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Help, the market has gone up!

Help, the market has gone up! post image

It’s a measure of how sophisticated the Monevator readership is that a sharp spike in fortune provokes worried emails.

Anyone invested in a diversified global portfolio will have enjoyed a Brexit bounce of 15% or more since June 24 – landing amid the fluffy cushions of interest rate cuts and sterling’s slide versus less Brexit-y currencies that means assets priced in dollars or euros are worth a lot more in pounds than they were before the vote.

But we’re not the sort who are just happy to find a horse-shaped gift on their doorstep. Oh no.

First, let’s whip out the ol’ mouth mirror and give those molars of success a damn close inspection before anyone does anything.

Really what rally?

Here’s one reader’s response to the post-Brexit rally. It captures the dilemma nicely:

I wonder if something that’s capable of making me go “wow” one day is equally capable of making me go “oh shit” on another, perhaps at a time when I care more and have shorter horizons.

Monevator has made me wary of volatility in all forms.

Fair enough. Many Monevator readers will be aware that fast-rising valuations are like pigging out on ice-cream. It tastes delicious at the time but is likely to hurt you over the longer term.

But there’s little to fear from this level of volatility except your own reaction to it.

This chart shows that even a 20% swing is pretty normal for UK equities:

Source: Barclays Equity Gilt study 2016 - UK equities 1900 - 2015

Source: Barclays Equity Gilt study 2016 – UK equities 1900 – 2015

You can expect a lurch of plus or minus 20% two out of every three years for developed world equities.

(As ever, this is not a guarantee, just an averaging of the historical record).

Volatility goes with the territory of investing in shares. A sort of pact we engage in for the promise of potentially higher returns.

Remove the risk of losing money on equities and you destroy the equity risk premium – the very force we’re all relying on to deliver our future wealth.

If investing in equities was as easy on the nerves as cash then you’d earn the same negligible return that you can expect from cash.

Remove the monkey

Like hard exercise, volatility is a good pain. The problem is that trying to avoid it can make us do strange things.

Our reader again:

I’m not on a regular investment plan and my uncertainty about Brexit (and bias towards Remain and the belief the country would do the sensible thing) made me pause my ‘throw in some money as I feel like it every few months’ approach to purchases. Another argument/justification for regular investment plans?

Having seen the lesson pre-Brexit, I again find myself thinking, “yeah, but now we’re really in a strange state, time to pause?”

Right now I’m resisting this instinct.

There’s always a potential reason to change your plan. But bad news is not the exception, it’s the norm.

Here’s just a few crises we’ve weathered of late:

  • Credit Crunch
  • Eurozone crisis
  • US fiscal cliff
  • China’s hard landing
  • Brexit

I admire the self-awareness of our reader. Who among us hasn’t instinctively sought short-term security in the face of bulletins about the latest global threat?

It happens to me all the time.

Some of my investment contributions are automated, some are deployed at my discretion.

The automated ones always do the right thing. Cash goes to the funds that I chose when I was thinking rationally. I buy the highs, I buy the lows, and the money is put straight to work.

The discretionary cash is more of a struggle. Always harder to commit. Always prone to second guessing. “But what about this looming threat over here? But what about that shiny thing over there?”

The investment gurus who urge investing on auto-pilot have it right. We love the illusion of control but in reality we have no idea what the market is going to do. How many of us predicted a surge in stocks if Britain voted out?

Study after study has shown that even pro investors suck the big one when it comes to beating the market. Muggles are just so much shark bait if they try.

The smartest decision you can take is to remove yourself from the process.

Don’t change your strategy in the face of big losses or gains in an asset class. That’s fear and greed working against you.

For example, you think “I’ve always believed I needed 10% more gold!” right after gold shoots up, or “That stuff about economic growth being irrelevant to investor returns is spot on!” when emerging markets take a tumble.

When your noisy brain starts inventing new reasons to shift your strategy, it’s almost certainly a sign that you’re being tossed about on the current of recent events.

Are you diversified?

Our forward-thinking reader rightly searches for a healthier remedy for their itch:

Worried me wonders if there’s something that could be done now by diversifying.

It is critical that our portfolios are diversified. It’s also important to know what diversification can and can’t do for you.

Losses happen. Diversification works over the long term to ensure that you are protected from nightmare scenarios like being all-in on an asset class that goes nowhere for 20 years. It should deliver a smoother ride and good returns over the years ahead.

But diversification won’t swing into action on cue like a bodyguard catching bullets in its teeth and knocking aside the blows of a dangerous world.

Correlations can and do ‘go to 1’, especially in times of crisis.

In this recent melt-up, equities, gold, property and government bonds have all rocketed. That can happen on the way down, too.

Again, if we weren’t taking any risk there wouldn’t be any reward. The only way to avoid volatility is to pick a portfolio that avoids the prospect of growth.

As long as your portfolio is diversified across the main asset classes and has components that work in most economic conditions then you can’t do any more:

  • Global equities and property for growth.
  • High-grade government bonds1 and cash for deflation.
  • High-grade inflation-protected government bonds for unexpected inflation2.
  • Commodity futures for stagflation.
  • Gold for doomsday scenarios.

Going much beyond this is likely to prove very hard work. It can suck you into a netherworld of exotic products and asymmetric information where you’re just the patsy at the table.

Get educated

Knowledge is not only power but a great stress-reliever. You’re far less likely to panic or worry if you know what to expect. Read as much as you can about the frequency of falls, the coming of crises, and the bursting of bubbles.

Know that investment losses are frequent and can be violent. A major downturn can feel awful and although recovery is never guaranteed (capitalism can end, totalitarian governments can confiscate wealth) in practice, on average, it has historically taken UK and US markets two to three years to get back on track.

Pause to reconsider your risk tolerance, too.

At the end of January 2016 the market was down about 20% from its previous highs. If that felt stressful but you just about held on then it may be worth nudging your equity allocation lower by 5-10% or so to ensure you can emotionally stand firm when a bigger storm comes.

Why we rebalance

Rebalancing is the great pressure release valve in any portfolio. If assets have shot up and become over-valued or pushed your portfolio into riskier territory then threshold rebalancing provides instant relief.

The idea is to sell off a little of the high-performing asset and buy more of the laggards so you’re selling high and buying low.

You rebalance back to your original asset allocations, ensuring your portfolio isn’t dominated by any one frothy asset that may be overheating.

The difference from calendar rebalancing is that a threshold rebalance can be triggered anytime that a bout of volatility pushes your allocation beyond your predetermined thresholds, rather than being held off until some pre-determined date.

For example if your threshold is set at 10%, a rebalance is due the moment, say, developed world equities rise from their original allocation of 50% to hit your trigger point at 60%.

The trick is to make your thresholds roomy enough so you’re not rebalancing every five minutes, cutting off winners and potentially incurring trading costs.

Fancy a trip to the wild side?

Okay, let’s indulge in some heresy for a minute.

Passive investing luminaries like William Bernstein, Rick Ferri and even John Bogle himself have talked about adjusting asset allocation in the face of changing market valuations.

In other words, you sell off a few percentage points of a particular asset class when its future return expectations are low.

Wh-Wh-what do you mean? Like, market timing?

Yes, it’s market timing. But before I’m accused of defecating in the font of St Peter’s in Rome, here’s how William Bernstein describes market timing:

Its spectrum stretches all the way from large and rapid changes in allocation based on things like macroeconomic parameters, relative strength, volume, sentiment, and overall gut feeling – certifiable behavior, in my opinion – to slow and relatively slight changes in allocations based on valuation and expected return.

This latter strategy, involving very small and infrequent policy changes opposite large market moves, more often than not improves overall portfolio performance.

We’re talking a step-up from rebalancing. Not just pruning your over-performing asset until it’s back in its asset allocation box, but knocking it back still more in a manoeuvre Bernstein describes as ‘overbalancing’.

Why overbalance?

Overbalancing arises out of the human instinct to meddle. Many passive investors find it next to impossible not to play an active part in their portfolios. This is one way of doing it that could add some value while serving an irrepressible human need.

For passive investors, overbalancing could have taken the edge off the worst of the Japanese stock market bubble or the dotcom bubble of 2000.

Again, Bernstein makes a subtle but telling point about where the limits lie:

Simply put, although the individual investor will likely come to grief manipulating the selection of individual securities, the judicious adjustment of policy allocations according to expected returns – increasing an allocation slightly when its expected return is very high, decreasing an allocation slightly when it is very low – will on average slightly enhance long-term results.

This is simply an amplification of normal rebalancing.

Bernstein doesn’t outline a practical methodology in that piece but he does in this interview:

If the stock market goes up X percent, you want to decrease your asset allocation by Y percent. What’s the ratio between X and Y?

If the market goes up 50 percent, maybe I want to reduce my stock allocation by 4 percent. So there’s a 12.5 ratio between those two numbers.

Well, that’s what it really all boils down to: What’s your ratio between those two numbers?

Bernstein is indifferent as to whether your allocation changes by 2%, 4% or 5% in response to the big market shift.

Do not fixate on the number. This is not a science and there’s no magic formula. The key to overbalancing is small shifts in response to big changes in valuations.

But: Why you shouldn’t overbalance

Swimming against the tide is never easy as Bernstein points out:

When the intelligent investor does some trimming back, he usually feels like a dummy for the next year or two. And when he trims back again, he feels like a little bit more of a dummy. And he feels dumb for a while each time after he does it.

But then there comes a point, three to five years hence, when he feels awfully smart.

Can you really bear the FOMO for the five years it could take to be right? If you’re right at all? Can you really sell a red hot asset when everyone else is spraying champagne? Can you really buy the loser asset as it sinks with no sign of the market bottom? This kind of thing can make you sick.

If you haven’t been able to rebalance during such conditions previously, you should forget about overbalancing. The market can defy your King Canute act for years and there are no guarantees of success, never mind earning any juicy overbalancing bonus that makes it all worthwhile. (For instance, this commentator demonstrates that overbalancing can fail.)

Apart from anything else, tracking market valuations across multiple asset classes is a lot of extra hassle. It’s easy to drift away from a simple and iron-rigid strategy into a messy, complex, ad hoc one where you’re constantly pulling all kinds of shapes in order to outguess the market.

Most of us should stick to a simple, automated, passive investing strategy and only get involved with some light rebalancing once a year, or when the markets have swung wildly.

Now might be a good time to take a look.

Take it steady,

The Accumulator

  1. Bonds should be hedged to Sterling for UK investors if they are not Gilts []
  2. Bonds should be hedged to Sterling if not gilts []
{ 43 comments… add one }
  • 1 John from UK Value Investor August 30, 2016, 11:24 am

    Took me a while to work out which FOMO you were talking about as there are at least a couple of variations (and some less savoury than others!).

    As for market moves I totally agree with the diversify/rebalance/ignore theory for passive investors. Market movements should not undermine your equanimity, and if they do then you’re not diversified enough.

  • 2 Cloudfloater August 30, 2016, 11:41 am

    This is a thought provoking post. I’ve read your posts over the years and noted your previous wariness with commodities as a suitable asset class. Are you more at ease now? I haven’t taken the time to understand contango and backwardation as I couldn’t find anyone that was particularly comfortable with it. I struggle with, and have paid the price for, the competing concepts of current valuations and diversification. I’d like more of the latter, but can’t seem to overcome the former. Now there’s a bias!

  • 3 gadgetmind August 30, 2016, 11:41 am

    I was perfectly happy back in Jan 2016 as valuations felt about right TBH!

  • 4 William III August 30, 2016, 12:04 pm

    Compounding the complexity of overbalancing is determining what is an what isn’t an asset class. Are global equity regions separate asset classes? Is a home one owns an asset that needs to be accounted for? Or even human capital?

    And if so, how balanced is my portfolio looking in the face of a low inflation-low interest foreseeable future, or in the face of an actual article 50 trigger, etc.

  • 5 Cloudfloater August 30, 2016, 12:12 pm

    @ gadgetmind. It’s the bond valuations and durations of inflation protected gov bonds I struggle most with (and have paid the price for not having!) and REITS seem toppy, a point Bernstein made on Bogelheads not long ago. So I have Global equities, EM and Cash…and an uncomfortable feeling of being caught on the wrong side of a bout of unexpected inflation. Hence the commodities query. But yes, I was more comfortable Jan 16 and pre Brexit.

  • 6 magneto August 30, 2016, 12:16 pm

    Good article TA.
    Subject (esp rebalancing) very dear to my heart, so please forgive extended comment.

    A summary of the main methods of allocating Assets hopefully to bring some further clarity :-

    1. Tactical Asset Allocation aka Market Timing
    An endeavour to seek out the most or least promising Asset going forward, generally for short-term outperformance, using such tools as economic criteria, valuations, or plain moving averages/accel/decel chartism. Can sometimes be taken to extremes by moving totally in or out from the most unpromising Asset Classes to the most promising Asset Classes.

    2. Investment Formula Plans
    2.1 Constant Value Investment (esp to Stocks allocation)
    2.2 Constant Value Investment, with added gentle slope over time (esp to Stocks allocation)
    2.3 Constant Ratio Investment (aka Strategic Asset Allocation) the most common ‘Passive’ default!
    2.4 Variable Ratio Investment (aka Dynamic Asset Allocation or Valuation Driven Investment)

    Because all the second group plans respond in a formulaic manner to whatever the market throws at them, then maybe they can all be deemed passive, and not deserve the soubriquet ‘Market Timing’?
    I.E. As all do not need any thought or decision making on the part of the investor, unlike TAA!

    We fall into the group who consider ignoring valuations almost as bad as driving a car blindfold.
    Valuations may come in to play for an investor in both absolute and relative terms, when examining Asset Class options in terms of risks/rewards. We therefore favour Formula Plan 2.4 when apportioning to the main income producing Asset Classes.

    For Investment Formula Plan Investors, whether Constant or Dynamic, it is unfortunate that the problem does not simply end with their choosing one of the formulae.
    How is momentum to be accounted for?
    Momentum will all too often be working against any of the Investment Formula Plan rebalancing methods, if acted upon too promptly.
    Some form of delaying action to the rebalancing/over-balancing process has from time to time been advocated, to ameliorate the momentum problem.

  • 7 gadgetmind August 30, 2016, 12:22 pm

    My issue with “strategic rebalancing” currently is finding anything that’s cheap!

    Miners debatably but be wary of historic dividends. EM perhaps but I’m already overweight there.

    I rebalanced my main SIPP recently and just stuck to my guns, though I haven’t yet done the top up to VUKE that maths would suggest leaving me 3% below target and slightly over regards cash. I can live with that.

  • 8 Mathmo August 30, 2016, 2:33 pm

    Great article TA. I built the online spreadsheet to flag up when to rebalance so I could stop thinking about it. I also built into that the ability to take stupid tilts, because I know I’m human, and for me, the key seems to be giving that lizard brain a small amount to play with while allowing wealth to accrue.

  • 9 Green_as_grass August 30, 2016, 6:43 pm

    I was interested to see Commodity Futures mentioned as I’m rather vague about this and not really sure what passive index fund might cover this asset class. Could you give me a suggestion as to what sort of passive fund you are thinking of and might be worth having a look at? (Hope I don’t sound too clueless.)

  • 10 Martyn August 30, 2016, 7:03 pm

    I simply buy whatever is of fashion.

    Banks crashed bought banks
    Miners crashed bought miners
    Property REIT’s crashed bought them
    House builders crashed bought them.

    Been doing this for years have utilties from the days everyone shunned them.

    It works – BrExit has made many things expensive for now, but others are cheaper and thats the thing you buy. Overtime it becomes diversified, everything is cheap at some point.

  • 11 Jed August 30, 2016, 8:08 pm

    This “melt up” has been a bonus for me. I was only 10% cash but with retirement looming in the next five to six years I will need a larger fixed interest holding if I am to avoid selling equities in down markets. Most of my portfolio is in a sipp therefore cash wasn’t an option. I choose a 1 to 5 yr uk gilts SPDR etf as the best option (in my opinion, and I have an inbuilt dislike of bonds). I got my 25% fixed income with my equity allocation value similar to what it was before the melt up. This was a good opportunity for me and I made the most of it. Now I know short bonds don’t yield much but they provide the fixed income allocation that satisfies me.

  • 12 Naeclue August 30, 2016, 8:46 pm

    Interesting article, but I feel the rebalancing bit may be a little overthought.

    I worked in a small business which I partially owned and my income from it was highly variable. For this reason we never really saved regularly. Instead about once per year we had an amount to invest which varied from nothing to a fairly large amount. When I invested I balanced things up by redirecting more cash into the below target assets. Over the last 20 years I think I have only really rebalanced 2 or possibly 3 times by selling assets to buy different assets and each time it was selling gilts to buy equities. I may at some point have sold equities to by bonds, but without checking I cannot remember doing that.

    Other times I have rebalanced when I needed to withdraw cash, either for business purposes or to buy property and then it amounted to selling where I was overweight. Since I retired we have again been selling assets for house improvements and other indulgences, and also to invest in ISAs for our children, probably for future property deposits. Again, I just sell what is overweight. I suspect I will now just continue to sell what is overweight each year and that is likely to keep things in balance.

    Nitpicking a few percent here and there according to valuations may give a slight theoretical edge, but I suspect the probabilities of adding and detracting value are finely balanced and more frequent trading is certainly more costly. IMHO it is best to leave well alone and rebalance just once per year if things are more than say 10% off target. Within an asset class, e.g. different geographical equity regions or property I would not bother to rebalance unless more than 20% over or underweight.

    I know the diversifying arguments for commodities and gold, but I really hate contango and/or paying for storage of an asset that is priced purely by supply and demand. Equities, bonds and cash deposits have intrinsic growth due to companies mostly making profits, debt requiring interest payments , short dated debt having lower redemption yields than long dated debt, property attracting rent, etc. OK, some bonds are on -ve gross redemption yields now, but that is historically unusual.

  • 13 BB August 30, 2016, 8:56 pm

    I really enjoyed this article and as I so rarely post in the comments I thought I would do this time to say thanks for this and all the other interesting reading you’ve given me.

  • 14 @algernond August 30, 2016, 9:29 pm

    In this article (http://monevator.com/asset-allocation-for-all-weathers/) you posted last year, Inflation linked bonds and commodities were in the same quadrant.

    Do you think a consideration to hold commodities is secondary if inflation linked bonds are already held?

  • 15 Naeclue August 30, 2016, 10:33 pm

    How the memory plays tricks. I have been looking through my records and can see far more rebalancings than I remembered. I had ignored the assets we held outside ISAs and SIPPs that I would occasionally sell and buy back inside tax shelters using accumulated income and annual subscriptions. Each time I did that, more often than not I would sell equity funds/ETFs outside tax shelters and top-up gilts inside tax shelters!

    I clearly had far more mini-rebalancing events than I first thought. These trades probably kept us away from more frequent major rebalancing events.

  • 16 TomB August 31, 2016, 11:30 am

    I agree with @algernond.

    Inflation linked bonds do not protect you from run-away inflation as it’s very likely that Central Banks would raise interest rates in this scenario and they have a very long duration.

    They are an asset best-suited to a stagflation scenario.

    Equities and property are your true inflation protection.

  • 17 NicM August 31, 2016, 11:40 am

    this is an excellent post.

  • 18 gadgetmind August 31, 2016, 12:35 pm

    And over the long term, that shiny yellow stuff!

  • 19 Neverland August 31, 2016, 4:36 pm

    31 Dec: £1 worth $1.51
    23 June: £1 worth $1.48
    31 August: £1 worth $1.31

    I’d say it was more a globally diversified portfolio has held its value rather than gone up

    Value held in Sterling in a bank has been spanked

    Value held in UK property has been pummeled

    Last stats I saw the UK current account deficit was about 7%, more fun to come

  • 20 Green_as_grass August 31, 2016, 4:44 pm

    …commodity futures anyone?

  • 21 Roger August 31, 2016, 7:47 pm

    Index swings of + and – 20% for two out of three years pretty well proves that patience coupled with timing the market is a valid option/alternative to the drip feed method of investing – as alluded to by Martyn.

  • 22 hosimpson August 31, 2016, 9:31 pm

    @ Green_as_grass
    “…commodity futures anyone?”
    It’s a specialist market, where most of the players are not investors: they are oil producers who are managing their risk and oil refineries that need to keep their cat crackers hot at all times. I know nothing about anything that isn’t oil, and even when it comes to oil I know very little. I’d never venture into the futures market, and I’d say unless your day job gives you an insight into the workings of the global market supply and demand for your chosen commodity, stay away from it.
    And there’s also contago.

  • 23 FIREplanter August 31, 2016, 10:22 pm

    I know passivers shouldn’t over analyse things to save their minds but Bonds/Gilts still worth it at their current yields/valuations? I have only global diversified index trackers and cash but admittedly, I am Year 1/2 of my accumulation phase in my 20s, so I didn’t allocate any to bonds/gilts at present.

    Investors can never be really satisfied can they?

  • 24 Neverland September 1, 2016, 8:47 am


    Looking at the Debt Management Office’s website a 20 year gilt yields 1.1% right now

    I wouldn’t be rushing to buy into that

    National Savings & Investments have some no capital risk products with a better yield, let alone banks and building societies

  • 25 magneto September 1, 2016, 11:25 am


    Yes these are testing times for say a determined 60/40 or 70/30 Allocator.
    Maybe someone can link to a a historic 10 year Gilt chart, but the 10 year Treasury puts present dilemma into perspective, even though US TREASURIES YIELD almost 1% MORE THAN GILTS..


    Surprised to see as significant a figure as Andy Haldane as admitting publicly “Central Banks have intentionally blown the biggest Bond Bubble in history”.
    That ties in with such recent alarmist headlines as ‘Lowest Interest Rates since the Bronze Age’
    But maybe ‘this time is different’?
    And then why aren’t the other half of the Keynesian tools being employed, such as Gov’t stimulation of the economy/inflation through spending?

    The impact on the Defined Benefit Pension Schemes continues to worsen as Gilts progressively yield less and less. Surely there must be a better way of valuing pension liabilities?
    More like our balanced portfolios?
    And the withholding of dividends by FTSE Co’s, imposed by legal restrictions concerning pension liabilities, is going to make the search for income by pension funds and others, even more acute.

    For those who take note of valuations, there IMHO continues one faintly attractive option in Fixed Income with Short-Term IG Corps, if they do not consider proxies such as Infrastructure appropriate. Presently ST Corps have a reasonable spread over ST Gilts and are ekeing out a +ve real yield. Also not too volatile due to shorter duration.
    But don’t expect any sign of a -ve correlation to Stocks from Corps.

  • 26 Neverland September 1, 2016, 2:19 pm


    I don’t think its very different this time

    Governments have a history of stuffing investors with crappy paper

    Non-exhaustive list:


    UK appears 4 or 5 times, most recent one being First World War bond in 1932

    The US, always being better than us, manages six entries

  • 27 FIREplanter September 2, 2016, 8:37 pm


    That’s interesting about sovereign debt crisis. I think I need to read more into that as a worst case scenario case study.

    What usually happens when this happens? Where does it end?

    So we have the debt restructuring with the ECB/IMF with Greece.

    Is something like Hyperinflation in Zimbabwe possible? All the QE in the EU doesn’t seem to be doing anything to inflation much.

    It just all doesn’t make sense!

    I think I will stick to saving saving saving, and can only hope for the best that the world doesn’t screw me over. The world wants to be progressive and be productive and innovative and succeed as well right? I will buy a stake in that!

  • 28 The Investor September 2, 2016, 10:00 pm

    I say this as an active investor — so not to judge — but all you guys claiming you can accurate call market and asset classes over-valued and so on should be making a *killing* in financial services right now. 😉

    Trying to time this or that aspect of the market is nothing new. It has a terrible record.

    Here’s just the latest reminder I’ve read: http://beta.morningstar.com/articles/767172/tacticalallocation-funds-even-worse-than-expected.html

    @Everyone else — Remember it is very easy to sound smart and prescient in blog comments. It’s also unaccountable. By all means invest as you see fit, but if you’re a happy passive investor who gets the big picture message, don’t let these sorts of comment threads derail you.

  • 29 Finance Solver September 3, 2016, 4:23 am

    Great overview of investing advice. I’ve invested oftentimes enough to the point where I am comfortable with volatility. I’m not comfortable with the lofty valuation however that’s rampant in the markets currently. I’m so scared that a correction is going to happen especially when I just started work!

  • 30 magneto September 3, 2016, 9:16 am

    Can we be careful with our terminology?

    Benjamin Graham had this to say in The Intelligent Investor.

    “Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possible ways by which he may try to do this : by way of TIMING and the way of PRICING. By timing we mean the endeavour to anticipate the action of the stock …… . By pricing we mean the endeavour to buy stocks when they are below their fair value and to sell them when they rise above such value. … We are convinced that the intelligent investor can derive satisfactory results from pricing …. We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up a speculator and with a speculator’s financial results This distinction may seem rather tenuous to the layman, and it is not commonly accepted in Wall Strret.”

  • 31 Naeclue September 3, 2016, 12:15 pm

    @Magneto and other Graham followers, you might want to read an interview that Ben Graham gave shortly before he died in 1976. Here is part of it:

    In selecting the common stock portfolio, do you advise careful study of and selectivity among different issues?

    In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then.

    Graham was a convert to EMH!

  • 32 Naeclue September 3, 2016, 12:16 pm
  • 33 Naeclue September 3, 2016, 12:27 pm

    @Magneto said

    “The impact on the Defined Benefit Pension Schemes continues to worsen as Gilts progressively yield less and less. Surely there must be a better way of valuing pension liabilities?
    More like our balanced portfolios?”

    Tinkering with the way pensions are priced will not resolve the problem of pension deficits. One of the reasons that deficits have worsened is that companies did not plug the deficits when assets were cheaper. If asset prices (bonds and shares) halved tomorrow, all else being equal (including estimated nominal returns), a company pension deficit would halve.

  • 34 The Accumulator September 3, 2016, 2:25 pm

    @ Cloudfloater, Green as grass and Algernond – I’m not at ease with commodity futures, no. No asset class causes a deeper split among passive investing proponents. I’ve read countless articles and papers, have a good understanding of how they work and of the benefits, but am spooked by the argument that the benefits have been swamped by the money flows in the past decade or so.

    This is a great debate between Larry Swedroe and Rick Ferri on the yays and nays of commodity futures in your portfolio: http://www.etf.com/sections/features-and-news/679-the-great-commodities-debate-part-i?nopaging=1

    However, it’s true that diversified commodity future ETFs (like the ones listed here: http://monevator.com/low-cost-index-trackers ) are one of the few assets that aren’t correlated with equities and bonds. Indeed, they’ve taken a right kicking over the past several years. Non-correlation is the main argument in their favour. This from Larry Swedroe:

    commodities should only be used as a means to provide a hedge against some kinds of event risk that can hit either stocks or bonds badly. They can be supply shocks, wars, political risk, those kinds of things.

    Regardless, you should expect very low correlation between the returns on commodities on average and the returns on your other portfolio options. So it does provide a diversifier, but it’s one with a very low expected return. But because of its high volatility, a small allocation to commodities is going to have a significant impact on the returns of a portfolio. Commodities may not deliver great returns, but their impact on the portfolio is bigger than just the return of the asset class itself, which is the mistake many people make. But the only right way to look at things is: When you add an asset to a portfolio, how does that impact the risk and return of the overall portfolio?


    So I get the theory but I haven’t personally had the courage to get off the fence and risk my own money. I think I’d be more comfortable putting 5 – 10% into a gold ETF, also in the name of insuring against equities and gilts getting a simultaneous pounding as they did in 1973-74. With a gold ETF I don’t have to worry about contango or counter-party risk, I also get a non-correlated asset but must accept that it doesn’t come with an intrinsic source of return. Essentially, I’m relying on it to come good during a nasty future shock – reducing volatility in my portfolio. I also need to have the cojones to rebalance into it when it’s taking a shoeing. I should point out at this stage that I don’t currently own gold. More food for thought:


    @ TomB – there are a lot of studies out there that show equities and property get pounded by rapid, unexpected inflation. Yes, equities and property keep pace over the long term but are highly vulnerable to inflation shocks. Again, witness 1973 – 74 crash. That said, I agree that the lack of short-term inflation-linked gilts is a problem and I’d be a lot happier if we could still buy NS&I index-linked certs on a regular basis.

  • 35 magneto September 3, 2016, 2:27 pm

    Thanks very much for the link to Graham’s later words. Have saved and very much appreciate the info. Think his thoughts could be open to several various interpretations.

    On EMH : was it Shiller who said something like; EMH is a goal, not an established fact?
    But markets do seem mostly efficient, except when they are not.

    Concerning Variable Ratio or DAA : Bernstein (Wm), in one of TA’s links, seems to be also throwing in the towel

    “If that’s market timing, then I too must plead guilty.”

    Seems we must learn to live with the title ‘Market Timing’ for anything but Constant Ratio?

  • 36 puzzled September 11, 2016, 7:51 pm

    I am new to this really informative web site.

    As a passive investor I am currently ‘re balancing’ my pensions/SIPPs etc.

    Because of charging structure by ad valorem platforms I feel pushed towards ETFs- what is point of holding a cheap index fund and then getting whacked by (comparatively) huge platform charges? (I already have substantial sums invested in traditional index funds in fixed fee platforms and want to spread my holdings to different brokers.)

    Being new to the world of ETFs, do long term passive investors not make strange ‘bedfellows’ with the massive daily trading of ETFs, with daytraders, short sellers, stock lending etc.?

    Also I was reading recently where, I believe, John Bogle says ‘These Standard & Poor’s index funds run by State Street called the SPDR turns over 7,500% a year and that’s a lot of turnover.’ He says ‘I think 10% is too high,…’

    Does this high turnover affect the performance/safety of the ETF when held by long term investors?

    Or, Terry Smiths article in the FT back in January (on buying an index fund) : ‘I mean an index fund, not an exchange traded fund (ETF). Given the rationale for this strategy is your lack of attention,why would you want a fund which allows intraday dealing, which is what the exchange traded part of ETF is telling you it provides?’

    As I said, I am new to the world of ETFs and perhaps missing the point but any comments would be welcome as (perhaps unnecessarily) I feel a tad uneasy buying these products!

  • 37 The Accumulator September 11, 2016, 8:38 pm

    Hi puzzled,

    Some worry that because you can buy or sell an ETF at any time then passive investors will be turned into foaming-mouthed day-traders.
    But if you can resist such evil temptations then you can use broad-based, index-hugging ETFs just like any other index funds. All you gotta do is not trade (much).
    Lots of Monevator readers and passive investors the world over use ’em without trouble.
    I think much the same arguments about moral decline have been used from time immemorial about everything from books to women in the army.

    short-selling and stock lending – happens in all kinds of financial products – not just ETFs. Doubtless some index funds too.
    I don’t see why an ETF tracking the S&P 500 should turnover any faster than an index fund. If turnover was an issue then you’d see it in the tracking difference – the amount by which the ETF or fund lags the index results.
    There is no evidence that ETFs are inferior to index funds when it comes to performance. Re: safety, look up the articles on synthetic ETFs and counter-party risk on Monevator. If you want to keep things simple, stick to physical ETFs.
    Re: Terry Smith – you might want it because in this country, tracking certain indices means choosing an ETF due to wider variety of choice. Not to mention the cost issue which you’ve already raised.

  • 38 puzzled September 12, 2016, 7:09 pm

    Hi Accumulator

    Thank you for taking the time to reply.

    I guess I wasn’t worried so much about me being tempted to trade too much, more about what effect the massive trading by others would have on the fund itself, when you see huge turnover figures like 7500%. I was worried that this high activity may ‘hurt’ the fund (or the fund’s performance) in some way !

    Once again thanks for your comments.

  • 39 Tim September 21, 2016, 6:57 pm

    Sorry, very late to this thread and I don’t know if anyone’s listening, but:

    I’m very curious about the two footnotes to this article asserting non-gilt bonds should be currency hedged to sterling. What’s the theory behind that? Why would it make sense for UK investors to hedge say US corporate bonds, but not US treasuries or US equities? I have read some “to hedge or not to hedge?” type articles which seem to reduce it to a straightforward decision about whether you want to be exposed to the additional risk of currency value fluctuations too or not… but I’ve not seen anything making a case why that decision might differ by asset class.

  • 40 The Investor September 22, 2016, 7:08 am

    @Tim — Just briefly in case it’s only me listening… 😉 There are several reasons (1) Your bond allocation in most passive portfolios is there to reduce risk not to hugely deliver return, so you probably don’t want to also add risk with currency (2) Returns from bonds are lower and more likely to be overwhelmed by currency risk compared to equity returns that are higher (this is over long term) and (3) Equities are as you know slices of companies, and such companies (and economies) have some built-in hedges with respect to currency moves that fixed income doesn’t have (e.g. If a currency weakens, it may make an economy/company in that economy more globally competitive, potentially increasing it’s value). Elroy Dimson and co. produced some data backing this up a few years ago in one of their Credit Suisse Global Equity handbooks. Of course it’s not always true, all the time, and not everyone agrees. (Hey, this is investing. 😉 )

  • 41 The Accumulator September 22, 2016, 8:00 am

    @ Tim – there seems to be a misunderstanding here. The footnote is saying you should hedge to sterling if you invest in US treasuries or any other international bond. If you’re investing in foreign equities then no need as you’re accepting the volatility that comes with that territory anyway, so no point incurring extra expense.

  • 42 Tim September 22, 2016, 2:18 pm

    @TheInvestor. Thanks; those are all good points. I’ve previously mainly tended to think of my foreign investments as being there to ensure I’ll still have the freedom to travel/emigrate/import foreign stuff in the event of GBP going to the dogs in future (oh, wait…), and from that point of view introducing hedging seems to work against that aim. But recently the “brexit bounce” rather surprised me by demonstrating just how internationally exposed the FTSE100 and FTAS is anyway. I also realized I actually do have quite a bit of hedged bonds in my Vanguard Lifestrategy holdings, and I can hardly complain about how those have been doing “despite” the hedging.

    @TheAccumulator: There are two footnotes: “1. Bonds should be hedged to Sterling for UK investors if they are not Gilts” and “2. Bonds should be hedged to Sterling if not gilts”. When I look back to the context, the first one applies to “High-grade government bonds” and the second to “High-grade inflation-protected government bonds”. I think it’s that “if they are not gilts” qualifier confusing me: I was assuming “gilts” == “government bonds” (any government’s), but investopedia’s definition claims it’s used for UK government only, in which case the “if not gilts” qualifier just seems redundant.

  • 43 Tim September 23, 2016, 11:40 pm

    Nice timing: I see a piece on the advantages of currency hedging bonds has appeared on etf.com today: http://www.etf.com/publications/etfr/risks-and-rewards-currency-hedged-bond-etfs (somewhat USA & USD oriented of course).

    Includes the point that: “But while currency hedging doesn’t bring down the overall volatility of international stocks much, it really brings down volatility for international bonds. That’s because bonds tend to be less volatile than equities overall, so a foreign bond’s volatility tends to originate more from currency fluctuations than from the value of the bond itself”

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