If you lived and worked on an isolated island community and were able to source everything you needed from your fellow islanders, retirement would be a relatively simple thing to plan.
You would earn a wage or make a profit doing your thing. You would not only spend your income on your fellow islanders’ goods and services, but you could also invest whatever you have left over in their businesses. When you retired, your share of the profits in those business would be directly correlated to the cost of the goods and services and everyone is happy.
You could, of course, lend money to these businesses instead but there would be no certainty that the fixed capital repayment or interest would be correlated to the cost of goods in the future. This inflation risk is why asset-backed and equity in particular are so good for retirement planning. We may not have felt it recently, but inflation does creep up on you over time.
In either case there are other risks: the business might go bust, the owner may not honour the agreement and so forth. These are things that apply to both the loan and the equity.
Butcher, baker, candlestick maker
I am imagining my theoretical example set in the 18th or 19th century: a blacksmith, baker, farmer, publican, tailor, doctor etc. Since then, advancements in transportation, industrialisation, and communications have led to globalisation which brings improvements and challenges to this premise.
Over the last generation, people have been able to invest in Mitsubishi, Nestle, Total, Tesco, BP, Diageo, M&S, GSK etc. Clearly being able to do this reduces risk through diversification and a fair and efficient market.
It does introduce additional market and currency risks, but nonetheless people can easily invest in the companies that supply them and this is sensible and encouraging. I understand that the reason funds tend to show top 10 holdings is mainly because investors feel reassured by this.
If globalisation impinges on our remote island scenario, had you invested in your local small business supplier, would it have been acquired and integrated into a global company, or would it have just gone? Whilst investing in equities for long term future retirement needs is compelling, the question of which share is important.
At Dynamic Planner when we use phrases like U.K. Large Cap Equity or Short-term Bonds it has a very specific meaning. For these examples, it is the MSCI UK Equity Large Cap Total Return Index and ICE BofA 1-5 Year Sterling Corporate Index. Individual funds or stocks and shares vary from that both in performance and in risk characteristics, as we can all easily observe. We of course calculate and measure this variance and use it when we risk profile funds at a holdings level.
Whilst indices are great for consistency of term and qualitative analysis, their components are very fluid and they are totally ex-post (or after the event) in nature. When a share grows, it enters or forms a larger part of that index; that doesn’t mean that it will stay there or remain at that proportion of the index.
Our service provides ex-ante, expected real returns; volatility, correlations and covariances as well as a Monte-Carlo stochastic forecaster. What we cannot do is tell you what stock will make up an index in 30 years’ time. If we could, I would be living on my own private island right now. When you think about asset manager charges, caps and their value, it’s worth reflecting on how difficult yet worthwhile it is for them to try to do this on your behalf.
The companies that make up local indices and the countries that represent a global index change quite dramatically. At the end of the 19th century commodities and the UK were dominant. By 1967 the largest companies in the US were GM, Exon, Ford, GE, Mobil, Chrysler, US Steel and Texaco -almost all car related.
At the same time, the UK was busy devaluing its currency and voting not to allow women into the London Stock Exchange. Back then half of UK shares were directly owned by individuals, so in many ways the market was closer to my imagined island scenario than the globalised fund-led market of the 21st century.
Change in relative stock market size from 1899 to 2021.
Things change. Would anybody like to be living off Kodak, Blockbuster or even Tie Rack shares today?
Whilst the basic principle of exchanging your labour for capital whilst you work, and then exchanging your stored capital for labour when you can’t, has been consistent and remains valid today, when it comes to choosing where to store your capital the fundamental question remains: whose labour, goods and services will be needed when you retire?
There has been a lot written about ESG and sustainability. Everyone has an opinion and many people have suddenly become experts. I am certainly not an expert and I won’t add my opinions to the pile.
It does, however, appear sensible to invest in companies that will still be around in the future, and it might be that use of the word ‘sustainability’ is all you need to prompt you to consider ESG information and your client’s preferences. A psychometric sustainability questionnaire and objective MSCI ESG data is available in our system.
Chris Jones is proposition director at Dynamic Planner