First Person: Where to save now?

This is the first of a new column by prominent City and economic experts on the key economic issues of our time

By Allister Heath, December 17, 2008

Here is a fact that will keep you awake at night. If you don’t have a traditional, final salary pension, how much do you think you need to save to make sure you maintain your lifestyle in your old age? Most people assume it’s around 10 per cent of their annual income. The answer, however, is nearer to 20 per cent. Truly frightening.

During the boom years, we borrowed too much and put far too little aside; what we did invest we squandered in over-valued buy-to-let properties or dud banking stocks. It is now imperative to make up for the lost time. So what is the best way to build a crunch-busting portfolio?

One option is to ride the gilts bubble, which has been triggered by slumping interest rates (bond prices and their yields are inversely related). Beware, though: with a huge over-supply of gilts in the pipeline as Alistair Darling’s budget deficit explodes, prices will eventually come crashing down.

Equities are a more sensible bet. Shares are, in the main, no longer over-valued. An investment in UK equities of £100 at the start of 1900 would, with dividends reinvested, have grown to over £2.2 million by the end of 2007, a annual return of 9.7 per cent. Long bonds and treasury bills gave lower annualised returns of 5.3 per cent and 5.0 per cent, respectively.

Even after the crash of the past year, the £100 is still worth around £1.5 million, which isn’t bad; and the return still easily beats bonds. Look for robust businesses trading at a discount. Choose high dividend shares. Over the past 108 years, $1 invested in US equities would have grown to $22,745 with dividends reinvested, but to just $239 with capital-gains only. Finally, favour smaller firms: they tend to out-perform their larger rivals.

After the devastation wreaked by the credit crunch, many shell-shocked investors are wondering whether it’s worth bothering. This sentiment is understandable; it is also completely wrong-headed. There’s only one way forward:

forget about your losses, identify a new strategy and give it all you’ve got.

Allister Heath is Editor of City AM

Last updated: 12:24pm, December 17 2008