UK Expat Pension – Why not take a DIY approach?
Expat without a UK pension? Don’t worry. There’s no time like the present to get one organized.
In this article we take a look at why you might think about taking a DIY approach to your pension if you live overseas.
Sure their are all kinds of pension products out there. You can read more about them here if you are interested.
But here’s the thing. In a lot of cases, particularly if you live overseas, you are better off avoiding them altogether and just taking matters into your own hands.
Index tracking ETFs have changed the game for expats across the globe. Now we can put together our own pension with a couple of mouse clicks.
And in doing so, take high fees, low quality products and unscrupulous individuals out of the equation.
Without further ado. Let’s get into it.
DIY investing
Many people are afraid to invest. They think it is too complicated and no surprise because there is a lot of conflicting information out there.
Some of it isn’t good, some of it is bad, and some information aimed specifically at British expats is outright deceptive. In fact, I would go so far as to suggest it is bordering on criminal. These three articles probably explain this better than I can.
It is no wonder many people don’t bother investing at all! If you don’t know who to trust, where to get the information or what to do, how are you supposed to invest? It doesn’t surprise me in the slightest that many people either don’t save at all or they stick their cash in the bank.
Not saving won’t give you a very big UK expat pension. Sure, sticking your cash in the bank definitely beats not saving at all, but there are much better ways to achieve your financial goals.
Inflation – the enemy of savers everywhere
Putting your money in the bank would be a great thing to do if it wasn’t for a small problem called inflation. Inflation is the enemy of savers everywhere. Every year the prices of goods and services go up. They inflate!
According to the Bank of England, over the last 35 years, inflation has averaged 2.8% per year in the UK, which means something that cost £1 in 1993 costs £2 today.
You can look at this in one of two ways. Either the price of things have doubled or the value of the pound has halved, and here lies the problem. A pension balance that halves in value won’t do you much good.
Of course banks do pay interest. The problem is they don’t pay enough of it to keep up with inflation. In fact right now the interest paid on savings accounts is just about as low as it has ever been.
Unfortunately for all those savers out there, this means that if you put your money in the bank your money is going to go down in value.
Investing in the Stock Market
So how do you avoid your money getting devalued? Well, it turns out it is really quite simple, you simply invest it in the stock market.
Stocks have proven time and again to beat inflation. And beating inflation generally goes hand in hand with beating cash in a savings account.
Time to introduce a tongue twister called the ‘equity risk premium.’
This is the amount by which stocks (shares) beat cash.
Nobody knows for certain what the equity risk premium is going to be in the future, but we can have a crack at guessing.
Ask the experts
In fact, rather than taking a guess ourselves, a much more sensible approach would be to listen to what trusted experts have to say on the matter.
Some of the best are the highly respected team of Elroy Dimson, Paul Marsh, Mike Staunton from the London Business School.
Every year they put together the Credit Suisse Global Investment Returns Yearbook. In the 2018 edition they say:
-Equities continue to offer the highest expected returns.
Credit Suisse Global Investment Returns Yearbook 2018
-Expect an annualized equity premium relative to cash of around 3.5%.
-An equity premium of 3.5% would see equities doubling relative to cash over 20 years.
3.5% doesn’t sound like much, but there are two things to bear in mind.
- That’s above inflation.
- Over the long term compounding at 3.5% over cash will almost definitely make you wealthy
If cash keeps up with inflation (which it never does) £300K in 35 years would give you £300K.
However, compounding at 3.5% above inflation would give you a cool million.
Sounds good so far, but it is important to recognize that investing in the stock market can be risky. It is not unheard of for your balance to drop double digits over the short term.
The longer your time horizon the less risky stocks become. In fact, if history is anything to go by stocks become a lot less risky over 10 years and if you are saving for over 20 years they aren’t very risky at all.
Highly educated, experienced, well paid financiers don’t usually come cheap!
If you are like most people the first idea you’ll have about investing is finding a pro and let them deal with your money.
There are three problems with that for expats.
- Finding somebody you can trust isn’t likely to be easy
- If you do find someone, the chances are, they will just invest your money in the stock market anyway
- They will charge you high fees
It’s worth going into a bit more detail on that last one.
Often people get mislead into thinking the fees they are paying aren’t high.
But here’s what Charles Schwab, the founder and Chairman of Charles Schwab Corporation (one of the first and biggest discount brokerages) has to say during an interview with Tony Robbins in Money Master the Game:
For every 1% over the lifetime of investing, it’s 20% of your money you’re giving up. Give up 2%, that’s 40%. Give up 3%, that’s 60%.
Charles Schwab
Working back from that 0.25% = 5% of your money and that sounds more like what we should be aiming for and it really is possible. These days we can buy index funds and exchange traded funds with ongoing charges as low as 0.04%.
You might be thinking the extra money will be worth it because a financial professional will be able to beat the market enabling you to achieve higher investment returns.
Unfortunately, for them, the overwhelming evidence suggests they can’t. In fact when fees are taken into account, they tend to underperform. You really are better off doing it yourself.
S&P Global research shows that you are likely to beat 90% of professionals by simply putting your money in a broad based index fund.
The art of stock picking – Pick all of them all of the time!
The thing is, these days you don’t even have to pick single stocks! Research has proven it is quite simple really: The art of stock picking – Pick all of them all of the time!
You should do well if you invest at regular intervals in as many stocks as you can using cheap index funds or exchange traded funds (ETFs) to invest in the markets.
For stocks a cheap global fund would be probably be perfect for most British Expat Investors. Take Vanguard’s FTSE All World UCITS ETF for example.
Even the experts agree most investors would be better off sticking their money in cheap index funds. Here’s what the master investor himself Warren Buffet has to say on the matter:
If you invested in a very low-cost index fund — where you don’t put the money in at one time, but average in over 10 years you’ll do better than 90% of people who start investing at the same time.
Warren Buffet
Add bonds to your investments
There’s no getting away from the fact that stocks can lose value from time to time. To even out the ride most experts recommend investing in some bonds too.
Bonds don’t provide you with the big returns but they do allow you to sleep better. They are just about as safe an investment as you can make.
It is usually better to invest in highly rated government bonds from your own country. If your home country doesn’t have highly rated government bonds it may be better to invest in one or more foreign countries’ bonds.
The bottom line is this. Most investors will be well served by investing in just two index funds: A global stock fund and a government bond fund. A mix of these two really is all you need for your UK expat pension.
Time to think about risk
How much you invest in each of these comes down to your risk tolerance and time horizon. That will take a bit of thinking about. Each person is different.
If you think you couldn’t stand the value of your investments to go down by much at all, and you were only saving for a couple of years, you’d probably be better investing in all bonds.
However, if you think you could handle the value of your investments dropping big but temporarily from time to time and have a longer timer horizon, say 20 years, then you might be OK with all stocks. Most investors are going to sit somewhere in between.
This is a very individual decision and one you should spend time thinking about. (You can read more about it here).
Lump sum vs drip feed
Most investors will invest at regular intervals because that is when they have the money. However, if you are one of the lucky ones who has a lump sum to invest, it worth taking some time out to consider whether you want to invest in one go or drip feed your money into your pension.
It is also worth spending some time to weigh up how much you should invest. Of course part of it comes down to how much money you have or can earn, but it also comes down to how much you think you will need in retirement.
A couple living on the outskirts of Manchester in their own mortgage free house, who like staying in watching TV, probably won’t need as much in retirement as a single guy, who rents an apartment in central London when he’s not globetrotting around the world.
Find an online stock broker
You maybe convinced with what I’m saying but unsure of how you go about setting up your own investments for your pension. But don’t worry if you think it is complicated. It isn’t.
In fact these days, it couldn’t be easier. You just sign up with an online broker that accepts British expats and you are good to go. There are plenty of good brokers out there which accept expats nowadays. (we’ve covered some of the better ones here).
Some investors prefer to keep their investments ‘off-shore,’ for tax purposes but this isn’t essential. We’ve talked more about tax here, but the key points are this.
- You may live in a low tax destination anyway
- British passport holders get the personal allowances
- You don’t pay tax on capital gains on shares
- You don’t pay other UK stock market taxes if you stay out of the UK for over 5 years
Often times, all you need to do is sign up with a good stock broker of your choice and start investing. These days they all operate online so there’s no need to fly half way around the world to open a brokerage account.
Summary
Heres a quick summary of what you need to do:
- Find a good stock broker (you can read my review of brokers that accept British expats here).
- Choose a broad global stock index fund (an example is Vanguard All World UCITS ETF which you can read about here).
- Choose a cheap bond fund (you can read about bonds here).
- Figure out what percentage of your portfolio is going to be in stocks and how much is going to be in bonds. (This is probably the most important decision you need to make so it is worth spending some time thinking about it. You can read more about this here).
- Decide how much money you are going to invest.
- Choose between investing your money in a lump sum or investing regular amounts.
- Invest!
And there you have it, the complex topic of UK pensions, made even more troublesome by the expat angle turns out to be…… well, simple.
It comes down to signing up with an online broker and investing in a couple of cheap index funds!
Easy!
