Why starting a pension early could be a mistake
By
MoneyWeek editor-in-chief
Merryn Somerset Webb Sep 12, 2011
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Here's something that you probably didn't know about JG Ballard. Before he hit the big time with Crash and Empire of the Sun, he worked as an advertising copywriter for a small agency in High Holborn.
It turned out that he had a flair for slogans. According to John Baxter in his new biography of Ballard, The Inner Man, when pharmaceutical company Beecham knocked on the door looking for help with an unpromising new product, it was Ballard who provided it. Beecham's product was pure lemon juice, bottled as PLJ. Ballard created a campaign that informed lady magazine readers that lemon would "shrink their stomachs" and make them thin.
It produced incredible results. I don't suppose many women lost weight as a result of drinking neat lemon juice, but sales of the stuff went from £30,000 in 1954 to £1,300,000 in 1959.
Still, while that's amazing enough in itself, the really astonishing thing is that the idea that lemons can somehow help you lose weight endures to this day.
In 2007, readers of one of our tabloids were urged to "lose weight for Christmas with the Lemon Juice Diet". Even now, the internet is covered with news about lemon combined with honey being "an excellent home remedy for obesity".
Last week – only just after I had heard Baxter talking about Ballard and lemons at the Edinburgh Book Festival – I opened one of the Sunday magazines to find a large picture of a lemon, and the news that the best way to kick-start weight loss is with "lemon and hot water in the morning".
My point? First, that Ballard was clearly a great copywriter. And, second, that once an idea takes hold – in particular an idea that promises great results for minimum effort – it never goes away.
In the financial world, there are a couple of equivalents. Most obvious of these is "buy and hold" – the idea that if you want to get rich all you need to do is buy a nice selection of equities and hold on to them for a decade.
This doesn't work. It very obviously doesn't work. If you'd been holding equities for the past ten years, you wouldn't be remotely rich: the FTSE 100 is around the same levels as it was in 2001, and in 1997 for that matter. Sometimes stock markets go up over a ten or 20-year period, sometimes they don't.
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What matters is not so much how long you hold them, but the price you pay when you buy them. Buy cheap equities and hold them, and you should do well. Buy expensive equities and hold them, and mostly you won't.
I had this – and the lemons in mind – when I read a note from Cass Business School this week. Cass points to another idea that is connected to buy and hold, but so entrenched that it seems utterly unchallengeable. Then it says that it is wrong. It is starting a pension early.
We all think that we should start saving into our pensions from the moment our first paycheque hits. But it turns out that if we were "rational life-cycle financial planners", we would wait until we are into our mid-thirties to save.
Everything we do financially should be to maximise our standard of living over our life cycles. In our early career years, when our earnings are low, we compromise our living standards if we save.
So we should consume our initial incomes and then step up savings as we earn more: with the percentage rising from zero before age 35, to 30-35% as we head towards 60.
I like this idea. Partly because it gives a pleasing hindsight justification to my own strategy. But also because it would have made sense over the past decade.
Any 25-year-old who poured cash into a pension at the start would have received little of the benefit of compound real returns that are supposed to be the point of early investing.
However, while it makes sense, it also comes with a problem.
People aged between 35 and 44 are very financially committed (mortgages, children, endless insurances). Given the impact of the new costs of university, it is hard to see how, with children, their 50s will be much easier. On the plus side, if you are in your mid-30s and you haven't started on a pension yet, it might be getting close to a good time in which to do so. A time that might even be one of those good times for buy and hold.
Equities have now fallen so far that you can buy some at a good price: even the usually bearish Dylan Grice of Société Générale is pointing out that European markets are now actually quite cheap. According to the Shiller ten-year average price/earnings ratios, equity markets in Germany and France are at the very low levels they hit in the 1970s and after the crash of 2008.
I imagine they will go even lower before this crisis is over, but now is still a better time than most to think about starting a pension fund.
• This article was first published in the Financial Times.
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Merryn Somerset Webb