Friday, January 04, 2013

Bond Bubble Burst

This could be yet another disaster for ordinary savers thanks to our dysfunctional financial services industry.

This morning I read a newsletter from a respected firm of pension solicitors highlighting 10 key issues for 2013.

Number 8 was to beware of a possible "bond bubble". The concern is that bond prices (government loans called gilts or other traded loans to companies) are so over priced that soon there will be a "crash". Gilt yields (due to high prices) are currently at a 200 year low.

If this happens then the value of personal pensions for many people approaching retirement who will tend to have most of their money invested in bonds will be devastating.

It's complicated because a fall in gilt prices should mean an improvement in annuity rates (the amount of money you will actually get each year if you retire on a personal pension) and will also help out defined benefit schemes. But there is no doubt that if you are in a standard "lifestyle" personal pension plan (which most people in "normal" times should be in) then in the 5 years before your retirement most of your money will be moved away from long term savings in equities and into bonds and cash. A predicted 40% crash in bonds would be a disaster.

As always, wealthy or financially sophisticated investors will avoid the risk. Joe Public will not. This is another reason why individual defined contribution (or defined ambition) schemes are not the answer to the pension problem in this country.

With individual defined contribution schemes (personal pensions in all their shapes and sizes) ordinary individual savers have to take all the risk over their pension fund asset allocation and investment strategy. That is not their job. That is not what they are good at in life. Their funds are usually far too small to be able to afford the expert and ongoing advice needed.

While most trust based collective defined contribution schemes can afford this advice and will hopefully will put in place measures to protect members I cannot see how they will be able to fully protect those about to retire if bond prices collapse. The "market" is not the answer to everything.

The answer is of course decent modern defined benefits schemes for all.
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