No one talks about annuities anymore. The introduction of the Pension Freedoms in 2015 were hailed as a new era in retirement planning. The new rules meant individuals no longer had to trade in their pension pots for an annuity at retirement age but could take the reins, keep their money in the market, and be in charge of their own financial future.
Which all sounds pretty wonderful, doesn’t it? However, that sales spiel does rather neglect the fact that staying invested through retirement and managing your own pension pot is not only incredibly complicated, it is incredibly risky. It ignores that fact that, for many people, an annuity really is still the best solution.
Maybe it’s the name. Annuity sounds opaque and unfathomable, like so many legacy financial products. If we called it what it is – a guaranteed income for life – suddenly the idea becomes far more appealing.
Because the product is a beautifully simple one: trade in your pension savings pot and in return get an income for as long as you live. (That’s a very basic precis, of course, and there are other considerations such as whether your income increases in line with inflation or includes spousal benefits).
The main reason annuities have fallen out of favour is that your pension pot can’t get you the same level of income as it once did. Annuity rates are linked to something very fiddly known as a GAD rate but for all intents and purposes they are affected by the Bank of England’s base rate, which we know is at a record low. The upshot is that where a £100,000 pension pot might previously have been more than enough to deliver a comfortable annual income, these days it might only get you a few thousand pounds a year.
I can appreciate that’s not a very appealing exchange for a lifetime of saving, but I still think the risks that come with keeping your money in the stock market through retirement are underplayed. Because generating an income from investment isn’t as easy as putting your money in nice, safe government bonds these days; yields on these have fallen just have annuity rates have, and that means retirees are forced to ramp up the risk.
When we talk about investing in the stock market, the rule of thumb is that you should ensure you don’t need to access the money for at least five years, to allow time to ride out any dips (see March 2020). That is not true for many retirees, who absolutely cannot afford any fall in the value of their savings.
And that brings us back to annuities. Simple, easy, and requiring no tinkering or ongoing oversight. They won’t be right for everyone, but don’t dismiss the idea before you’ve weighed up the pros and cons.
When to Ignore an Economic Moat
My colleague Susan Dzuibinski loves to put together a list of top stock picks – hey, we’ve all got to have a hobby. And the starting point for many of these lists is whether a stock has an Economic Moat. Because, at Morningstar, we love an Economic Moat. A moat around a stock, just like a moat around a castle, provides valuable protection – in this case from competitors, rather than an invading army though – and indicates a business that will stand the test of time.
This week, however, economic moats went out of the window. None of Susan’s 7 Surprising Stocks have an economic moat. What they do all have, is a share price that is currently trading below its fair value. And that’s important. Because you can have the biggest, widest moat out there but it doesn’t guarantee a successful investment if the share price is too high.
The trick to generating returns is not to pay more for an asset than it is actually worth. It’s a good reminder that you can’t just look at one metric when you’re investing, there’s much more nuance and balance involved than that. And that may be worth remembering when we start to look at some of these seemingly unstoppable tech stocks that are so en vogue.
Inspiration Strikes
Standing in a queue with a tin of paint in my arms this week, I had to look up Kingfisher's share price. Because surely the owner of B&Q is one of the true victors of lockdown.
Everyone talks about how well Amazon, Zoom and the supermarkets are doing out of our shop-from-home, work-from-home lives, and they are. But let's not forget the other major trend of recent months, that trapped in our homes for months on end has forced us to stop ignoring all those DIY jobs that need doing. It seems like everyone I know is rennovating at the moment, whether it's painting a bedroom wall or getting a whole new roof.
Kingfisher's shares have more than doubled from their March 2020 low of 124p to a current level of 274p. If I'd bought shares in the business last year, I would have spent the proceeds hiring someone to sand the stairs, because I'm really not enjoying doing it myself.
