What caught my eye this week.

Hey there, thanks for stopping by. I appreciate things are a bit quiet around Monevator the past couple of weeks. We are having a summertime hiatus.

My co-blogger The Accumulator is on holiday. Quite the opposite issue here – I couldn’t do anything for the blog beyond comment moderation until Thursday night, as work has piled up with a particular client.

Meanwhile erstwhile contributors The Details Man, The Greybeard, and Lars Kroijer all seem to have said their pieces for now. Our bench is not so deep these days.

So far so gloomy. The good news is that this could be the calm before the… well, not the storm exactly but at the least what weather forecasters call ‘changeable’ conditions.

Because while I’m busy currently, my professional workload is set to get significantly lighter in a few weeks. I’m not sure how much time will be redirected towards Monevator. But certainly: some.

This is an interesting time for the blog. We’re still standing after 13 years. (Tiny trumpets!) Traffic plateaued years ago though. (Tiny violins!) People come, get the simple message, and leave. Or, starting around 2015, they never leave social media or YouTube to find us at all.

(If you’re wondering where all your favourite independent websites went, it was thataway.)

We’re at a low ebb financially speaking, too. Long-time readers will recall this was always the weakest leg of this operation. Post-Covid-19, that gammy leg has fallen off altogether.

No matter – it all sets the stage for some overdue introspection. (And it means we might FINALLY get our book finished…)

Asset allocation is not the only fruit

I was ruminating about what a passive investing / money blog should aim to do in 2020 and beyond when I came across an interesting post by Robin Powell at Humble Dollar.

In his article Robin outlines what people really pay good financial advisors for. It struck me most of his points could apply equally to our kind of investing website:

Good financial planners will play a number of pivotal roles for their clients, none of which is found on the typical job description.

Here are seven of those roles:

Guide. Most people know what they want or, at least, know what they don’t want out of life. What’s often missing is a sense of how they can get there. A planner provides an independent plan, showing possible pathways and the tradeoffs involved in each.

Teacher. Many people’s sense of what drives investment returns comes from the day-to-day noise in the financial media. It’s all about investment products and short-term returns. A good planner shows clients what drives long-term returns and connects this to their life.

Coach. It’s easy to make financial resolutions—to save more, to spend less, to grow wealth, to leave a legacy. It’s not so easy to keep them. At their best, financial planners will ensure goal accountability, keeping clients on their desired path and talking them off the ledge in anxious times.

Organizer. Our lives are busy. Jobs and family commitments leave little time for dealing with the minutiae of insurance, portfolio analysis, rebalancing, cash flow analysis and so on. A good advisor takes care of this complexity and frees you to focus on what really matters to you.

Filter. The problem right now isn’t gathering enough information. Instead, we’re overloaded with the stuff. The challenge is finding the right information for us in a form we can digest. A good advisor becomes a trusted source and an information filter.

Counselor. Few big choices in life are simple. There are always competing imperatives. Planners who can help you cut through the noise and focus on your underlying values are worth their weight in gold.

Sentinel. The best financial planners are not only looking at your circumstances as things stand today, but also what might be coming over the horizon to change all that. And they are mindful of your legacy—the welfare of future generations and how your wealth can keep working beyond your lifetime.

Go read the full post at Humble Dollar, especially if you’re in the market for financial advice.

And Watch This Space.

This website is much more geared towards evolution versus revolution in its DNA, so don’t fret if you’re already a fan.

It is, however, time for some modest mutations.

Have a great weekend!

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What caught my eye this week.

Passive investing is a solved problem. Invest regularly into index funds or their ETF equivalents, allow your money to compound for 30 years, and then enjoy the fruits of the market’s return by spending down your portfolio in your later years.

Sorted. Next!

Well maybe. It’s been hundreds of years since much of anything stayed the same for long. So it seems likely to me our kids and grandkids (maybe future Monevator readers?) will be doing it their own savvy way.

Live and direct

Direct indexing seems very likely to replace index funds in time, for a start.

The idea is simple. Rather than put your money into an index fund, a robo-platform basically buys the index for you via the appropriate mix of shares (or fractions of shares). This approach cuts out the middleman and makes you a direct shareholder in all the companies in the index (rather than via a proxy, such as Vanguard).

One advantage if you do this outside of tax shelters is more opportunity to defuse capital gains and exploit capital losses to reduce your tax bill, since you’ll hold the index’s winners and losers at the individual level.

But I believe it is the push towards ESG1 investing that will drive the industry towards direct indexing.

I don’t want that one!

I’ve sat through at least a dozen start-up pitches over the past few years from fintechs arguing that millennials and their younger siblings want a way to invest that’s as easy as buying an ETF but without having exposure to a fossil fuel producer or an arm’s manufacturer.

Fair enough, target ESG investing towards them then. But understand that ESG is a moving target.

For instance in the past month, fast fashion darling BooHoo has been painted as a ruthless exploiter of workers after some investigations into aspects of the UK garment industry.

I’m not convinced this picture is fair – and I own shares in BooHoo – but I don’t intend arguing the toss today.

The point is, if I was an ESG-minded investor than a company I might have considered as previously no problemo I might now wince at owning.

I’m not saying that’s a very rationale way to think about shareholder democracy. I’m saying it’s how millions of people do think.

With a traditional ESG fund – active or following some ESG index – you’d have to wait weeks or months for a third-party to kick out BooHoo of the fund, assuming they do at all.

All the time your money in the company, ruthlessly exploiting away on your behalf…

But with direct indexing, you could do it yourself. You could own the market minus BooHoo after just a couple of clicks.

Everyone of us is different. You might believe that BP and Shell are transitioning to green energy, but you hate pharmaceutical companies for what you see as high drug prices – and you want extra-exposure to High Street retail because you believe it’s important for local communities.

Good luck getting an ESG fund to reflect that view!

However start with the index, dial up energy companies and retail exposure, dial down pharma, press the ‘Direct Index Me Up’ button and you’re away.

Coming soon

According to some, direct indexing could do for investing what Napster and the iPod did for music – and sooner rather than later.

Quoted in an article on MarketWatch this week, Dave Nadig, an index industry veteran, said the technology to do this is already available for the rich or institutional, and it will soon reach oiks like us:

“All that’s changed over time is the thresholds for accessing an index have gotten lower and lower.

It’s just a software problem. And the technology required to produce that customized account has plummeted to the point where it’s almost retail.

It’s not quite mom-and-pop, but it’s heading there.”

I doubt Vanguard and Blackrock and the other big passive fund investors are quaking in their boots just yet.

For direct indexing to truly take off it will need to be as easy to do as buying a tracker fund. And people will need to understand what they’re doing, too, which adds an educational burden. (Think how long it took to get investors to shift towards a passive mindset. Decades.)

Also, the potential for financial services industry chicanery is high.

I therefore expect it will take a while before the landscape is one where direct indexing is really challenging our favourite passive fund approach. But be aware you might well retire investing differently to how you first got started.

Have a great heatwave weekend, everyone!

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1. Environmental, Social, and Governance [↩]

Let’s say you have £10,000. There’s no rule that says you have to invest it.

In fact, many people would spend it!

Why not put it under the mattress, and leave it for a rainy day?

One word: Inflation.

Take a look at this graph:

This graph shows how what you can buy with £10,000 falls over the years, due to the impact of inflation.

Inflation is the tendency for the cost of things – bread, houses, wages – to rise.

As such it reduces the spending power of your money each year.

• In 25 years time, you will still have £10,000 in nominal terms. Your twenty £500 notes will still be under your mattress, and the Queen of England will still be frowning at you.

• But in real terms the spending power of your money will be diminished.

The graph shows the impact of just 2% annual inflation on your money.

2% reduces the value of your money by only a little bit each year, but it adds up to a 40% loss in real terms over 25 years.

The inflation rate can rise and fall

The Bank of England and many other countries target a 2% inflation rate.

But sometimes, such as in the 1970s, inflation can rise to 5-10%. Such a high inflation rate can halve the value of your money in less than a decade.

Inflation can get even worse in extreme situations, such as 1920s Germany or Zimbabwe more recently. Hyper inflation in a crisis can hit triple digits or more.

The first reason we invest is to maintain the spending power of our money. Every year we need to grow our savings by at least the rate of inflation.

Generally – but not always, and especially not in recent years – you can keep up with the rate of inflation by keeping your money in a good cash savings account.

Cash accounts pay interest on your total savings. By adding this interest to your existing pile of money, you can grow your savings over time.

This may seem trivially obvious, but it’s an important point.

The spending power of each £1 still goes down over time. But by growing the total amount of £1s in your savings pot by earning interest and reinvesting it, you can aim to offset the impact of inflation and maintain the spending power of your total savings.

In the graph above:

• The blue line shows how your £10,000 grows over 25 years with 2% interest. This is the amount you see piling up in your bank account.

• The red line shows how £10,000 would lose its value in real terms at 0% interest. For example, if kept under your mattress!

In reality you will get interest and see your wealth rise but – invisibly – each pound in your bank account will also lose some of its spending power due to the impact of inflation at the same time.

If inflation was running at 2% for the entire 25 years and interest rates were also 2%, then the two would cancel each other out.

This is shown in the green bar in the following graph, which is the real spending power of your money, with 2% interest and 2% inflation.

You’d very rarely see inflation and the interest rate on your cash savings exactly matched like this, of course, let alone for 25 years!1

Some times interest rates will easily outpace inflation. At other times it will be very hard to get a real return, especially if you pay tax on your savings.

But the principle is clear. At the very least, you need to grow your money in nominal terms, just to offset the corrosion of inflation.

Investing like this will at least maintain the spending power of your money.

Key takeaways

• The real value of £1 decreases over time, due to inflation.

• Over the long-term, this can seriously reduce your wealth.

• At the least, we need to invest to offset the rate of inflation.

This updated post is from our occasional series on investing for beginners. Subscribe to get our articles emailed to you (we publish three times a week) and you’ll never miss a lesson! And why not tell a friend to help them get started?

1. Some interesting products such as the government’s sadly suspended index-linked savings certificates did enable this, plus a bit of icing on top. [↩]