Simple Pound

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May is drawing to an end, and so is my time at University. Next month I’ll already get my first salary (well it’s a relocation bonus, but it’s money from my employer) and after the necessary expenses that come with moving and living in a “proper” flat (as opposed to college accommodation) I should be able to progress with my (financial) goals much faster than I am at the moment.

My sub-goal for this month was to keep my overall expenses close to what I spent in April. I don’t have a budget yet that determines how much I am “allowed” to spend on various items, but I figured by sticking to the lowest monthly expenses I had this year I wouldn’t be over-spending. Unfortunately I didn’t quite make it but spent just under 10% more. This was mainly because my boyfriend and I finally decided on some crockery for the flat (and subsequently bought it) and due to higher expenses for public transport as I had to go down to London to figure out in which area we’re going to look for flats.

Moreover, I paid off the last outstanding credit card balances and got myself a coin jar to be able to put at least some money towards the goals on the progress page. The coin jar is an idea that is treasured by many personal finance bloggers on the web, and is a simple way of putting aside some cash without really noticing it. Every evening, after looking through my receipts and entering my expenses into a spreadsheet, I put all loose change (except for 1-pound and 2-pound coins) into a jar and put it out of sight. Now (at the end of the month) I’ll have the pleasure of counting (I love counting money!!) and allocating it towards one of my goals. While it’s not going to be a lot of money, I still feel it’s worth it because it keeps me motivated despite having limited funds available at the moment.

*counting*

*still counting*

It’s a total of £5.37 - which constitutes more than 5% of what I have in my account at the moment, so I keep telling myself it’s not that bad at all (you’re welcome to donate though )!

And finally, you will hopefully have noticed the progress bar on the right-hand side by now (yet another one!). With my life insurance premiums invested in mutual funds, I figured it is about time to start tracking my overall net worth. This is basically a measure of all money I have available in a reasonably liquid state (if I wanted it to be…) less any outstanding debts.

Now, those of you who have read my progress page will know that I owe my parents some money for minor repairs on my Mum’s car, but I won’t use these against the net worth because I don’t really have a due date for paying back that money and thus it doesn’t “feel” like debt. Further, I’m planning not just to pay back the outstanding money for the car repair, but also some more beyond that. My parents don’t expect this at all, but I feel it’s just fair because they have supported me for so long, paid tuition fees and rent and insurance premiums and were always concerned I might not have enough money. To make up for the slight imbalance this will create, the net worth won’t include any money I plan to use for paying back these sums.

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I have talked about Zopa.com a little while ago, and my initial thoughts were fairly positive. I still plan on trying it as soon as I have sufficient funds available.

J.D. @ Get Rich Slowly has posted a couple of articles on Prosper.com, which - as far as I can tell - is fairly similar to Zopa.com. The articles have generated quite a heated discussion and he has reproduced some of the comments in a further blog entry (that also includes comments made on other people’s blog).

I thought you might be interested in reading more about people’s experiences with personal lending sites, so I want to share the links here:

• Original article: Investing on YOUR Terms
• Prosper Personal Lending Update
• Comments Round-Up

Let me know what you think!

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I finished this book within 2 or 3 days and figured I might as well share not only my opinion on it but also its key points as a neat summary for me (and others) to look up.

In general I think this book is immensely helpful, well written, thoroughly explained while still engaging and I definitely recommend it to anyone who wants to organise his / her own portfolio.

The book is divided into three parts: “Asset Allocation Basics”, “Asset-Class Selection” and “Managing Your Portfolio”. I will look at these in turn, but spread the review across several posts to give you some time to digest what you’re reading.

Since I am planning to write more of these reviews (especially about books that are there to teach you something and thus contain some actual advise), I have added a new heading to the menu so that you can access all reviews from a convenient and central place. I’ve just ordered “A Random Walk Down Wall Street” and still have Jack Slater’s “Zulu Principle” sitting on my shelf, so there are definitely more reviews ahead!

Asset Allocation Basics

Chapter 1 – Planning for Investment Success

This chapter mainly focuses on the basics underlying investment success: the development of a prudent investment plan, the implementation of that plan, and a commitment to follow the plan in good times and bad. He explains that there are no shortcuts to stable financial well-being (“It takes only one bad investment decision to wipe out years of prudent saving and investing”) and that people who learn to manage their money early, will end up being better off – both financially and emotionally.

Ferri explains how difficult it is to beat the market and how few investors actually manage to do so – be they individuals or fund managers. He uses various examples to illustrate his point, the technology stocks boom in 2000 being one of the most obvious choices. While trying to beat the market might certainly be a very exciting job to do, it is also a highly risky one and thus not suitable for most (individual) investors. Instead, asset allocation provides a fairly reliable (but unfortunately boring) alternative that will – if done properly – secure you a decent return with limited risks.

A paper by Roger Ibbotson (University of Yale) supports Ferri’s view in that it concludes that “more than 90 percent of a portfolio’s long-term variation in return was explained by its asset allocation” and that “only a small portion of the variation in return was explained by the individual stock or bond selections”.

The remaining part of the first chapter advocates mutual funds as the optimal way of building a portfolio across the different asset classes. This guarantees a diversification within the asset class on top of the diversification benefits gained from asset allocation itself and therefore reduces risk while increasing long-run returns.

Chapter 2 – Understanding Investment Risk

The second chapter is dedicated to the analysis of risk and the risk-return relationship. Ferri explains that one can only expect higher returns from an investment if simultaneously accepting greater uncertainty and hence risk. Most people who have thought about investing will be aware of this relationship. But what I learned is this: “A properly designed portfolio is expected to have a higher risk-adjusted return than each of the individual investments that make up the portfolio”. Therefore, by adhering to a proper asset allocation strategy, you will increase your long-run returns while reducing your overall risk. While you’ll never be able to compete with the highest-return portfolios in a bull-market (i.e. a market that shows increasing stock prices and great investor confidence), you’ll certainly outperform your friends in a bear market if you stick to your original asset allocation.

Ferri further explains the different perceptions of risk: while risk translates into portfolio volatility for investment managers/practitioners, individual investors tend to see risk as losing money. The volatility of a portfolio can be observed by monitoring the up-and-down movement in the value of an investment, either on a daily basis or by comparing weeks, months or years. A bond with regular interest payments, for instance, will have a lower volatility than a small-cap stock that might gain 30% in value today only to lose 20% tomorrow.

Practitioners measure volatility in units of standard deviation, which measures the movement around the mean of a data sample. This measurement, however, is by no means static (even though the range tends to be fairly consistent) and changes along with the general market, economy and investor’s confidence. One important thing to note is that greater variation in returns reduces long-term compounded returns. To illustrate this point, the author gives the following table of example portfolios:

As you can see, despite the fact that all portfolios share a simple average of 5% return per year, the actual compounded return (that represents the steady increase in portfolio value divided by number of years) gets lower the higher the variance of the returns per calendar year. Therefore, by reducing the volatility of your portfolio, you’ll increase the overall return in the long run (as demonstrated in portfolio A).

There are two further chapters in the first part, which go into a bit more depth about the asset allocation procedure, but I want to have a think about the important points mentioned so far and decide for yourself whether or not you can live with an investment plan that is – as Ferri puts it – rather boring.

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Apologies for the less frequent updates, but our project has reached a stage where we actually need to do some work. The good thing about this is, that I can research new current account, savings and investment options and call it “studying”.

So I’ve spent most of yesterday comparing current accounts and calculating interest based on the average Briton. According to National Statistics, the average UK resident’s current account incomings and outgoings can be broken down as follows:

• weekly pay: £447
• food & non-alcoholic beverages: £40.90 (or 9.15%)
• alcohol & tobacco: £17.66 (or 3.95%)
• clothing & footwear: £ £26.51 (or 5.93%)
• housing: £81.09 (or 18.14%)
• household goods and services: £28.88 (or 6.46%)
• health: £7.78 (or 1.74%)
• transport: £67.85 (or 15.18%)
• communications: £10.59 (or 2.37%)
• leisure: £53.60 (or 11.99%)
• education: £6.26 (or 1.40%)
• hotels & catering: £53.60 (or 11.99%)
• misc: £52.39 (or 11.72%)

Unsurprisingly we spent most of our money on housing and transport. Bearing in mind that this “average person” as such probably doesn’t exist, how well do these numbers reflect your spending patterns?

Now that I had some numbers to play with, I calculated the average monthly interest people can expect from the various current accounts on offer. My previous intentions were to switch banks immediately after getting my first pay cheque, but some precautions should be considered before making the final choice.

When searching for the best current accounts, the ranking you get is the following (assuming an average credit level of £1,000):

1. Alliance & Leicester Premier Direct: 6.50% AER
2. Abbey: 6.30% AER
3. Halifax High Interest: 6.17% AER

I have realised that Lloyds (my current bank) is actually willing to pay me 4.25% AER if I credit my account with at least £1,000 a month (salary!). That interest rate applies up to a balance of £5,000 - and this is exactly the catch. While the above banks offer a substantially higher interest rate, many of these are either time-limited (i.e. introductory offers) or apply to only a fraction of your balance.

This makes Abbey the worst offer of the three ones listed above because you only get 6.30% AER on the first £1,000 in your account and that rate only for 12 months - I suspect that afterwards you’re credited using the standard interest rate which is 2.50% AER.

In case you are interested, the average Briton would earn £3.74 in interest with Alliance & Leicester, £3.55 with Halifax and £2.44 with Lloyds TSB. While this constitutes a spread of more than 50% you will have to know for yourself whether the extra few pounds will be worth the trouble.

My general guidelines here would be:

Don’t forget tax. Bear in mind that the quoted AER rates do not include the 20% income tax you are automatically charged. This means that the best offer of 6.50% comes down to only 5.20% after tax.

Understand how interest is calculated and when it will be credited to your account. Most banks will calculate your interest on a daily basis and credit your account either monthly or annually. I personally prefer to get my interest monthly, because it serves as an excellent motivation to spend less. But admittedly this will be more important with savings accounts, because I usually keep my current account balance at a minimum while stashing away extra cash in an instant-access online savings account with real-time transfer.

Beware of introductory offers. If you don’t want to keep switching banks, make sure you know what interest rates you can expect after the introductory time is over. Don’t give your money to banks who can’t or don’t want to share such basic information.

Beware of other limitations. Many of these high-interest accounts assume you pay in a monthly minimum. Find out what happens if you fail to meet this requirement and how long it will take to get “back on track”. Also, bear in mind that the quoted interest rates may only apply to a certain amount of money. If, for instance, your average monthly balance exceeds £1,000 you are better off choosing a current account with Halifax than with Abbey despite the lower interest rate.

Real-time, instant access savings account? If you like keeping the bare minimum amount of money in your current account (e.g. to discourage you from thinking you’ve got all that money to spend!), an instant-access online savings account is a must. Most banks will offer such an account in connection with their current account, but make sure that transfers happen real time and don’t take 3-4 working days! If I expect a cheque to come through I can transfer funds between my accounts within seconds!

Cross-check other product offerings. If you prefer simplicity over an additional 5 pounds a month, then you should check the other products your potential new bank has on offer and how they compare in the market. Choosing an average current account offering with a decent savings account will be better for you in the long run than having the best current account the market has to offer but being stuck with lousy interest rates for your savings account.

My current favourite is Halifax because they seem to offer a decent range of products and a great current account with the 6.17% AER on balances up to £2,500. Share your thoughts on yours! Where does your money currently go to? And how happy are you with your current bank?

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The case Brennan vs. NatWest is still dragging on. After three days of hearings on whether the case should go to court or not, the judge reserved his judgement.

In the meantime, you can feel that NatWest, represented by barrister Pilling, is getting rather annoyed with Brennan and the idea of being made a precedence:

“It is not for Mr Brennan to set himself up as a consumer champion - that is exactly what his claim is all about.”

“He is pursuing this action for the benefit of other people, not himself - he is pursuing a crusade”

You have to admit, he has a point. That’s why I don’t like lawyers. They always seem to have a point no matter how wrong you want them to be…

Update: Apparently the judge estimates to need six weeks to reach a final decision. Read a very comprehensive summary about the last day of the hearing here.

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A 20-year-old of good health with a life insurance. Sounds like a waste of money? Maybe, but I will still disagree with you. There are two simple reasons why:

1. Tax-free money: My parents took out this life insurance for me at the last possible date where I wouldn’t have to pay taxes in case I have the money paid out (in the future). Any insurance policy that comes into effect on or after the 01.01.2005 is assessed under a different tax law which applies income tax to any proceedings from the insurance.
2. Mutual funds: The insurance is based on a selection of mutual funds and while the insurance company guarantees a certain minimum payment in case of my death, the amount of money I could eventually get out of this insurance entirely depends on the performance of the underlying funds. I stop making additional payments towards the insurance in 2034 (I’ll be 48 then), but the money will stay in the selected funds until I decide I’d rather go and spend it now.

The insurance has been running since December 2004 and my parents have been kind enough to pay the monthly premium since then. When I start working in July, all these payments will go out of my own account, which was one of the reasons I sat down earlier to figure out how exactly the insurance works and what sort of funds my money sits in.

There are about two dozen mutual funds to choose from, each covering a specific asset category like European growth stocks, emerging market bonds or world-wide real estate. I have analysed the current selection of mutual funds and here are some results of this analysis.

The current split between bonds and stocks is 30:70. The bond section of the portfolio contains some stable, boring government bonds but also high-yield bonds and emerging market bonds. I figured that was quite a decent distribution so I didn’t analyse it further. The following graphs only concern the 70% stocks in the portfolio.

The term “America” refers to the continent as opposed to only the United States and therefore includes Latin America and Canada as well. But it surely doesn’t come as a surprise that US stocks make up at least 90% of this share.

The sector termed “Knowledge” includes both software and hardware, as well as media and telecommunications. Services covers health, consumer and business services, and finance while industry comprises materials, energy but also consumer goods. The highest sector allocation can be found in finance (16% out of 70%) and health (12% out of 70%).

I am quite keen to optimise it, as I don’t think it’s quite ideal yet. If you have any recommendations or thoughts on the current distribution of funds, asset classes, geographical regions, etc. please leave a comment. In fact, I would love to stimulate some reader participation here! So the question is: “What would you change in this life insurance portfolio?”

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