Investing for retirement has never been easier. Even for expats! Simply, pick a couple of index funds. Add money whenever you have some, and then just sit back and enjoy the important things in life while your pension pot swells in the background.
To begin you choose the most diversified stock index fund you can get your hands on.
Ex-hedge fund manager and and financial author, Lars Kroijer puts it best when he says:
A global equity index tracker is the most diversified investment, in terms of equities (shares), that you can possibly get your hands on.
Whilst traditional index funds can sometimes be tricky to buy when living overseas, expats can simply buy index tracking ETFs. Examples being:
- Invesco FTSE All-World UCITS ETF (FWRG) TCO 0.15% (OCF 0.15%)
- SPDR MSCI ACWI IMI ETF (IMID) TCO 0.18% (OCF 0.17%)
- iShares MSCI ACWI ETF (SSAC) TCO 0.20% (OCF 0.20%)
- Vanguard FTSE All-World ETF (VWRP) TCO 0.24% (OCF 0.22%)
(OCF = Ongoing Charges Figure = the amount you pay each year as a percentage of your total investment = £10K * 0.22%/year = £22 / so all of the above can be considered low cost)
Historically, global stocks have returned over 9% a year. The only problem is they have a nasty habit of crashing every few years, so unless you have a cast iron stomach, you need bonds to help you through the bad times.
(Just to be clear, stocks (have) always bounce back. Sometimes quickly, but sometimes it can take a few years).
Bonds is a big topic all on its own. You can read more on here if you are interested, but here’s the crux of the matter. With a bond you essentially lend your money to some entity, for some time period and then get paid interest for your trouble. As with anytime you lend money there are risks involved: Bonds have three you need to be aware of: Duration, Credit and Currency.
- Duration – The shorter this is the less risk there is so the common approach is to invest in short to intermediate bonds.
- Credit – The higher this is the more chance you’ll get your money back. Developed market governments tend to be considered the best so the common approach is to invest in government or a mix of government and others.
- Currency – Investing in bonds in the currency of the country where you are going to retire avoids currency risk (and here in lies the problem!)
It is that last point that causes an issue.
Currency risk
For Brits retiring at home, its easy. Just choose UK bonds. Similarly, for Brits retiring in the US just choose US bonds. Simple. But what if you don’t know where you are going to retire?
It turns out there is a pretty straightforward solution for this. You invest in a global bond fund.
Here are three examples:
- iShares Global Aggregate Bond UCITS ETF
- iShares Global AAA-AA Government Bond UCITS ETF
- iShares Global Inflation Linked Govt Bond UCITS ETF
They are all from the same fund provider for no other reason than they offer the best examples right now.
I’ve summarised the main differences between these below:
Bonds for the undecided
| iShares Global Inflation Linked Govt Bond UCITS ETF | iShares Core Global Aggregate Bond UCITS ETF | iShares Global AAA-AA Govt Bond UCITS ETF | |
| Ongoing Charges Figure (%) | 0.20 | 0.10 | 0.20 |
| Weighted Avg Maturity (Years) | 12.82 | 8.88 | 10.14 |
| % US Bonds | 45 | 37 | 20 |
| % UK Bonds | 30 | 5 | 10 |
| % AAA rated bonds | 51 | 37 | 67 |
| % AA rated bonds | 38 | 15 | 32 |
| Includes corporate bonds | No | Yes | No |
| Includes EM | No | Yes | No |
| Inflation protection | Yes | No | No |
It’s worth just defining a few of those things we are looking at.
Ongoing Charges Figure (OCF) – as touched on above. This is a measure of the total costs associated with managing and operating an investment fund. In this case even the more expensive ones at 0.20% are still pretty cheap, but all things being equal the cheaper the better.
Weighted Average Maturity – refers to the length of time it will take until the average security in the fund will mature or be redeemed by its issuer. Generally, the shorter this is, the less volatile a fund will be. People tend to like a shorter duration when they are expecting inflation too. However, bonds do payout interest, and this tends to be higher the longer the duration. It is also worth noting that government bonds with long durations do tend to go up when stock markets crash so many investors like them for crash protection.
%US and UK Bonds – is looking at what percentage of the fund is allocated to each country’s bonds. The US makes up a large part of the bond market in many funds due to the sheer size of its financial markets. Some investors like to have a lot of exposure to the US market, others not so much. And as a Brit I like to know what % of the fund will be allocated to my home country’s bonds.
%AAA & AA bonds – considers what percentage of the fund is allocated to these highly rated bonds. AAA being the best, but bonds rated AA are also considered high quality. The more of each you have the less likely for any defaults and the more likely it is that you’ll get your money back. (In reality, you’ll get your money back from developed country governments. Bond defaults would just mean the funds performance suffers.)
Corporate bonds and emerging markets bonds – both have their advantages and disadvantages. Having them in your fund adds a little more diversification to your investments and they typically provide slightly higher returns. However, at the same time, they are considered more risky. Essentially, there’s more chance of the odd default or two. Only one of the funds includes these and in both cases the actual amount is low.
How to choose your fund?
Which bond fund you choose will depend on what you prioritise.
For what its worth, my take on it goes like this. If you are worried about inflation and want to priortize protection against that then iShares Global Inflation Linked Govt Bond UCITS ETF is probably a good choice.
But if you want to prioritise credit quality or you’d prefer not to have your investments heavily weighted to the US then iShares Global AAA-AA Govt Bond UCITS ETF could be just the ticket.
Then again, if you want to diversify as much as possible or perhaps keeping fees to a minimum is your priority then iShares Core Global Aggregate Bond UCITS ETF might make sense for you.
And no doubt there are plenty of other reasons for choosing one over the other, but its my guess, that most investors over the long term will be served equally well with any of these options.
How do I divide between stocks and bonds?
The only question then becomes. How much of your money should you put in a bond fund when compared to your equity fund.
This is a big question which you can read more about here if you are interested. But in short, it pays to do you due diligence.
That said as time goes on I like the 4% rule more and more. It says you should have 4% of your portfolio in equities for every year you invest. The rest of your money should be put in bonds.
So if you were investing for 10 years you’d have 40% of your money in equities and the rest in bonds. Alternatively, if you were to invest for 2 years you’d have 8% of your money in equities and the rest in bonds.
And in fact you can tweak this to match your own temperament. If you are risk averse then swapping 4 with 3 could be a good decision. Investing for 10 years would drop your equity allocation to 30% with this approach. Maybe you won’t make quite as high a returns if the market continues its upward trend, but you’d be better protected in a bear market or market crash.