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Are bonds a good investment in 2021?

Given current economic conditions, are bonds a good investment right now? The dilemma was summed up by one Monevator reader like this:

“I’m led to believe that current bond returns are likely very poor, and they could quite conceivably crash too with interest rate rises. So, are they a good idea to have in a 2021 portfolio?”

I believe bonds are a good investment still, and the following thought experiment helps illustrate why.

Imagine you’re 100% in equities with a portfolio of £200,000. The economy takes a dark turn, and the stock market falls 25%.

Your all-stock portfolio is now worth £150,000.

It’s a blow but you can handle it. You’ve seen bear markets before and recovery soon follows.

But the market doesn’t recover; it falls another 35%.

Your portfolio is now worth £97,500.

And the economic news is dreadful. Everyone thinks worse is to come. Your plans have been set back years.

Meanwhile your job is at risk. Your industry is convulsing. Waves of redundancy sweep through your firm. You could be next.

An economic depression looms. Your portfolio is your family’s lifeline.

So you panic. You sell. Now your portfolio really is worth £97,500.

The loss is locked-in. It’s real.

Avoiding that is why you own bonds.

Are bonds a good investment? Depends how you judge them…

Bonds are a good investment mainly because they’re a shock absorber that can stop you hitting the panic button.

We all know that equity declines can inflict savage losses on a portfolio.

The UK stock market fell 72% from 1972 to 1974. Some 57% was wiped off US stocks from 2007 to 2009. And near-90% was erased from the Dow Jones during the Great Depression.

Few of us really know how we’ll react, though. A crisis feels like a crisis because we can’t see the bottom of it.

The overriding point of government bonds is to protect you from the urge to panic.

The reason minimal-risk bonds can do that is encapsulated in the phrase: the flight-to-quality.

When the economy implodes, a money-tsunami flows out of equities and into government bonds.

Investors assume that, when the smoke clears, bond-issuing countries like the UK and the US will still be standing and paying their bills – even if their companies are in dire straits.

That time(s) when bonds saved the day

We can see evidence of the flight-to-quality at the low point of many historical downturns.

When the dotcom bubble burst, gilts gained 14% from 2000 to 2002 as UK equities sank 41%.1

In the following additional case studies, ETF returns data and charts come from the portfolio-building service JustETF. The blue line is UK government bonds and the red line is world equities.

Coronavirus crash 2020

Gilt performance during the coronavirus crash

The developed world stock market (represented by iShares MSCI World ETF) fell -26% by 23 March 2020.

UK government bonds (represented by iShares Core UK Gilts ETF) rose 4% by the same date, as investors bailed on equities and took refuge in bonds.

Global Financial Crisis 2008-09

Bond performance during the global financial crisis

The World ETF crashed -37% by 6 March 2009. Gilts softened the blow by moving 14% in the opposite direction.

European Sovereign Debt Crisis 2010

Bond performance chart during the European Sovereign Debt Crisis

Equities slumped -15% but UK gilts were up 5% by 2 July 2010 and 9% by 31 August.

Global Stock Market Downturn 2018

Bond performance during the 2018 stock market downturn

World equities delivered a lump of coal on Christmas Eve 2018 as they slid 16%. Christmas cheer came from gilts – up over 1%, and near 5% in March.

August Stock Market Downturn 2011

Bond performance during the August 2011 downturn

Equities dropped 19% while gilts countered with a 5% gain by 19 August 2011 and 11% by 29 November.

Guilty pleasures

Time and again we can see the flight-to-quality effect, as investors sell off equities and flee into government bonds.

Gilts have improved portfolio returns – thereby suppressing the panic reflex – in the majority of UK downturns for over a century.

They don’t work every time (and we’ve talked before on what improves your chances) but the fact is high-quality government bonds usually limit the damage when equities plunge.

Other assets don’t come close. Not emerging markets, tech stocks, infrastructure, dividend aristocrats, commodities, property, cash, corporate bonds, gold, bitcoin, or even index-linked bonds.

A diversified equity portfolio does not help in a crisis.

Stock markets buckle like carriages in a train crash in a globally interdependent economy. You can see this using any stock market charting tool.

You’re not diversified if your holdings all behave the same in adversity.

That’s why true diversification means spreading your bets across asset classes, rather than just among the many shades of equity.

One last time: high-quality (developed world) conventional (not index-linked) government bonds are the best asset class to own when recession hits.

For UK investors that means including gilts or a global government bond fund hedged to the pound when choosing your asset allocation.

Expected bond returns

It’s true the outlook for bonds is poor.

The expected return of your bond fund is its current yield-to-maturity (YTM).

To take one example: the YTM of the SPDR UK Gilt ETF is 0.85% as I write.

Subtract 2% for inflation and an intermediate gilt fund is liable to return a small loss in real terms2 for the foreseeable.

The historical real return of UK government bonds is around 1.4% a year, so it may seem unacceptable to lose, say, 1% per year now.

But that nick is much more acceptable set against the risk of locking-in a double-digit loss during a stock market panic.

Call it an insurance payment.

Bond market crash

What are the chances bonds could inflict a more grievous loss?

  • When market interest rates fall your bonds make a capital gain.
  • But when market interest rates rise, your existing bonds take a capital loss.

The fear of a bond market crash resonates because interest rates are lower than my chances of winning Olympic Gold on an all-chips diet.

Pundits predict the only way is up for rates. That implies capital losses for bonds.

There’s two important things to know, however.

1. Pundits have been predicting a bond market crash for over a decade.

Stopped clocks may strike it lucky but financial markets can defy received wisdom for decades – and indefinitely after a so-called ‘regime change’.

There’s no law that says interest rates must return to the old normal. Indeed there is evidence that rates are in secular decline. And there’s plenty of runway yet for negative yield bonds.

2. Bond market crashes are a mild after-dinner burp in comparison to the Krakatoa-esque implosions of the stock market.

Compare these two charts showing 120 years of UK equities and gilt returns from the Barclays Equity Gilt Study 2020.

Distribution of annual UK equity returnsEquity returns are dispersed like a shotgun blast: anywhere from over -50% to over 60%. Note the frequency of corrections (-10%) and bear markets (-20%). Major slumps occur regularly.

Distribution of annual gilt returnsGilt returns are overwhelmingly distributed between -6% to 6%. There are only three annual losses greater than 20%.

Point being the outlier bond crashes marked on the agony-to-ecstasy chart above do not match the equity market’s extremes.

Gilt bear markets and corrections happen much less often than more familiar equity woes.

The worst return for gilts was -33% in 1916 amid the bloodbaths of World War One. That’s grim but still, the stock market would sniff “Hold my Beer”.

Note too, the worst three negative results are amplified because the bonds being measured were undated (1916 and 1920) and 20-year long (1974) bonds.

The longer your bond takes to mature, the more vulnerable it is to inflation.

Rampant inflation hammered all bonds during these periods. But the results look especially horrendous if you track the long varieties, or worse, undated bonds that never mature.

In today’s environment, you can lower risk by using intermediate or short duration bonds. They will react much less violently to interest rate rises.

The worst annual loss since Barclays began tracking 15-year gilts is -14% in 1994.

Not all bonds are alike

Outcomes can vary dramatically depending on the average maturity date of your bonds. The farther away the maturity date (that is, the ‘longer’ the bonds), the harder they could fall (all things being equal).

Bond funds use a metric called duration that indicates how they’ll perform if interest rates rise or fall 1%.

For example:

  • A bond with a duration of seven years will lose around 7% of its market value for every 1% rise in its interest rate.
  • A bond’s price will similarly shoot up by about 7% if its rate falls by 1%.

Whatever your bond’s duration number, that’s how big a gain or loss you can expect for every 1% change in interest rates.

You can control your exposure to downside risk by choosing a bond fund with a lower duration.

For example, SPDR ETFs offer short, intermediate and long gilt funds with very different durations:

Bond fund type Bond fund name Duration
Short SPDR UK 1-5 Year Gilt (GLTS) 3
Intermediate SPDR UK Gilt (GLTY) 13
Long SPDR UK 15+ Year Gilt (GLTL) 21

Source: SPDR

Imagine interest rates rose by 1%. With these funds, you’d brush off the 3% loss inflicted on the short-dated GLTS much more readily than the -21% gouge out of GLTL’s long bonds.

On the flipside, eagle-eyed readers will pounce on the fact that if interest rates drop 1% during a recession, you’d gain 21% from GLTL versus a limpwristed 3% hoist from GLTS.

That’s the Damoclean choice we make:

  • Short bonds are more resistant to rising interest rates but they offer less stock market crash protection.
  • Long bonds can inflict equity-like losses if interest rates hike significantly, and equity-like gains if rates drop a percentage point or two.

Thankfully, intermediate bond funds offer a third way. They blend bonds across the maturity spectrum into a single fun-pack.

Remember too that rising interest rates mean higher future yields for bond investors as your fund manager sells off the old and buys the new. If your interest payments are being reinvested then they’ll buy new bonds at cheaper prices than before the rate rise.

The maths shows that a bond fund will eventually recover its initial capital loss and end up ahead due to a rate rise.

The duration metric reveals how many years that will take (approximately).

For example, a duration 7 fund will breakeven around seven years after the rise.

Note: I’ve had to simplify some of the above for sanity’s sake. Use duration as a rule-of-thumb rather than a written guarantee from the Queen.

Interest rates are forever fluctuating, and this doesn’t affect all bonds evenly at the same time.

See our previous deep-dive into how bond prices react to interest rate changes for more (and check out the appendix below this piece).

If you’re especially keen, you can also glean interesting information on how rapidly interest rates can change in the modern era from Monevator reader and professional bond manager ZXSpectrum48K.

Good bond investments

Choose low-cost index trackers that hold gilts, or high-quality global government bonds (developed world) hedged to the pound.

Hedging to the pound negates exposure to currency risk, which would otherwise add volatility to your defensive allocation.

A total bond market fund that includes high-quality corporate bonds is okay. It’s likely to perform worse than straight government bonds in a recession though.

Accumulators

Think intermediate bond funds. Long bonds could mean a world of pain and short bonds barely spike in a recession.

An intermediate bond buffer should leave you with plenty of dry powder to buy cheap equities during the next crash.

A 5% to 10% slug in cash and gold further diversifies your defences in a downturn.

Some people hold no bonds in favour of cash. But cash won’t counter-rise in a crash. Cash yields are also currently negative, after-inflation. Some cash is fine but don’t go crazy.

Similarly, don’t go overboard on gold. It’s performed very well during the last two crises but its long-term track record is patchy. Gold is like a funny drunk – erratic and highly unreliable, but occasionally brilliant.

For good inflation protection you can put about half your bond allocation into index linked bonds. This is the best asset class to defend against runaway inflation. However it doesn’t do much during standard recessions.

The young and new to investing assume they’ll be fine with 100% equities, but that isn’t necessarily true. Some people just can’t stand losing money.

Read this piece on estimating your risk tolerance to know thyself.

Decumulators

There aren’t good alternatives to bonds for those spending down a portfolio. The same forces that previously boosted their portfolios now leave decumulators bereft of defensive assets that can generate a return.

It’s best to suck it up. Think of bonds as an insurance policy and thank your lucky stars for the bull markets that got you this far.

Given elevated stock market valuations, now isn’t the time to ramp up portfolio risk, though it’s a tricky balancing decision.

Personally I’m holding no more than 40% of my portfolio in cash and bonds, in this climate. But at the same time I’m not deluding myself that I’d be safer by going more overboard on shares, either.

Bonds help you manage your cashflow. Short bonds are for near-term bill-paying needs. Intermediate and index-linked bonds help create an all-weather portfolio that should see you through the decades ahead.

What if someone pushes you a product that supposedly has the defensive capabilities of government bonds based on their proprietary back-testing?

Well, they’re probably trying to sell you something, aren’t they?

If you’re tempted to reach for yield then read the wise words of Warren Buffett. (He thinks it’s a bad idea.)

High-yield bonds, low volatility equities, and dividend aristocrats offer the mirage of a circle squared – but they belong in your risky asset bucket.

Are bonds a good investment? The short answer

In a crash situation, bonds can be priceless because they can cushion the losses that turn a crisis into a full-blown panic.

Yes, conventional bonds are vulnerable to an escalation in interest rates, especially if the economy overheats.

That’s ‘if’.

Equities are vulnerable to a massive stock market crash.

That’s a matter of when.

Take it steady,

The Accumulator

P.S. The lived experience of others can help us imagine the unimaginable. The Great Depression: A Diary is a contemporary account of an economic cataclysm that scarred a generation. I had a new respect for bonds after I read this book. Bonds kept people afloat as their equity positions disintegrated.

Bonus appendix: Bond market interest rates

‘Interest rates’ in the context of bonds does not refer to the central bank interest rates we’re used to.

Instead, we’re talking about the interest rates that apply on the bond market.

Each and every bond is subject to its own interest rate that’s a function of its supply and demand.

This ‘market’ interest rate is the return investors require to invest in that bond.

Bond interest rates fluctuate constantly as the market’s view adjusts in line with new economic data including inflation, the bond’s credit rating and maturity date, and – yes, those all pervasive central bank interest rates.

It’s an incredibly deep and liquid market. Are bonds a good investment in 2021? As ever think very hard before deciding you know better than the sum of the world’s investors!

  1. Annual data from Barclays Gilt Equity Study 2020. []
  2. That is, inflation-adjusted. []
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Weekend reading logo

Whisper it, but it does seem like the long shadow of Covid may at last be retreating in the UK.

That’s not the case for the whole world. Countries like India are feeling the full force of what some in Britain still march and vote to deny. Average global cases recently sustained a new peak of 800,000 a day.

But thanks to our long (and, yes, damaging) lockdown, high vaccination rates, and the immunological protection granted by previous infection, the UK appears to be leaving the tunnel we entered back in February 2020.

Now, as we blink back into a world of hugging and hubbub, we’ll finally find out what has changed and what has not.

Just like starting over

At the start of Corona-crisis, there was talk that Covid would kill off the quest for financial independence.

Even some esteemed contributors to Monevator’s comment section rushed to dance on the grave of the FIRE1 movement.

That was crazily premature, and proved that no matter how often you show someone a graph of the stock market going down and then going up again, they’ll struggle in a crash to grok it.

Fourteen months on, and it seems more middle-aged people in US than ever are pushing to retire earlier after their Covid experiences.

Booming US stock markets have to be part of that story. But as Bloomberg (via MSN) reported this week, life re-evaluation is also in the mix:

About 2.7 million Americans age 55 or older are contemplating retirement years earlier than they’d imagined because of the pandemic, government data show. […]

Financial advisers say they’re seeing a new “life-is-short” attitude among clients with enough money socked away to carry them through retirement.

The prospect of going back to the daily grind is going to be “a really tough pill for a lot of people to swallow,” said Kenneth Van Leeuwen, founder of financial services firm Van Leeuwen & Co. in Princeton, New Jersey.

One of Van Leeuwen’s clients, an executive whose portfolio has soared, is retiring at 48. After the past year, the prospect of going back to traveling 10-12 nights a month just isn’t appealing anymore.

Many people have had a hard reset. Now we’ll see how we reboot.

Back to life, back to reality

Anyone wavering about whether to retire or not could do worse than read Debt-Free Doctor’s summary this week of Bill Perkin’s Die With Zero.

I’ve been around this block more than few times. The concept of doing more, spending mindfully, and working less is hardly novel.

But I was still struck by the force of Debt-Free Doctor’s recap:

…if you spend hours of your life acquiring money and then die without spending all of it, then you’ve needlessly wasted too many precious hours of your life. There’s no way to get those hours back.

If you die with $1 million left, that’s $1 million of experiences you did NOT have.

I’ve added Die with Zero to my reading list. If anyone has read it let us know your thoughts below.

Turn! Turn! Turn!

As you get older, these decisions take on a less theoretical hue.

Indeed I was also struck this week by a blog post by one of the team at Bunker Riley about a teenage skateboarding hero of mine.

It seems veteran skater Tony Hawk has done his last ‘ollie 540’ – a signature trick with a very high wipeout-to-glory ratio.

Hawk explained:

They’ve gotten scarier in recent years, as the landing commitment can be risky if your feet aren’t in the right places. And my willingness to slam unexpectedly into the flat bottom has waned greatly over the last decade.

So today I decided to do it one more time… and never again.”

When age – and risk versus reward – starts catching up with your childhood idols, these questions no longer feel quite so academic.

I can see clearly now

What will you do in the months and years following the great reopening?

Will you retire early? Move to the countryside?

Or move back, because rural life proved to be a Covid fad with all the staying power of a Tamagotchi?

Of course if you’re younger – or poorer – some of these choices remain theoretical.

You might have decided the pandemic has shown you the rat race is a total kabuki show, but you’re 25 and £20,000 in debt. FIRE isn’t for you for a long time yet.

But at the risk of sounding too happy-clappy, that doesn’t mean there isn’t a spiritual Covid dividend for you, too.

It takes most people several decades – and a few funerals or a health scare – to really understand that life is precious and nothing is given to us.

If Covid has taught you how precarious normality can be in your 20s, then you’re ahead of the game. Even if you’re behind in your bank account.

Personally I’d suggest looking for a more fulfilling career than going full-tilt on extreme frugality for an early and potentially under-funded retirement. But my co-blogger The Accumulator might disagree, so there’s definitely two sides.

One thing working in your favour if you’re young: companies may be desperate for talent as the economy takes off.

The venture capitalist Hunter Walk believes we’re on the cusp of a ‘Great Talent Reshuffling’ as the psychological after-effects of Covid ripple through society, with younger workers looking for more meaning and older workers abandoning ship to find meaning elsewhere.

It could be the greatest economy-wide game of musical chairs we’ve ever seen, outside of the wartime.

Are you ready to dance?

[continue reading…]

  1. Financial Independence Retire Early []
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Never ever respond to a cold call

Photo of a cold call taking place

Whenever you receive a cold call, an unsolicited marketing email, or an offer from a company you’ve never done business with – hang up, delete it, or throw it in the bin.

This strategy will save you from the majority of frauds. It will also improve your life.

I’m sorry if your job is to cold call strangers to tell them about genuine investment opportunities. Or charity drives. Or alumni fund raises.

These things do exist.

But life is simpler and safer if you presume they don’t.

Just hang up.

Cold call as ice

As an on/off fan of Radio 4’s Moneybox over the years, I’ve heard about far more scams, frauds, hucksterism, and shysters than I’ve seen in real-life.

And most – close to all – the schemes that undo the victims start with a cold call. Or a knock at the door. Very occasionally a supposedly random meeting (say with a timeshare pitch at a holiday resort).

Here’s a typical example from Which?:

Member Robert lost £65,000 to fraudsters claiming to represent a firm called TD Global Finance in July 2020.

‘A man phoned and said he was from TD Global. He rattled off a shortlist of familiar-sounding firms and offered to send me an email and prospectus. He said he’d call again in a week, which put me at ease, as scammers try to rush you. The email linked to a professional website. I checked the FCA register and saw TD Global is regulated.’

Robert later discovered that the very convincing website – tdglobalfinance. co. uk – was a clone. Unhelpfully, the real company has no website listed on the FCA register so nothing seemed awry when he checked this.

Robert ended up transferring money in batches, both over the telephone and at his local Halifax branch. He was taken through security in a private room at the bank, during which he explained he was investing in TD Global and showed staff the ‘invoice’ he had been sent.

He was handed a scams pamphlet and warned about cold calls, but no alarms were raised. An FCA warning about a clone of TD Global Finance appeared shortly after the final transfer to the fraudsters.

Horrified, he immediately told the police and his bank. Halifax returned £30,000 but refused to reimburse the rest, stating that Robert had ‘failed to make sufficient checks’ before investing.

Which?, 28 April 2021

Why would anyone respond to a cold call when there are dozens of legitimate investing platforms a mouse click away?

Why would someone think they were being pitched an incredible investment opportunity by a total stranger?

Funky cold calling Medina

It’s easy to mock or despair at such victims.

But firstly, let’s remember they are just that – victims. They’ve been done over by crooks who prey on the better aspects of our nature, such as trust. Victims deserve our sympathy.

Also, scams happen so often there’s obviously something else going on.

Sure, many of the victims are in the vulnerable elder who is out of their depth category. People who rip them off are morally bankrupt pond detritus. (They should really be working in the City – badoom tish!)

But I’ve noticed many of the victims that we hear about seem to be retired company directors or other high-flyers.

Partly that’s because they have the money to steal, no doubt.

Also director details have long been trivially harvested from Companies House.

But I suspect it’s also because in their professional life such people were used to being pitched by suppliers, vendors, and other industry sorts.

So a cold call for them doesn’t trigger the alarm bells that it would for me.

(In my case, picture a klaxon wailing and blue and red lights flashing in an underground bunker at the merest hint of a butt-dial.)

Smart and accomplished people can be prone to over-confidence, too. They may even be experienced in evaluating investments and other opportunities.

But such experience counts for nowt when you’re assessing a scam as if it’s legitimate.

Brains isn’t enough to avoid scams. One recent survey found that 62% of investment fraud victims had a four-year or longer college education.

And blowing the ‘poor grannie’ stereotype out of the water – at least when it comes to the targets of investment scammers – 81% were male. Men have a proven tendency to be over-confident compared to women.

That same survey also found nearly 60% of the victims received at least one investment cold call a month.

Is it any wonder that eventually a scammer got through?

Baby it’s a cold call outside

You might still be thinking that you can tell a fraud from a legitimate pitch.

Or that you’ll know a boiler room con or a scripted scam when you hear it.

Maybe you work for the police or MI5, or you’re a fraudster who can sniff out a fraudster.

Maybe you’re great at reading poker bluffs.

So sure, maybe you can tell a dodgy cold call from a real sales approach.

I like to think I could, too.

But why bother? What’s in it for you or me?

I’m an investing junkie who has read countless money and investing books.

I can’t remember a single one where a person got rich because someone cold called them on Saturday afternoon to take up five minutes of their (oh they understand!) precious time.

Don’t bother. Hang up on as soon as you know you don’t know them.

Thank you! Goodbye. Hang up.

That’s it.

If this isn’t already your policy when you get a cold call then this might just be the most valuable article you’ll ever read on Monevator.

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Vanguard LifeStrategy funds review

Vanguard LifeStrategy portfolio diversification in cartoon form

The Vanguard LifeStrategy funds are ideal for anyone who wants to invest their money but not a huge amount of their time.

These funds are straightforward, effective, and do not demand a great deal of investing knowledge or DIY management.

If you think that sounds too good to be true – or that the trade-off must be these funds are sub-standard – then you’re dead wrong.

The truth about investing is you can achieve life-changing results just by getting the basics right:

  • Diversify across the global equity markets.
  • Mix your risky equities with high-quality bonds for additional diversification.
  • Choose a low-cost fund so your money fattens your bank balance not some fund manager’s.
  • Use a passive investing strategy that offers a great balance of results, simplicity, and best practice.

The Vanguard LifeStrategy funds answer this need and while they have been imitated, they are yet to be bettered as a one-stop solution.

Who are Vanguard LifeStrategy funds for?

Vanguard LifeStrategy funds are for inevestors who need to invest their money to achieve a major financial objective like retirement, financial independence, or sending the kids to Uni in a decade or two.

Cash earns pitiful rates, and the State Pension is not enough to live on, so most people realise they must invest to safeguard their financial future.

Most people also don’t know where to start. And they can’t afford to pay or trust a financial advisor to do it on their behalf.

That’s the gap in the market the LifeStrategy funds fill – along with sister product the Vanguard Target Retirement funds.

We should also point out that Vanguard didn’t pay us to say these nice things.

We write about these funds because our passion is helping others to look after their investments.

The LifeStrategy funds are one of the best ways to do that.

Who is Vanguard?

Vanguard has grown to become one of the biggest asset managers in the world. It is famous for index funds and driving down investment costs on behalf of consumers.

Vanguard was founded in 1975 by the late John Bogle. Bogle was a visionary on a mission to offer a better deal to investors and disrupt the fund industry.

It took decades but Bogle ultimately won the argument. Vanguard’s success forced competitors to respond with their own ranges of cheap index funds and ETFs.

Vanguard repeated the trick when it arrived in the UK from the US in 2009.

UK investors have enjoyed a cheaper and wider range of investment products ever since, and index tracking funds continue to take market share from the traditional fund industry.

How to choose your Vanguard LifeStrategy fund

The best thing about Vanguard LifeStrategy funds is you don’t need to spend much time building a complicated portfolio with lots of moving parts.

You can pick one fund and you’re done because they’re diversified across thousands of shares (aka equities) plus government bonds to boot.

You can then automate your investing using a monthly direct debit and leave the fund alone while your wealth compounds.

Still, there are five LifeStrategy funds in the range. How do you pick one?

The funds differ by their allocation to global stock markets.

At one end is LifeStrategy 100%, which is purely invested in equities.

LifeStrategy 20%, at the other end, is 20% allocated to equities, with the rest in bonds.

Your fund choice depends on your attitude to risk and need for growth. (More on that below).

Here’s the full LifeStrategy range, and the all-important equity/bond split:

Fund name Equity allocation Bond allocation
LifeStrategy 20% Equity Fund 20% 80%
LifeStrategy 40% Equity Fund 40% 60%
LifeStrategy 60% Equity Fund 60% 40%
LifeStrategy 80% Equity Fund 80% 20%
LifeStrategy 100% Equity Fund 100% 0%

Each fund’s equity allocation is an indicator of its risk vs reward trade-off.

  • An aggressive investor prepared to bear much stock-market-related pain might pick the LifeStrategy 80% Equity Fund in the pursuit of higher expected returns over time.
  • A more cautious person would pick LifeStrategy 40%. Most of their assets would be in less volatile bonds. They would accept lower expected returns as a consequence.

The financial advice industry uses metrics such as risk tolerance to help people understand how much risk they can take.

It’s best to choose a fund that aligns with your risk tolerance. Even seasoned investors can find stock market crashes very hard to handle.

Risky business

Ideally you’d know your risk tolerance and create an investment plan based on your personal circumstances.

Realistically, many people can’t find the time, or discover it’d be easier to nail jelly to a wall.

Some substitute rules of thumb for a proper plan, just to get started.

It’s all too easy to lose years, even decades, to inertia. I know because that happened to me – though you can turn it around.

One of the best known rules of thumb suggests you choose your equity allocation like this:

110 minus your age = your equity holding

You can then round up or down to the nearest Vanguard LifeStrategy fund.

Potentially you can even blend Vanguard LifeStrategy funds so that your equity allocation is 50% or 70% or whatever you prefer.

The rule of thumb above assumes that young people can afford to take more risk than older investors.

That’s because young ‘uns have more working years to recover from a stock market crash. And they’ve less wealth on the line in the first place.

While that’s broadly true, investing features more exceptions than English grammar. Read up about risk tolerance to gain a deeper perspective.

If that’s too much then know that the industry default position is a 60:40 equity:bond asset allocation. That equates to the LifeStrategy 60% fund.

As you close in on your goal, you can mitigate the damage from a stock market crash by transferring from riskier funds into the less volatile LifeStrategy 40% or 20% fund.

It’s definitely time to consider this move once a big financial objective (such as retirement) lies within seven years.

Best way to buy Vanguard LifeStrategy funds

You can buy and sell Vanguard LifeStrategy funds through Vanguard or through other financial platforms. See our broker comparison table.

Currently, investing directly with Vanguard is the cheapest option if you’re just starting out:

Investing in a Stocks and Shares ISA

  • Use Vanguard if your fund portfolio is worth less than around £40,000.
  • Check out Lloyds Bank Share Dealing if your fund portfolio is worth more than £40,000.

Investing in a SIPP

  • Use Vanguard if your fund portfolio is worth less than around £170,000.
  • Check out Halifax / Bank Of Scotland Share Dealing if your fund portfolio is worth more than £170,000.

Choose your platform, set up a direct debit, and then employ your platform’s regular investment tools to automate your investing.

Vanguard LifeStrategy: performance

As a passive investing product, Vanguard’s LifeStrategy funds should deliver profits in line with stock market returns and your bond allocation.

Over the last ten years, you’d have been very happy with this choice.

However I’m not including any performance charts in this piece for one good reason. Performance charts are a bad way to choose between funds.

That is a hard fact for new (and indeed old) investors to accept. But it is true:

  • You do not have the ability to predict which investments will outperform in the future.
  • Past performance charts do not contain predictive data. This is clearly stated in any fund literature you care to read.
  • You can pay someone else to predict the future but they will probably either overestimate their ability, or charge you so dearly for the privilege that you’re actually worse off.
  • In many cases they will overestimate their ability and charge you dearly. This will eat up your profits.

Passive investing products have surged in popularity over the past decade because the evidence is overwhelming that most people are better off with a passive strategy.

The following three articles are our best attempts to explain why you should dismiss past performance as a variable, and also be wary of anyone’s claims about investing skill:

Though past fund performance is not relevant, historic asset class returns do matter.

You can expect a highly-diversified portfolio of equities to outperform bonds and bonds to outperform cash over the long term, because otherwise investors would not invest in riskier assets.

Equity returns are your reward for taking the risk that for some years – even decades in extreme cases – equities underperform bonds and cash.

Vanguard LifeStrategy: the good

You get a low-cost, globally diversified, passive investment product in one simple package. It’s an off-the-shelf portfolio that’s extremely low maintenance.

The Ongoing Charge Figure (OCF) of the Vanguard LifeStrategy range is currently 0.22%.

What does that mean? Essentially, you pay Vanguard £2.20 to manage your fund for every £1,000 worth you own, per year.

That’s highly competitive. You can compare it against other funds by scanning their OCFs.

Some managers refer to the Total Expense Ratio (TER), which is comparable with the OCF. Ignore references to Annual Management Charges (AMCs). These miss important costs and are misleading.

Vanguard automatically rebalances your holdings. This helps control risk and saves you the time and cost of maintaining the portfolio yourself.

Each LifeStrategy fund’s asset allocation is clearly fixed between equities and bonds.

Rival multi-asset funds typically allow asset class exposure to float over a wide range, so you don’t really know what you’re getting.

Vanguard is FCA-authorised. The LifeStrategy funds are UK domiciled, so they benefit from the UK’s FSCS investor compensation scheme.

Vanguard LifeStrategy: the bad

The funds hold more UK equities than investing theory suggests is optimal. This skew is called ‘home bias’ and it exists because people like holding shares in firms from their own country.

The LifeStrategy prospectus states that the UK stock market typically accounts for 25% of each fund’s equity allocation. You’d expect to hold around 4% UK in a global index fund that was free of home bias.

Taken to extremes, this tendency can leave investors under diversified. But Vanguard hasn’t overdone it, so it’s more of wrinkle than a wrankle.

If your fund is more than 60% invested in bonds and cash at any point during its accounting year then its distributions count as interest payments – not as dividends.

Interest payments are taxed at a higher rate than dividends, so beware if you hold LifeStrategy 20% (and potentially LifeStrategy 40%) outside of your ISA and SIPP tax shelters.

Note: This is a general issue with bond fund taxation. It’s not Vanguard-specific.

Vanguard LifeStrategy: the indifferent

LifeStrategy funds do not invest directly in other asset classes like property and commodities.

However, they do hold equities with exposure to these markets (for example, mining companies). And you can always add other asset class funds to your portfolio later by using specialist index trackers.

Multi-asset funds like LifeStrategy work by holding individual funds within a single ‘fund-of-funds’ wrapper. It is slightly cheaper to hold the underlying funds separately; with LifeStrategy you pay a small OCF premium for the convenience of buying in bulk.

That said, your overall costs may still be cheaper with an all-in-one fund as you’re not paying dealing fees for trading and rebalancing multiple funds.

Either way, the time-savings are well worth it.

Alternatives

See how rival funds-of-funds stack up.

Read more on the best global trackers.

The big win

For my money, the best thing about the Vanguard LifeStrategy funds is the convenience at low-cost.

You get an entire portfolio in a one-er and you aren’t sacrificing much of anything to get it.

Investing is about as much fun as slopping out for many people. If that’s you then you could do much worse and by investing in a Vanguard LifeStrategy fund and getting on with your life.

Take it steady,

The Accumulator

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