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Weekend reading: Costs trump the best asset allocation decisions

Weekend reading

Good reads from around the Web.

Once people get beyond trying to pick stocks and embrace the ‘total investing’ religion, they typically displace their former zeal for buying tinpot miners and tiny tech start-ups into agonizing about their asset allocation.

Should they put 1.3% into gold?

Maybe 7.2% into commercial property?

Or perhaps 7.4% would do better?

This sort of finickity fiddling is a waste of time for passive investors.

Rather, in my view a cheap and simple asset allocation – such as the lazy ETF portfolios – fits the bill for most.

That is not to say that some particular mix of assets won’t turn out to have been the best choice over your lifetime.

While the data from the US suggests that different lazy strategies tend to achieve similar results over the decades (especially once you consider volatility and risk), a percentage point or two of extra growth does make a big difference to how much you end up with, due to compound interest.

However I think it’s hard, if not impossible, to know which strategy will do best in advance, even if you turn to valuation and so forth.

By all means give it a try if you love investing.

It’ll probably be more profitable than trainspotting or crochet.

But don’t feel you have to – that’s my main point.

Far better to focus on keeping your costs low and sticking to your long-term plan, whatever it might be.

Costs count – a lot

I was discussing this with a Monevator reader in the comments the other day.

He had sensibly rejected a hard-charging wealth manager’s expensive investment plan, but he still felt the need to complicate things in order to do a proper DIY replacement job.

Specifically, he started asking how much he should put into private equity and hedge funds…

Now such so-called alternative assets might have a place in the world – though that’s debatable – but any role they do have is hugely undermined by the high fees they charge.

Which is why we preach low-cost investing here on Monevator. It’s very hard for people to grasp the impact of high fees.

Again, a reader was arguing with me recently that we make too big a deal of high fees.

We really don’t. Fees are one area of investing you can control, and as Rick Ferri discusses this week the cheapest funds (usually index funds) have historically done far better than the more expensive ones.

Reducing costs therefore scores very high on the risk versus reward scale.

Cutting your costs delivers a clear and known benefit, compared to the huge unknowns and likely wealth-sapping impact of punting on fund managers or fancy but pricy asset classes, or perhaps even venturing into costlier Smart Beta trackers and the like.

Look at them go

Need more evidence? Then take a look at this very interesting article in the FT this week [Search result], which draws on Mebane Faber’s new book, Global Asset Allocation.

The FT writer John Authers says the book:

“…shows clearly that the gap between the best and worst asset allocation schemes is narrower than the gap between the highest and lowest fees.

In other words, the precise asset allocation model you use is less important than keeping control of fees.”

Authers runs through the returns from several different asset allocation models over the past 40 years, as illustrated by the following graph:


Now, you might be looking at this and thinking you’d like some of the one that went up the most – and less of the laggard!

What was all that guff I just spouted about most allocations achieving roughly the same thing?

Firstly, as I said, it’s easy to see which allocation did best in retrospect. That’s very different knowing what will happen during the next 40 years.

Secondly, some allocations are much more of a rollercoaster ride than others – look at the huge plunge in the winning red line, for example.

If you don’t care about risk at all, then the best bet is to dump all you can into shares for most of your working life and cross your fingers.

You may do terribly (especially if shares crash shortly before you retire) but the odds favour a strong result.

But many people just can’t take the deep dives that come with an all-stock portfolio.

High fees are not the bee’s knees

But anyway, I was talking about fees – and this is where Authers’ second graph is really illustrative.

He notes that a portfolio based on US bond guru Mohamad El-Erian’s portfolio would have performed the best since 1973.

But look what happens when hypothetical fees are taken into account:

Fees eat your returns for breakfast.

Fees eat your returns for breakfast.

The impact of imposing fees is dramatic.

The drag from just a 1.25% annual fee is sufficient to pull the returns from the El-Erian portfolio beneath the return from a simple 60/40 stock/bond split.

It only just edges the worst performing strategy – the lower-returning but very stable Permanent portfolio.

And as for the 2.25% fees…

Now you might say you’d never pay 2.25%, and good for you. But I regularly field comments from readers who say we make too much of high fees.

For these people – and the many who never discover sites like Monevator, or even articles like John Authers’ – a 2.25% fee would sound a bargain to pay in order to get invested with what was the best performing asset allocation strategy of the past 40 years before costs were taking into account.

You see how it works?

Don’t fall for it!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: Pioneering peer-to-peer website Zopa is 10 years old this weekend. The Guardian reviews how Zopa and the other P2P players have fared.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • Investing: Nobody knows anything [Search result]Economist
  • Swedroe: On negative yields from bonds [US inflation-linked government bonds (TIPS) are the focus of this rather technical discussion, but lots of Monevator readers are asking why anyone would ever buy a bond with a negative yield, and Swedroe outlines some of the nuances]ETF.com

Active investing

  • We can’t recreate JP Morgan’s claimed fund returns – Bloomberg
  • 10 UK shares that Warren Buffett should buy – Telegraph
  • Jim Slater on the signals sent by director buys and sells – Telegraph
  • Buffett thought more would spot stocks Vs bonds thoughts [We did]WSJ
  • John Lee: Lessons in value from the rag trade [Search result]FT
  • Don’t sell your winners [Search result]Economist

Other stuff worth reading

  • Banking crackdown sees banks dump loyal customers – Guardian
  • Equity release and pension planning – Guardian
  • How cash beat the FTSE 100 over the past 15 years – ThisIsMoney
  • How soon will your pension run out? – Telegraph
  • The jobs that make you happier than a high salary – ThisIsMoney
  • An interview with Mr Money Mustache – Vox
  • Don’t buy the worst house in the best neighborhood – Quartz

Book of the week: Warren Buffett’s latest annual letter recommended John Bogle’s The Little Book of Commonsense Investing, which sent it soaring up the bestseller lists!

Like these links? Subscribe to get them every week.

  1. Note some FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. []
{ 27 comments… add one }
  • 1 Retirement Investing Today March 7, 2015, 12:50 pm

    Great post (as always) TI. Minimising expenses has been one of the pillars of my approach since 2007. I’m now down to 0.31% across the portfolio which could be further significantly reduced if only I could find a way to escape from my expensive employers pension fund. It’s one of those surreal cases where the fees are ridiculous but my employers match more than compensates for the fees. If only I could have both though.

    The other one that is fully in your control is minimising taxes. Avoid wherever possible I say…

  • 2 Greg March 7, 2015, 1:17 pm

    @RIT There might be a mechanism for transferring _some_ of the money out of the employer’s pension into a SIPP. Simply do this when you build up a large enough sum in the former.

  • 3 Retirement Investing Today March 7, 2015, 1:57 pm

    @Greg. Thanks for the hint. I’ve investigated this and I can’t seem to transfer out while the account is being paid into. I could open a new account and then transfer the old one but my employer doesn’t seem to want to do the admin. I’m still working on it (both pension company and my employer) but I might be forced to wait until I someday leave the company.

  • 4 The Escape Artist March 7, 2015, 1:58 pm

    Fantastic post. Loads of people pay 2.25% of fees a year. So anyone that tells Monevator not to write so much about fees should be put in the stocks at the village fete with a supply of rotten vegetables placed conveniently nearby.

    I know the key message is to focus on minimising fees and I have already implemented that. But I confess I am curious as to what the winning El Erian asset allocation strategy was. I looked at the FT article but it didn’t say anything about the El Erian allocation…or even which of Erian’s books it appeared in?

    Can TI (or anyone else) shed more light on the El Erian allocation?

  • 5 dearieme March 7, 2015, 2:03 pm

    “their former zeal for buying tinpot miners”: how very dare you? It’s gold pot and silver pot miners for me.

  • 6 The Investor March 7, 2015, 2:08 pm

    @TEA — It’s from a book Mohamed El-Erian wrote a few years ago before he was famous outside of bond circles. (He’s only really famous even today in nerdy investor circles!) A quick Google will show you that there’s been various interpretations. It’s very equity heavy, and also has some semi-alternative assets that are likely to do badly/well with equities, such as private equity and hedge funds. So lots of look-through risk, which is likely why it did well long-term but also plunged in 2009.

    Edit: Oops, should have added emerging market heavy. This clearly helped it in the noughties and immediately after the financial crisis. Arguably some hindsight bias in there. (Would people have really thought EMs were so hot in 1973 — and keep in mind they were barely investible to the masses for much of the period covered.)

  • 7 dearieme March 7, 2015, 2:33 pm

    Thank you for the Authers’ link: rather persuasive.

  • 8 Matt March 7, 2015, 6:04 pm

    I take the point on fees, but in terms of portfolio comparisons to say El-Arian’s is better in any way could be misleading to hose who don’t study really very carefully… I mean the date you buy in could have such a huge impact eg. if you bought into El-Arian’s in 2007 you would only have got your money back and nothing more (I suspect he was heavily loaded in commodities in some way).

  • 9 M from There's Value March 7, 2015, 6:34 pm

    Yup, fees are a killer. In terms of rebalancing portfolios though, you could just add new money to underweighted areas rather than sell overweights (why is it that selling always seems to cost more?).

  • 10 Mathmo March 7, 2015, 7:46 pm

    Lovely article, TI, thank-you, and super comparison with the costed/uncosted portfolio. I do worry that we risk group-think: uncritically repeating our beliefs and fall into the same trap as those who are wrong so it is great to see some proper number-crunching. On that — an appeal — I’d like to repeat some of the analyses. Where does one find daily or monthly closing prices for the main indices / asset classes or their suitable predecessors? Schiller publishes some USD ones, but GBP indices I haven’t seen.

    Some great articles linked this week. (I particularly enjoyed Epicurean Dealmaker on Buffet, as you might imagine, and MMM’s quote:

    “Both my life and your life are ridiculously abundant and safe compared to almost every human who has ever lived before you in the history of this planet. If we can’t be happy in this incredible place of privilege, we need to punch ourselves in the face and try again.”),

    but also the expectations article: you *should* hate some of your investment choices. Apposite as I traded one portfolio into its target asset allocation this week, and watched the position move 1.5% against me an hour later. I felt bad. I realise now I should have felt great: I was exposed to the risk I chose.

    One other thought — it’s well worth being skeptical about the 15 year view many of the media put forward (Telegraph on pensions, Mail on FTSE100 vs cash) — that’s one of the worst 15 years in history — so good as a doomsday position, but not what you should expect the next 15 years to look like. Nor indeed what the past 16 years looked like: I’d kill to buy at Dec 1998 prices (5,882). You have to be very very lucky to time the market — for better or for worse. As I said previously: anyone picking Dec 1999 as their base for a general analysis, should be having a quiet word with themselves. The headline for the cash article should read:- “even when it’s as bad as it ever gets for the FTSE100, cash barely outpaces it”. Not so snappy. Natch.

  • 11 MadMonkey March 8, 2015, 12:11 pm

    Hi Guys,

    Need some help. I am from Europe and have some difficulties with my bond/”risk free” allocation as this has now become interest-free risk, thanks to Mr. Draghi. I do not want to allocate to any Southern European bonds either (1,5% for a 10-yr. Italian bond?!?!?). Cash accounts yield 0.5% p.a.

    Any advice? Just equities & cash? Thanks.

  • 12 The Investor March 8, 2015, 2:00 pm

    @MadMonkey — Bonds aren’t put into most long-term portfolios for return, they are put in for risk control:


    As such, you get what you get with them. Remember that according to classic economics, if bond yields are low then equities returns should be lower also.

    I personally have my doubts and think rate tarting around cash accounts is a decent alternative in the current environment, but pure passive investors should probably just hold their bond allocations that suit their risk tolerance and get on with life, as we’ve discussed many times over the past 3-5 years. (During most of which time bonds have done fine and confounded the skeptics, though that wasn’t the point). Perhaps you could keep your duration fairly short (i.e. invest around the 3-7 year market) to avoid as much interest rate risk as you can.

    @Mathmo — Yes, thought you might like the Buffett piece after our discussion the other day. 🙂 As I say, I read everything from all sides.

    Regarding cash, I don’t really agree. The Doomsday position was 1999 to 2008. That was the time when cash absolutely thwacked equities, at far far (far!) lower risk. I have long argued in this blog (posts accessible via search bar! 🙂 ) that cash is underrated by private investors, I think due to the literature mainly addressing institutional portfolios. The rate chasing potential of a modest cash pile of say £5,000 to £200,000 is very high, even today.

    Cash seems to be massively overrated by those who know nothing about investing (i.e. the mass of savers who should be buying trackers) and ironically also by many keen investors (who’ve seen long-term graphs). There’s a sweet spot in the middle, I believe.

    Especially because — as always — it isn’t either or! You can have a mix of these things.

    My takeaway from the Telegraph article therefore is “Wow, a 25% cash allocation that never went down and ticked up steadily over those 15 years would have been a really nice dampener to the drawdowns caused by the two bear markets we saw over the period, let alone all the investing fear and so forth.”

    @Matt — Yes, I’m not making any point about portfolios here, just fees. In fact, you’re making my point for me that I mention in the article — getting hung up on one portfolio over the other — especially on the basis of past performance of some particular mix — is likely a red herring.

  • 13 SemiPassive March 8, 2015, 3:17 pm

    Re: MadMonkey’s question, some cash for sure but also gold, especially if you live in a southern european country.
    I’d imagine quite a few Greeks would have swapped their at-risk Euro savings to gold.
    Whether the risk is conversion to new drachma or just continued Euro QE.
    Be curious how many European investors hold gold in comparison to US and UK investors.

  • 14 James March 8, 2015, 11:12 pm

    I thoroughly enjoyed the same article, particularly since I’ve just finished reading the book “The Permanent Portfolio”. Not because I’m going to set one up, but more to broaden my investing horizons, which it’s very good for.

    The main thing I want to point out though, is that aside from fees paid to so-called IFAs – who are often anything but independent in the UK – and fund managers (pah!) many people get picky about the fees they pay their fund supermarket.

    I use Hargreaves. I probably pay somewhere under a hundred quid a year more in fees than if I went to a cheaper company, but am happy to do that for their customer service. Over the years, the teeth-gnashing anger I get when phoning someone who forces me to listen to “Your call is important to us… please press 1 for… etc.etc.” is something I’m happy to pay a bit to avoid. My point is that you can get too obsessed about fees and forget that it’s sometimes worth paying a bit more for great service, when you find it.

    I had to telephone Fidelity the other day to sort something out for a friend and nearly screamed!

    Great GREAT blog, keep up the good work. jm

  • 15 R Lee March 9, 2015, 1:54 am

    Surely in most cases fees paid to a manager are more than compensated for by the superior performance arising from his expertise and diligence in selecting investments?

    Only kidding, it’s just a shame this kind of article is still necessary. It’s as if you were blogging for marathon runners in a world where 50% of runners smoked 40 a day so instead of writing an article about fartlek vs interval training you have to keep saying that the difference is trivial compared to whether you smoke or not.

  • 16 Richard March 9, 2015, 11:06 am

    Another good article – thank you. I would quibble with the point about a stock market crash just before retirement as I suspect most Moneyvator readers will be investing through their retirement, not coming out of the stock market on the day they turn 65, or whatever. Especially with the new pension freedoms.

    When looking at fees I use a 40x multiplier as I expect to be investing for another 40 years. For relatively small annual fees a simple compounding is fine.

    So that extra 0.5% per annum will actually take 20% off my final pot.

    I tend to work on a real return after fees, rather than split return from fees. My prudent retirement model uses 2% real long-term return for equities after fees.

    If I die at 90 I’ll have funds of £1.0m. If I assume that fees go up 0.5%, so my real return is 1.5%, my pot is £0.8m.

    That’s the impact of fees – I don’t think about 0.5%, I think about £200k in today’s money. Sobering.

    That said I do have some active funds charging nearly 1%. Do as I say, not as I do…

    I’m also pro-cash, to an extent. I would certainly grab more National Savings Index-linked Certificates if/when they come back on sale.

    And while cash is essential for the rainy day buffer it’s also useful to have on standby for when the stock market takes a dip. I want to retire early but I’d like to be working when the next stock market crash happens so I can feed in my wages.

  • 17 Mathmo March 9, 2015, 1:54 pm

    @TI You are right that applying hindsight, 1999-2008 gives the Doomsday cash vs equities backstop. Apparently risk-free (inflation?) although it’s easy to forget the fear that struck even holders of cash in late 2007. Remember the queues of people outside Northern Rock?

    The point being that cash isn’t usually actual cash (reds under the bed), it is a loan, and differs from bonds only in that it’s callable, variable and untradeable. It is sometimes insured by the state (as gilts are) sometimes not.

    That said, however, I agree it’s a great part of the portfolio. Where else are you going to stick wealth while you’re waiting for the more volatile bits to get cheap?

    FWIW, I consider my Zopa loan portfolio part of my cash allocation rather than my bond allocation. I wonder if I am I deluded? I also keep a solid chunk in insured savings accounts, and exclude 1 yrs expenditure from my portfolio total.

  • 18 Lee March 9, 2015, 1:57 pm

    Rebalanced in January and sold off my high TER funds. Thank god. Bought them before I started reading blogs like this.

    One is left from Aberdeen – gosh their fees are high. If it wasn’t down x% I would have also sold it by now.

    Matter of time. ..

  • 19 The Investor March 9, 2015, 2:27 pm

    @Mathmo — I have all sorts in what I call a “cash-like” slug of wealth, even including a few grains of portfolio dust in mini-bonds, for my sins! 🙂

    Remember the queues of people outside Northern Rock?

    Yep: http://monevator.com/thoughts-on-a-very-british-banking-crisis-at-northern-rock/

  • 20 The Investor March 9, 2015, 2:30 pm

    Hi @Lee

    One is left from Aberdeen – gosh their fees are high. If it wasn’t down x% I would have also sold it by now.

    It’s not for me to give personal advice, but remember you don’t have to make it back the way you lost it. If you wait 5 years paying, say, 2% over the odds, then that’s another 10-15% down the swanny.

    Let’s say one has an expensive actively managed emerging market index fund. One could swap it for a cheap EM tracker or ETF, and still benefit from the recovery in emerging markets if/when it comes — but dump the known and certain drag from the higher fees.

    Of course the Aberdeen fund may or may not do better than an EM tracker, but that’s what most of the other articles on this site are about, as you know. 🙂

    Best of luck!

  • 21 dearieme March 9, 2015, 3:22 pm

    “If it wasn’t down x% I would have also sold it by now.” Sell the bloody thing; you won’t hurt its feelings, you know. It neither knows nor cares what you paid for it.

  • 22 The Rhino March 9, 2015, 4:52 pm

    @Mathmo i think ZOPA behaves more like a bond than cash for sure, so i would categorize it as such. I have some misgivings about the actual liquidity of P2P loans like ZOPA. It all seems a bit murky what you would actually get back if you wanted to retrieve your loan before it matures after they have sliced off their 1% fee. With actual bonds there is a secondary market to take care of this issue but with ZOPA that secondary market is a bit opaque, it must sort of exist as they do offer a cashback option but ive never seen a clear explanatin of how it works/how it is priced

  • 23 Mathmo March 9, 2015, 11:06 pm

    Rhino – thanks. That’s what I was wondering.

    I’m prepared to suppose that in the big picture, it doesn’t make much difference: it’s all non-equity wealth, and the two categories do blend into each other (ultrashort term bonds vs money market funds, anyone?). Both have default and inflation risk and interest rate risk according to term.

    Looking at the zopa redemption – you pay 1% to them and the difference in interest on the remaining time (the relevant interest rate being their tracker rate). If there is a buyer.

    Just thinking out loud, that’s a lot like bond pricing: value moves down by term*rate increase (and think of their 1% as the market’s spread) although on the other side, the borrower has the right to repay early: if interest rates go down then you’d expect redemptions rather than price increases. Downside but no upside. Like a bond that can’t get priced over 99 until redemption. That would be part of the premium. Liquidity is another and default risk a third part.

    I guess I think of it in the cash bucket because the effective term of the portfolio is pretty short (a stable 5-year loan portfolio has an effective term of <2.5-years), so the interest rate exposure is small compared with IGLT or VGOV's 10yr gilts. It's insured by zopa's fund (which isn't as good as state insurance, but better than being directly exposed to personal defaults).

    The pain in the category for me is that I can't trade it inside my wrappers — the cash sitting in my ISA can't pop into a zopa loan, it has to sit as cash or short-term bonds. But then 5.1% on a 2-3 year bond is pretty sweet (cf 4% on a 3yr NSI pensioner bond for a feel for default premium). I'd love a zopa etf…

  • 24 The Investor March 10, 2015, 9:36 am

    @Mathmo @TheRhino — There’s a peer-to-peer Investment Trust, called P2P Global Investments:


    I have no opinion on it except I thought it was an interesting development when it launched a while back, and haven’t looked at it in detail.

  • 25 SemiPassive March 10, 2015, 9:57 am

    Peer to peer lending in an ISA would be useful, but can it be categorised as truly risk-free?
    On asset allocation, currently I run separate ISA and SIPP portfolios, but while index linked gilt ETFs have served well in both wrappers they’ve taken a hammering in the last few weeks.
    After many false dawns this could be the canary in the coal mine for rising rates.
    And with conventional 10 year gilts offering 2% I don’t fancy putting my “risk-free” part into them either.
    So considering moving my Stocks and Shares ISA to a 2 year fix Cash ISA @ 2% in tandem with selling remaining Index Linked Gilt holdings in my SIPP and shifting the money into shares, specifically investment trusts that I want to add.
    So my SIPP would be 100% equity but balanced by ISAs being 100% in Cash making it easier to sleep at night. Opinions anyone?

  • 26 The Investor March 10, 2015, 10:58 am

    Opinions anyone?

    More a reminder of the point of bonds, especially for other readers. 🙂

    I’m an active investor as you know, and currently hold no government bonds. I also favour cash (and other quasi-cash and exotic fixed income investments). My portfolio is a menagerie!

    But if I was a pure passive investor I definitely wouldn’t dump all bonds — though I’d probably have shortened duration to 5-7 years in the past year or two.

  • 27 SemiPassive March 10, 2015, 11:14 am

    Yes, I know you can’t condone this behaviour officially 🙂
    INXG has an ‘effective duration’ of nearly 20 years, so its days are numbered for me as very exposed to even small and gradual rate hikes.

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