should 65 year olds think just 5 years ahead?

Maybe I need to clarify that in the piece?

"As you are both 65 and in good health, your investment horizon is around 20 to 30 years. So we have to ask which investment is most likely give you the best return over the next 20 to 30 years?"

Brendan Burgess said:

"As you are both 65 and in good health, your investment horizon is around 20 to 30 years. So we have to ask which investment is most likely give you the best return over the next 20 to 30 years?"

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Good point! But by time horizon I don't merely mean "how long do you think you will be on the planet?". It's just a focus point to try and illustrate the riskiness of outcomes. When thinking about what might come of your investments in 5 years you are implicitly thinking of what you will be wanting at that point to see you through to the next 5 years etc.

There is absolutely nothing wrong with some equities here in fact an allocation to the Stock Market makes perfect sense for many people in this position.

The real question is how much or how little to allocate to equities?

If you put half of your money in equities you should expect a 20% decline in your portfolio about 2.5% of the time or one year in 40. In practice you might experience worse than this and more often. That is the nature of the stock market.

In Numerous studies, retirees have been shown to underestimate their life expectancy and this should be taken into account when considering your retirement options.

In one such study, although some retirees did correctly identify average life expectancy at age 65 as around 17 years for men and 20 years for women, far too few appreciate that this means that half of them will live beyond these projections.

For example let’s consider the probability that you could live to at least 90—for the general population, this is about 20% for men and 33% for women, and on average is even higher for those retired with benefits from an employer-sponsored pension plan.

You can't really give honest advice without sitting down with clients for at least an hour to find out about them. Even then, it will only give you an idea of what they are about.

You also need to look at all their commitments now and into the future. Do they have enough from their pensions to pay for their day to day lifestyle?

A 65 year old couple, who have just retired are going to be quiet active and do lots of things that they couldn't do when they had to work 5 days a week.

If they have dreams that they wanted to fulfill, I would look at them spending the money on that first. There's no point in brining a pile of money and a load of regrets with you to the grave.

Another key area that I haven't seen mentioned is their capacity for loss. If €100,000 is all they have, it is unlikely that they want to take on the risk that goes with investing in equities. You telling them that equities produce the best long term return will be of no comfort to them as their life savings falls by 50% in 12 months.

Depending on how much is left from them fulfilling their lifelong ambition, I would put a large chunk of it on deposit as they are likely to need it over the next 5 years when they are active and a small amount in a diversified portfolio for at least a 5 year investment term.


Steven
www.bluewaterfp.ie

the irish stock market is too small and undiversified,You would have been far better off putting it in the US or even UK market. However even investing in the irish stock market in 2004 you would now only be down 6%, whereas putting it in irish property in 2004 you would now be down 40 to 50%. It shows how property investing is not really that safe because you cannot diversify like you can with the stock market.

joe sod said:

the irish stock market is too small and undiversified,You would have been far better off putting it in the US or even UK market. However even investing in the irish stock market in 2004 you would now only be down 6%, whereas putting it in irish property in 2004 you would now be down 40 to 50%. It shows how property investing is not really that safe because you cannot diversify like you can with the stock market.

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And just for completion, if you had invested in Post Office savings certs you would be up 50%, admittedly without the fun of the roller-coaster ride.

Duke of Marmalade said:

And just for completion, if you had invested in Post Office savings certs you would be up 50%, admittedly without the fun of the roller-coaster ride.

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I dont think those interest rates were available on post office savings certs back in 2003/4. I think the government only made those available in 2009 when they were not able to get money any where else and when everyone was afraid that the irish government would default. Also you have to leave it in for a whole decade and then collect your 50% in 10years which is ok but can easily be obtained by compounding anyway. If you had asked me in 2009 which is safer investing in coca cola or mcdonalds and collecting dividends and capital gains for 10 years or give it to the insolvent irish state i know what I would have done.

Here is the chart of the FTSE 100 over the last 30 years:

http://uk.finance.yahoo.com/echarts?s=^FTSE

It's been a roller coaster ok, but it's gone from around 1,000 to 6,800. Your investment in state savings certs has gone from 1,000 to, well 1,000.

While it is still only at its 1999 peak, it has also paid dividends since, so an investment in the FTSE at its peak is probably doing about the same as an investment in savings certs.

If people invest their savings over time in the stockmarket, they should get a very good overall return.

There is a risk that somone who invests all their savings on a particular date, such as in the current question, may just pick the peak of the market and have to wait a long time for values to recover.

S Barrett says that you would be very unlucky to invest at the peak and cash out at the bottom. Unfortunately, that is what quite a few people do and it's one of the dangers of the stockmarket. Individuals tend to invest at the peak and then sell in panic after the market falls.

The best long-term approach is to invest your savings as you accumulate them in the stockmarket.

This is becoming a really good debate

The key issue for each individual to consider is their need, willingness and capacity for risk.

Let's consider two individuals both who need an income of €40,000pa after tax.

The first is the example Brendan gave at the top of the thread.

In my first post I make the following points:

So, this couple has a gross taxable income of €33,920 and a total income tax exemption of €36,000 pa.

Unused personal income tax allowance of €2,080 or 2%pa of capital of € 100,000

Is the occupational pension indexed or level?

If they were able to invest their capital in a savings account at a gross rate of 4%pa then the annual return would be €4000pa and half of this would be tax free due to the unused personal allowances.

But this would still be short of their target income of €40,000pa net of tax.

The return they NEED from their €100,000 is the difference between their current income and their target income (€40,000- €33,920) which would be €6080pa or a little over 6% net of tax.

This is a very high target income and isn't really realistic. The income they need would require them to invest in a very high risk investment strategy which may be inappropriate for their risk capacity - they are 67 years old, with only 100k in capital and an occupational pension of just €10,000pa.

Some people might be willing to have a punt on an appartment or some shares but objectively it would probably be extremely ill advised to do so. These people simply lack the capacity to take on a high risk.

In practice a competent adviser would review the expenditure and work out a sustainable household budget in order to establish a sustainable strategy that is appropriate for the needs of this particular family.

The basis of a good financial plan is good financial management and that starts with a good household budget where everything is properly accounted for.

We have known this to be true since Mr Micawber in Charles Dickens's David Copperfield:

"Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery."

Now contrast this with a couple with an annual net pension of €50,000pa and an annual expenditure of €40,000pa.

The difference is that these people have capacity to invest. They don't NEED their savings and so who are they investing for? Probably their children and grandchildren. Their focus can be less on capital preservation and more on Estate Planning. Their investment horizon is potentially many decades into the future if they are investing for Grandchildren and a perfectly acceptable stategy would be to invest the whole amount in to the stock market.

What matters here is the needs and circumstances of the individuals. There is no one size fits all solution. State savings are not better or worse than an investment in the stock markets. It depends on the needs of the investor.

Brendan Burgess said:

It's been a roller coaster ok, but it's gone from around 1,000 to 6,800. Your investment in state savings certs has gone from 1,000 to, well 1,000.

While it is still only at its 1999 peak, it has also paid dividends since, so an investment in the FTSE at its peak is probably doing about the same as an investment in savings certs.

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The most impressive message from that link is that FTSE is trading at half the price levels of 1999 in terms of Price/Earnings ratio. In fact Earnings are running at 8% p.a. which seems good value historically.

But let's not get too excited by dividends. The link says these have been 2.1% p.a. since 1999. Knock off tax and charges (presuming you use a collective vehicle to get diversification) and divies just about wash their face.

The fact is that Post Office savings are subsidised even at today's levels of 1.75%.

To see this consider an obvious comparative - Irish Government Bonds of 5 year duration. The yield on these is currently 1.8%. But the coupon on this bond is 4.4% so for a standard rate taxpayer, the after tax return is about 0.7%.

Furthermore if current very low yields where to spike in the next couple of years you would be trapped in the bond which would have fallen in value but you can exit the Savings Certs, even with a bit of interest added to your investment. Make no mistake if Savings Certs type instruments were offered to the wholesale community they would be trading at less than 1% yield. Why else do you think there are maximum limits on these products?

Finally, and I have been at this before. The 11bn or so of Savings Certs will be the very last to be defaulted upon. There is no-one in the current Dail, so far as I am aware, who has it as a policy objective to burn the widows and orphans so as to pay off the bondholders and I do not foresee any such party gaining electoral majority in the next 5 years.

So there you have it. Tax free. Easy exit terms. Absolutely safe. Fill your boots.

Has the exemption on DIRT and PRSI on savings for pensioners been factored into the calculations and savings/investment advice?

Brendan,

Might you include an additional fact find at the outset: does the €460 a week plus €10k per annum of pension monies (€34k per annum all in) cover the couples annual outgoings?

If yes, then losing capital is not a life-changing event, and higher risk can be taken. I'd be in your camp for a properly diversified portfolio of equities assuming reasonable value in markets.

When we choose equities, or property, we do so on the assumption of on-going economic and business prosperity. That's been the way to go in the past 200 years in the developed world. But as we can't know the future then this is a choice and one most should make if they see the future through a half-full glass.

But many see the future through a half-empty glass. Nothing wrong with that. None of us know what the future holds and whether inflation or deflation lies ahead, both of which are no good for equities, with deflation being a mortal danger.

Rory

I think there's a distinction between should a 65 year old have equity investments and should a 65 year old begin equity investing.

There's a learning curve with shares, it might be 10+ years before someone will know what style suits them, 65 is late to begin working this out.

You need to learn how little you can glean from annual reports (Anglo's were excellent until they went bust).
You need to figure out how tolerant you are to a market shock (9/11, Lehmans etc.)
You need to know when to sell and when not to sell.
Etc..

It takes mistakes and time to gain experience.

If you start into shares in your 60s chances are you'll end up at AGMs hurling eggs at CEOs who've disappointed you. Shareholders should expect no sympathy and blame no one except themselves.

Rory Gillen said:

Might you include an additional fact find at the outset: does the €460 a week plus €10k per annum of pension monies (€34k per annum all in) cover the couples annual outgoings?

If yes, then losing capital is not a life-changing event, and higher risk can be taken. I'd be in your camp for a properly diversified portfolio of equities assuming reasonable value in markets.

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This is an interesting point and is also made by Marc. Should you change your investment strategy if depending on how closely your income matches your expenditure?

If you are relying on income from your investments, should you have a different strategy?

I have changed the initial case study to make the income match the expenditure.

But let's say that the couple is spending around €3,000 a year more than they are earning, so they will be eating into their €100,000.

It is argued that they should "adopt a less risky strategy". But I still think that putting money on deposit is the most risky strategy. Now their money is being run down both by inflation and by withdrawals. They will probably run out of money in around 15 years or so. If they invest in equities, they might well run out sooner. But is it not more likely that their money will last them much longer?

But maybe the first approach should be to assess whether they have enough to fund their costs, whether they invest in equities or put their money on deposit.

"So let's assume you put your money on deposit.
You are drawing down €3,000 a year at the moment.
With inflation, it is likely that you will increase this level of drawdown.
Also, your costs may increase anyway due to healthcare or homecare.
So let's say that you gradually run down your deposit over the next 15 years. Of course, it could well be longer - your €100,000 might last you 25 years.
What if it lasts 15 years?
Well you will be 82 years old and be spending more than your income.
However, you will still have your home which you can use.
You can sell your home and you will have the equivalent of €300k in today's money.
Or you may be able to borrow against your home"

So your total assets of €400k is probably enough.