Three questions

Brent, Homer and Richie each have a net worth of zero. Add up their assets, deduct debts: zilch.

1 Brent rents his flat: should he take out a loan to invest in the stock market?

2 Homer has a mortgage. Should he increase his mortgage to invest in the stock market?

3 Richie has a mortgage, and some shares. What should he do?

For the vanilla investor there is only one answer. You don't borrow to buy shares. Ritche should sell his shares and pay off the mortgage.

Vanilla in a nutshell

The personal finance industry is a drain on resources: yours.  Vanilla Finance came about as a way of saying to us ordinary punters: this is what you need to know and its not a bad plan [maybe not the best, but that is unknowable in advance].

Vanilla Finance says 

1 Own asset classes, rather than individual shares or loan stock. Passive investing.
2 Over a lifetime of saving, your asset allocation determines your outcome.
3 Work out an allocation that suits you, and stick with it unless your circumstances change.

Just as dieting can be summed up in a few words [eat less, exercise more], so can vanilla finance [index and rebalance]. Like dieting it can be hard to stick to the rules. Unlike dieting it gets easier the lazier you get. Rebalancing is the most active part, and that can be left for years [every two or three years still seems to work as well as anything].

Implicit in this approach is that professional managers [eg unit trusts] do not add value [some do, some don't, but you don't know which in advance].

Figures in the landscape
When I give examples I mostly use real [not nominal returns]; I also assume 1.5% advisor charges with funds, but only 0.5% with trackers and etfs. Benchmark returns [ie 'what if', not predictions] are 1% for gilts, 2.5% for corporate bonds, 4% for equities; an equity risk premium of 3% [until recently that was the on low side of the consensus]. They also give handy doubling times of 70, 30 and 18years which have a very human scale to them.

As befits vanilla simplicity I only have two asset uber classes. Boring and bouncy. Boring has reliable returns, 'bouncy' doesn't. Index-linked gilts, and shares are examples of each. 

In the simplest version of vanilla 'boring' contains' 3  asset classes: cash, short-term gilts, and index-linked gilts.  Bouncy contains: shares, overseas shares and commercial property.

Other asset classes, like private equity or timber turn up later; hedge funds never show up. Commodities have been shown the door but keep trying to climb back in through the window.

So the big decision comes down to the mix between boring and bouncy in your asset allocation. 

If you only make one decision in your investing life, this should be it. Once you have made it the rest is detail.

It's like mixing a cocktail. How much from the boring bottle - and how much from the fizzing bubbling bottle that hints at the promise of riches to come? A bit of fizz can be more fun, but it can also give you a headache in the morning [or worse, 40 years later on retirement].  The sheer weight of responsibility might make you hesitate before mixing up this cocktail of assets for your lifetime - but in fact you will have already done it. You have an asset allocation right now, its just you haven't checked out what it is.  The variations are practically endless - but vanilla suggests 3, as yet unamed, benchmark cocktails: 

adventurous 2:1; balanced 1:1 or cautious 1:3.

Note even the most adventurous allocation only has 67% 'bouncy' -  far short of 100% equities, and certainly nothing over 100% [which would be leverage with a loan]. The cautious cocktail has 75% in cash and gilts - once upon a time this was thought suitable for a 75year old...

So finally we get there: mixing up first a balanced cocktail we have 50/50:

20% gilts, 20% index linked gilts, 10% cash - the boring bit
20% shares, 20% overseas shares, 10% commercial property - the bouncy bit

There's enough of a kick from the 'bouncy' side to leave you a bit dizzy from recent market falls. And the strong hint of commercial property that added zest a few years ago, now just leaves a nasty taste in the mouth.

The cautious cocktail gives you

30% gilts, 30% index linked, 15% cash

10% shares, 10% overseas, 5% property

There's a hint of fizz and a lot of boredom. And right now boredom is in short supply.

You can get this coverage with trackers or etfs [eg ishares]. The contentious bit is there are no corporate bonds. Opinions differ as to whether they offer the best of both worlds or the worst. Vanilla is in the latter camp and recent events have confirmed it. Next year may be a great year for corporate bonds, but then it may be a great year for equities too.

Also overseas equities have a strong covariance [move in tune with] with domestic, so they ain't a great diversifier.  But as the pound has dropped overseas  holdings have been useful. Overall the 50/50 portfolio would have saved you from the worst excesses of the market slump.


So far, so what?

Well if you cut 1% off your charges, that makes a big difference. Chances are a disciplined approach will save you even more. Studies of what investors actually earn make for depressing reading. Money-weighted rates of return are very different from time-weighted. Money-weighted is the one you eat.  

Earning 100% on £50 is not much use. Next year you earn 0% having been encouraged to invest £50000. Your charts say you have earned a simple average of 50% a year. You would be the pin-up of the funds industry, maybe feature in their ads. But your spouse knows you have earned £50 over two years.

Also vanilla finance favours delaying paying into a pension fund until you can get a 40% rebate - and that might mean waiting until your 40s.

And last but not least vanilla finance says you can usefully use all your savings to pay down the mortgage - and forget the rest. Once the loans are off your back then you can start with the cocktails.

The man who had six pensions...

The pensions landscape is littered with forgotten tax breaks, misguided schemes and failed initiatives. Even the 25% tax free cashback rule  is the result of some long-forgotten compromise dating back to the 1930s. And over it all hover the birds of prey of the finance industry, looking for easy pickings. But all of us have to find a way through somehow - so what is the best path to choose?

Here's the vanilla guide to the key features.

Broadly there are three places to go to get a pension. And each offers two choices. That's six different pensions....

The big three pensions organisers you can look to are

• the government
• your employer or
• you can do it yourself.
  

The government provides the basic state pension, and also offers an additional state pension [ASP] that used to be called SERPS [state earnings related pension] and then became the Second State Pension. Savers could skip the ASP by contracting out. Recently the UK governments focus has changed to making sure we all contract in for an additional basic minimum. Their solution is the personal pension accounts from 2012, but these really belong in the 'employers' section.

Employers provide two kinds of pension schemes. The old style 'defined benefit' promised a pension based on number of years worked. Your pension savings didn't bounce around with the stock market. As long as your employer didn't go bust your pension was secure. Very nice to have but also expensive [for the employer], which is why 'defined contribution' schemes are taking over. Here your pension depends on how much money is in the pot when you retire. And that depends on how your savings have done. These are also known as money purchase schemes. Employers usually pay towards the admin costs of these schemes, and may add in their own contribution. Think of it as free money. 

Finally you can organise your own pension two ways too: by paying into a personal pension plan [ie from an insurance company] or by doing the whole thing yourself [a self-invested pension plan, SIPP].

So which is best?  Whatever's cheapest, most secure, and index-linked.

In first place:

Anything from the government is about as good as it gets [unless you are CEO of a failed bank]. The state pension is due to be indexed in line with earnings [not just inflation linked]. And if you work for the government, so much the better. [Better still for women]

In second place

Almost any 'defined benefit' scheme - because the good ones will have insulated savers from the roller coaster ride of 21st century equity markets. [Also good for women]

In third place

Anything with free money - eg where the employer makes a contribution. Or you can get national insurance rebates ['salary sacrifice'].

And languishing outside the medals is the whole of the personal pensions industry. It has to, almost by definition. It feels the full lash of market forces with no protective buffer [unlike defined benefit schemes, or those with employer contributions.]  But even here there is a winner.

In fourth place:

The SIPP - self invested pension.

Which puts the personal pension plan - the raison d'etre of much of the finance industry - firmly in last place.  Why? Because it charges the most with no discernible uplift in performance.

So what am I supposed to do?

Hold back on the traditional personal pension plan until you have checked out the other options

Which are?

Buying additional years if you can; seeing if employer will match any of your contributions; exploring salary sacrifice [national insurance rebates]; seeing if  your employer's additional voluntary contributions [AVCs] have low charges; start your own SIPP...

SIPPS are expensive

Yes they can be - but for the very simplest SIPPs set up costs and annual running costs can be under £50, or even zero. Google cheap SIPP. I got Hargreaves Lansdown, SIPPDEAL and Alliance Trust. But if you don't want to pay the  1.5% charges of managed funds [and vanilla investors don't] then be wary of HL -  they will hit you for 0.5% anyway [capped at £200] on other investments. Either way they are looking to get their 0.5%.

Does the odd 0.5% make such a difference?

Every year. Until you retire? Yes. You should aim to get all your expenses under 0.5%, under 0.3% you are doing well, under 0.1% and you are probably in a US government scheme. UK fund expenses usually start around 1.5% and in practice [by the time you buy, and then sell] will have exceeded 2% per year.

What about stakeholder schemes?

Capped at 1.5% expenses for the first ten years? Poor value. The government wanted to make the charges a flat 1% - and failed. That tells you something about the importance of the odd 0.5%.

Are women really better off in defined benefits schemes?

If you buy a pension for cash it cost about 10% more if you are a woman.

My friend's been a teacher all her life. She's retiring at 60.

If she is in the state system she will be ok

But she says she is only get £20 000 pa pension

That would cost £600 000 to buy. How may people save that much in their lifetime? Tell her to cheer up.

Is it true women get their state pensions early?

Up until 2020, yes. Are you a woman?

No

Would you like to be?

?

If you have a sex change and get a Gender Recognition Certificate you can claim your pension early.

I'd rather have a small pension and a ...

Just checking