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Staying safe costlier than living with risk.

Posted: July 21st, 2021, 2:45 pm
by TahiPanasDua
An interesting article in today's FT with the above headline.

A couple of snippets: a simple 60/40 stocks/bonds portfolio underperformed the S&P 500 alone by over 250% cumulatively over the past 25 years. The author claims the cure is worse than the disease often with hidden costs. Interventions against looming market crashes ultimately lead to lower compound returns than those crashes would have cost them. Markets have scared us far more than they have harmed us.

The author makes interesting observations but, to my mind, makes the usual omission of a key determinant in such articles. Our personalities and perception of risk encourage us to find comfort in certain strategies and not others. It is not solely logic. Emotion plays a major part. We are each of us placed somewhere on a continuum from one extreme of fear to the other. As a result we will see merit in different approaches. Is this confirmation bias?

I know these are complex matters and you can probably prove almost anything with selective timing and asset combinations. It seems there are very many possible permutations leading to understandable confusion. Occasionally on this forum we see strategies repeated in mind-boggling detail as though justifying a fact of life. There is no perfect solution though it is only human to want to find one. We only have frequently disconnected past events on which to base a strategy. We have no absolute facts about the future, only probabilities.

For example, I am personally towards one end of the spectrum compared to a friend who inherited a fortune but trawls supermarkets to save pennies and drives second-hand clapped-out bangers. Owning even one share would fill him with terror. Everyone else is somewhere between the extremes and will view and justify investment tactics accordingly.

What I would prefer to see is strategies that openly admit the precarious nature of assumptions about the future and offer a small range of solutions to cater for different personalities.

TP2

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 3:48 pm
by Dod101
I am quite relaxed about being about 90% or more in shares at all times and take very little action in downturns. I am though as I now realise fairly impetuous about the major things in life. I am more likely to fuss about buying a pair of trousers. I am not a great planner and as TPD has implied, I too am amazed at the detail people seem to go into to decide if they can afford to retire for instance and agonise over SWR./

In general markets and economies tend to progress and the only way to tap into that short of the crystal ball is to stay invested. Worked for me so far.

Dod

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 4:03 pm
by Mike4
Dod101 wrote:I am quite relaxed about being about 90% or more in shares at all times and take very little action in downturns. I am though as I now realise fairly impetuous about the major things in life. I am more likely to fuss about buying a pair of trousers. I am not a great planner and as TPD has implied, I too am amazed at the detail people seem to go into to decide if they can afford to retire for instance and agonise over SWR./

In general markets and economies tend to progress and the only way to tap into that short of the crystal ball is to stay invested. Worked for me so far.

Dod


And a slightly different aspect to this effect is how difficult I've found it to make any decisions about in what to invest a lump of cash I have slowly deteriorating in the bank. Years have slipped by as I have tried to fully understand any given option (as is received wisdom), but failed. Eventually I just bought a Vanguard fund to fill up last year's ISA and even that turns out not to be quite what I thought it was, but is has still made me some money, more money (or had last time I looked) than the cash in the bank.

So for me staying safe (by making sure I understand my investments) has been costlier than taking a risk, holding my nose and jumping, so far at least. I think there is a lot to be said for making decisions based on partial understanding rather that waiting until one fully understands and missing out on market shifts, in either direction. Very little seems to be written about this effect.

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 4:07 pm
by EthicsGradient
It's well recognised that if you're invested long enough (and 25 years has been long enough in the past), stocks do better. If you get a sudden load of cash (eg an inheritance), then spreading the investments out a bit could decrease the chance of a market drop right after you've invested it, if you haven't got 25 years before you need it all. And similarly, you wouldn't want to be forced to remove it all right after a sudden drop (eg if you were investing to pay back an interest-only mortgage).

But if you're investing for the long term from excess income, you may as well put it all in stocks from the beginning, and keep it there until you actually spend it. Apart from an emergency fund, which depends on your circumstances (eg likelihood of losing your job and not getting something new at once).

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 4:12 pm
by Urbandreamer
TahiPanasDua wrote:What I would prefer to see is strategies that openly admit the precarious nature of assumptions about the future and offer a small range of solutions to cater for different personalities.

TP2


You do sometimes find such stuff written, but seldom by financial journalists. Journalists seem to like the idea of "one-size-fits-all". Or "the average person" etc.

Although you described attitude, financial education and circumstance play a huge amount.

I for example drive an old banger and search for bargins in the supermarket, yet am happy to have most of my wealth in equities.
Then again, do I? I am fortunate enough to have a small frozen DB pension and should get a full state pension. I predicted my situation out to 67 and worked out what effective percentage that would be, assuming that the income equated to 4% of a nominal capital sum. Near enough 40% of nominal wealth. How many consider the state pension as a bond proxi?

I will confess that I did the calculation after I looked at a 40% paper loss on my portfolio due to covid. Thankfully it got better.

The book "Beyond the 4% rule" is very good at arguing that there are many options/solutions available when pension planning.

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 7:13 pm
by LooseCannon101
Staying safe usually means wealth destruction rather than wealth creation.

The stock markets of the world fluctuate due to greed and fear of both retail and institutional investors.

Investors who can keep their nerve i.e. long-term, buy-and-hold types will reap their reward at the expense of those who listen to market babble.

I would much rather have a relatively volatile portfolio that averages 10% per annum, than a relatively nonvolatile portfolio that averages 5% per annum. A highly diversified portfolio of individually risky assets reduces that risk considerably.

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 7:38 pm
by Dod101
Mike4 wrote:
Dod101 wrote:I am quite relaxed about being about 90% or more in shares at all times and take very little action in downturns. I am though as I now realise fairly impetuous about the major things in life. I am more likely to fuss about buying a pair of trousers. I am not a great planner and as TPD has implied, I too am amazed at the detail people seem to go into to decide if they can afford to retire for instance and agonise over SWR./

In general markets and economies tend to progress and the only way to tap into that short of the crystal ball is to stay invested. Worked for me so far.

Dod


And a slightly different aspect to this effect is how difficult I've found it to make any decisions about in what to invest a lump of cash I have slowly deteriorating in the bank. Years have slipped by as I have tried to fully understand any given option (as is received wisdom), but failed. Eventually I just bought a Vanguard fund to fill up last year's ISA and even that turns out not to be quite what I thought it was, but is has still made me some money, more money (or had last time I looked) than the cash in the bank.

So for me staying safe (by making sure I understand my investments) has been costlier than taking a risk, holding my nose and jumping, so far at least. I think there is a lot to be said for making decisions based on partial understanding rather that waiting until one fully understands and missing out on market shifts, in either direction. Very little seems to be written about this effect.


Yes my dear friend. You worry too much. I think you would be better 'learning on the job' than reading lots of theoretical stuff that academics love. They are academics after all; the stock market is real life.

Dod

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 8:59 pm
by Degsy67
Changing equity to fixed income asset allocation over time is a way to optimise. Risk tolerance changes over time. Returns vs volatility have a time dimension which needs to be considered.

An investor could be 100% invested in equities if they have 25 years or so to go to a key life event (eg, planned FIRE). As they approach this event (eg, on track to meet their own definition of ‘enough’) then risk tolerance can change as you’re reaching a point where you will be intentionally moving from accumulation to decumulation. This may warrant a shift in asset allocation - eg 5 - 10 years out. This would reduce volatility at the expense of potential returns if equities perform well during this time. A decreasing equity glidepath up to the point of FIRE.

Post-FIRE, the most significant risk for decumulation is sequence of returns risk so having a balance (maybe 50/50 or 60/40) equities to fixed income makes sense during this stage. Beyond the 5-10 year mark however, sequence of returns risk is less of a factor and it makes sense for a decumulator to sell out of fixed income and to increase exposure to equities. A rising equity glidepath.

Having an appropriate investment strategy is a combination of determining the correct asset allocation at a point in time, based around personal risk tolerance and the future investment horizon, and then within that asset allocation having one or more strategies which relate to the stocks, funds, sectors, geographies etc etc to invest in. The two topics should be separated out.

Journalists over simplify. They are paid based on word count as opposed to the amount of background research they do and how well they lay out the complexities and options.

Academic research provides interesting insights around what works and what doesn’t work.

An individual needs to determine their own strategy by educating themselves or paying higher fees and placing their trust in someone else to help them through this. I vote for self education over higher fees.

Degsy

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 9:11 pm
by Dod101
Degsy67 wrote:An individual needs to determine their own strategy by educating themselves or paying higher fees and placing their trust in someone else to help them through this. I vote for self education over higher fees.

Degsy


I vote for self education as well but ignore academic studies. On the whole, they are not worth the time of reading them.

Dod

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 9:24 pm
by Degsy67
Dod101 wrote:
Degsy67 wrote:An individual needs to determine their own strategy by educating themselves or paying higher fees and placing their trust in someone else to help them through this. I vote for self education over higher fees.

Degsy


I vote for self education as well but ignore academic studies. On the whole, they are not worth the time of reading them.

Dod


I beg to differ but I appreciate your perspective. They have to be read in context and conclusions need to be carefully considered. Credible academic studies published in reputable journals add to the body of knowledge available to investors. No one paper has the answers but I have usually been able to take a little bit of knowledge from every paper I’ve focused on, even if I come away concluding that the paper was over simplistic and reached conclusions which were not backed up fully or couldn’t be more widely applied. I’ve found them to be a good test of what I’ve learned, what I still need to understand and my own conclusions I’m reaching over time.

There is however a risk of confirmation bias. The counter to that is to go looking for research which deliberately offers the opposite conclusions to the ones you are reaching and then to do similar tests for credibility.

We only get one life (let’s not debate that here!). We have two options: learn from our own experience only or look to add in the experience of others. There is no reset button to go back to the start if we get it wrong. On that basis, I’d prefer to take some input from other sources but carefully test their credibility and conclusions.

But each to their own and everyone needs to find the path that’s right for them.

Degsy

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 10:05 pm
by fisher
Mike4 wrote:And a slightly different aspect to this effect is how difficult I've found it to make any decisions about in what to invest a lump of cash I have slowly deteriorating in the bank. Years have slipped by as I have tried to fully understand any given option (as is received wisdom), but failed. Eventually I just bought a Vanguard fund to fill up last year's ISA and even that turns out not to be quite what I thought it was, but is has still made me some money, more money (or had last time I looked) than the cash in the bank.

So for me staying safe (by making sure I understand my investments) has been costlier than taking a risk, holding my nose and jumping, so far at least. I think there is a lot to be said for making decisions based on partial understanding rather that waiting until one fully understands and missing out on market shifts, in either direction. Very little seems to be written about this effect.


I too find it difficult investing large lumps of cash in one go. I have been investing in equities for over 30 years, but when I came into a lump sum last summer I found it very difficult to decide if it was a good or bad time to invest. I found it easier to split my lump sum into chunks and invest them piecemeal. For me this was some invested immediately but a lot of them drip fed in monthly. As it turns out (so far) I would have been better off investing it all last summer, but I couldn't have known that at the time and I am sticking to my monthly plan. It is often easier to start investing a smallish amount on a regular basis and then increase it as you become more comfortable than it is to commit it all up front.

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 10:51 pm
by Dod101
Degsy67 wrote:
Dod101 wrote:
Degsy67 wrote:An individual needs to determine their own strategy by educating themselves or paying higher fees and placing their trust in someone else to help them through this. I vote for self education over higher fees.

Degsy


I vote for self education as well but ignore academic studies. On the whole, they are not worth the time of reading them.

Dod


I beg to differ but I appreciate your perspective. They have to be read in context and conclusions need to be carefully considered. Credible academic studies published in reputable journals add to the body of knowledge available to investors. No one paper has the answers but I have usually been able to take a little bit of knowledge from every paper I’ve focused on, even if I come away concluding that the paper was over simplistic and reached conclusions which were not backed up fully or couldn’t be more widely applied. I’ve found them to be a good test of what I’ve learned, what I still need to understand and my own conclusions I’m reaching over time.

There is however a risk of confirmation bias. The counter to that is to go looking for research which deliberately offers the opposite conclusions to the ones you are reaching and then to do similar tests for credibility.

We only get one life (let’s not debate that here!). We have two options: learn from our own experience only or look to add in the experience of others. There is no reset button to go back to the start if we get it wrong. On that basis, I’d prefer to take some input from other sources but carefully test their credibility and conclusions.

But each to their own and everyone needs to find the path that’s right for them.

Degsy


We are being generous to each other which is good but overall I think and believe that academic studies are fine on the edge but provide very little where it matters. Experience and actual outcomes are so much better.

Dod

Re: Staying safe costlier than living with risk.

Posted: July 21st, 2021, 11:54 pm
by Steveam
My youth was full of stories of how great uncle Bill had lost everything and that side of the family had lost their business etc. I think I’m scarred by these stories from the depression. Later another side of my (remote) family lost everything to a collapsed currency (Venezuela).

I doubt any/many on these boards had significant wealth and lived through a 50% drop followed by another 50% drop … this happened in the 70’s. I’ve lived and invested through high inflation, the tech crash, the GFC, and now the pandemic but I’m still not sure how I’d react to a slow and grinding scenario with drop after drop after drop and year upon year upon year of losses.

I’m still mostly in equities but have an expensive house and some index linked pensions to fall back on. I’m very aware that disaster can strike (Greece, Venezuela, Lebanon) and see diversification and age (limited life expectancy) and “buffers” as securing my future against the unknown unknowns. (Things change - two of my stalwarts of yesteryear: Shell and HSBC - are very sad).

Best wishes, Steve

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 12:37 am
by dealtn
Degsy67 wrote:Changing equity to fixed income asset allocation over time is a way to optimise.


Well I think you need to defIne "optimise" because on that bald statement I have to disagree.

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 12:56 am
by 1nvest
Steveam wrote:My youth was full of stories of how great uncle Bill had lost everything and that side of the family had lost their business etc. I think I’m scarred by these stories from the depression. Later another side of my (remote) family lost everything to a collapsed currency (Venezuela).

I doubt any/many on these boards had significant wealth and lived through a 50% drop followed by another 50% drop … this happened in the 70’s. I’ve lived and invested through high inflation, the tech crash, the GFC, and now the pandemic but I’m still not sure how I’d react to a slow and grinding scenario with drop after drop after drop and year upon year upon year of losses.

I’m still mostly in equities but have an expensive house and some index linked pensions to fall back on. I’m very aware that disaster can strike (Greece, Venezuela, Lebanon) and see diversification and age (limited life expectancy) and “buffers” as securing my future against the unknown unknowns. (Things change - two of my stalwarts of yesteryear: Shell and HSBC - are very sad).

Best wishes, Steve

January 1969 retiree, applying a 4% SWR. End of 1974 their portfolio value was down to around a third of the inflation adjusted start date value. By the end of 1979 20% remained. 1985 they were broke. Accumulators in contrast added new money (savings) into relatively lower prices, so broadly did well. A factor however is that in some cases cash/bonds can also decline considerably, not really provide any/much protection. Similar worst case outcomes, whilst tending to lower the broader average rewards. Keeping say £20K in bonds so you don't have to sell stocks to unexpectedly pay for a new roof can align where inflation had soared and the new roof cost three times as much when bonds had also halved in real terms via a combination of high inflation, high interest rates, and (uncoincidental) high taxation.

All stock is fine provided you reduce the risks - but that lowers average rewards. Average in over two timepoints, half at year start, half at year end. And into at least two main indexes such as UK and US. And also reduce the SWR, from 4% to 3% for instance, in the average case after a number of years the portfolio will likely have done well enough that you can then raise the amount being drawn. Even then however the portfolio value might at any time halve or more in real terms (be 60% down), at which time some capitulate, or shift some into bonds only to miss out on a subsequent rebound. The popularity of World indexes is somewhat misplaced, as there are many hidden costs involved, such as a broad range of dividend withholding taxes and other costs. It's very important to keep costs and taxes low otherwise you can take on all the risks just to line other peoples pockets with the rewards.

Yes with averaging in there is a greater inclination towards some regret, lower rewards than had you lumped all in from day one. But the difference will tend to be relatively small, whilst de-risking a potentially very bad case outcome.

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 2:15 am
by 1nvest
TahiPanasDua wrote:What I would prefer to see is strategies that openly admit the precarious nature of assumptions about the future and offer a small range of solutions to cater for different personalities.

1. Hard currencies, £, US$, gold, stuffed under a mattress yearly rebalanced back to thirds. Will tend to lag inflation, but in part also offset some of inflation, for instance broadly -1.5% annualised. Drawing a income of 3% SWR might last 27 years before all spent.

2. As above, but with £ and $ deposited to earn interest. More inclined to broadly offset inflation, even marginally exceed it by perhaps 1%. 3% SWR and after 30 years still around a third of the inflation adjusted start date capital value remaining. With recent negative real yields however the number of years or surplus capital values are inclined to be reduced (however in perhaps 5 years time things might have swung around again to see positive real yields that compensate for the recent negative real yield years).

3. Buy a annuity. Might be much the same as 2. maybe even a higher income provided and covering more years (longevity) but where if you die in earlier years there's nowt left for heirs. They are after all collective insurance type products where some relatively lose out, others win.

4. Stock, stock/bond (and maybe gold) blends. Worst cases could be worse than the above, average cases however will tend to average higher benefits, potential for a income that rises ahead of inflation and/or leaving more to heirs, potentially substantially more than the inflation adjusted start date capital value.

There are variations of the above, for instance for 1. a index linked ladder might be constructed/spent. Or mixtures might be employed, start with 60% in 'safe' spending 3 each year for 20 years. 40 in stock accumulation, that over 20 years might have grown at 4.7% annualised real, see 40 grow to 100. Starts with 40/60 stock/bond, ends with 100/0, averages 70/30. Rather than 70/30 constant rebalanced, moving from 40 to 100 stock over 20 years is a form of time averaging, that can work well in a otherwise bad sequence of returns situation.

There are a plethora of other alternatives. SWR provides a regular and consistent inflation adjusted income. Others for instance might opt to spend all/some of dividends, but risk seeing potentially large differences in income from year to year.

Fundamentally a question of who you are investing for. If you have little regard for leaving much for others then you can de-risk your own position via safer/more-reliable choices. If you want to maximise wealth, be one of the richest in the graveyard, then that potential benefit for others involves risk to your own position. Subject to degree of wealth. One of the safest is to be wealthy enough such that a 2% or lower SWR is enough, in which case it matters little how that is invested as the capital will more likely outlive you.

For deposits, treasury/gilts support any amounts deposited being fully insured and are liquid, no early withdrawal blocks or penalties, other than T+3 delay between placing a order and having access to the cash. Other choices such as High Street Bank fixed term/income bonds have default risks or protection limits (£85K), but that tend to pay more in interest in reflection of those risks.

Groucho Marx (Marx Brothers) started with a massive fortune invested in stocks, but transitioned over to just holding treasury bonds in his later life after large losses from stocks. There are many cases of where individual investor would have been better served by simply holding treasuries throughout, bad behaviour/emotion driven changes can be very costly and no matter how investors might think they might react under certain conditions its not until they actually live through such is that tested and often failed. It takes a certain kind to have absolute faith and persist through bad times whilst 'staying the course'.

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 10:47 am
by hiriskpaul
TahiPanasDua wrote:A couple of snippets: a simple 60/40 stocks/bonds portfolio underperformed the S&P 500 alone by over 250% cumulatively over the past 25 years. The author claims the cure is worse than the disease often with hidden costs. Interventions against looming market crashes ultimately lead to lower compound returns than those crashes would have cost them. Markets have scared us far more than they have harmed us.

I have not found the article, but I really don't find these observations particularly illuminating. Take more risk (compensated risk) and you can expect a higher return and most of the time, but not all of the time, that is what will happen.

What would be more interesting, and the article might explore this for all I know, is what proportion of historic 25 year periods did 60/40 beat 100/0? How do the lowest tenth decile performances compare (haven't checked, but strongly suspect 60/40 did much better) How does it look across different developed economies, UK, Japan, etc (to make sure you have not just been lucky in picking the S&P 500)?

60/40 can be expected to underperform 100/0 over any time period, but in the worst case outcomes 60/40 can be expected to be better than 100/0. That is the tradeoff to be made and for some investors 100/0 will be fine, for some 60/40 will be preferable because reducing the tail risk of ending up in the lower decile performance of 100% equities is very important to them. In some cases, eg saving for a deposit on a house over a couple of years, 100% cash might be the preference as that narrows down the target end date.

If someone is wanting to draw an income of around 4% SWR from the portfolio, then going for 100% stocks increases the risk of running out of money compared with 60/40, but increases the expected legacy. So again a tradeoff of risk (running out of money vs more money) and the asset allocation decision hinges on the level of risk the investor is able and willing to take.

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 11:03 am
by tjh290633
1nvest wrote:January 1969 retiree, applying a 4% SWR. End of 1974 their portfolio value was down to around a third of the inflation adjusted start date value. By the end of 1979 20% remained. 1985 they were broke. Accumulators in contrast added new money (savings) into relatively lower prices, so broadly did well.

I have posted this before, but it is a record of my portfolio in the 1970s, when I was an "accumulator".

.        Change    From      Previous Year
. Cost @ Value @ Income
. 31 Dec 31 Dec

Dec-71
Dec-72 -7.25% 8.60% -17.07%
Dec-73 7.25% -20.60% 1.17%
Dec-74 -1.06% -36.61% 24.81%
Dec-75 23.15% 118.96% 3.00%
Dec-76 5.72% 3.00% 22.35%
Dec-77 -32.06% -10.48% 16.57%
Dec-78 8.56% 15.72% -24.94%
Dec-79 11.82% 10.45% 27.23%
Dec-80 23.92% 34.35% 27.17%

You can see the change in value for 1974, but note the increase in income. 1977 was a year when I sold some investements to fund the deposit on our current property. Hence the fall in income during 1978.

Somebody using an SWR might have had problems, while somebody living on Dividends would have fared better, because dividends held up.

TJH

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 11:42 am
by TUK020
tjh290633 wrote:
1nvest wrote:January 1969 retiree, applying a 4% SWR. End of 1974 their portfolio value was down to around a third of the inflation adjusted start date value. By the end of 1979 20% remained. 1985 they were broke. Accumulators in contrast added new money (savings) into relatively lower prices, so broadly did well.

I have posted this before, but it is a record of my portfolio in the 1970s, when I was an "accumulator".

.        Change    From      Previous Year
. Cost @ Value @ Income
. 31 Dec 31 Dec

Dec-71
Dec-72 -7.25% 8.60% -17.07%
Dec-73 7.25% -20.60% 1.17%
Dec-74 -1.06% -36.61% 24.81%
Dec-75 23.15% 118.96% 3.00%
Dec-76 5.72% 3.00% 22.35%
Dec-77 -32.06% -10.48% 16.57%
Dec-78 8.56% 15.72% -24.94%
Dec-79 11.82% 10.45% 27.23%
Dec-80 23.92% 34.35% 27.17%

You can see the change in value for 1974, but note the increase in income. 1977 was a year when I sold some investements to fund the deposit on our current property. Hence the fall in income during 1978.

Somebody using an SWR might have had problems, while somebody living on Dividends would have fared better, because dividends held up.

TJH

Terry,
You and 1nvest are not talking on the same basis, He was discussing inflation adjusted, you have posted nominal figures. Over this period, the difference is considerable
tuk020

Re: Staying safe costlier than living with risk.

Posted: July 22nd, 2021, 11:49 am
by tjh290633
TUK020 wrote:Terry,
You and 1nvest are not talking on the same basis, He was discussing inflation adjusted, you have posted nominal figures. Over this period, the difference is considerable
tuk020

Yes, of course inflation played a part, but the peak in 75-77 would have had less effect around 74, when the RPI was c.7% increase.

TJH