While in the midst of biting my nails over the election result, a friend said:

‘Watching the results coming in was like putting our books and magazines down to concentrate when the plane takes off.’

As if the power of our minds could somehow help the pilot get the bird up in the air.

My friend decided it was all too much. She needed to detach. She needed to accept the outcome was beyond her control.   

Chastened, I looked at myself sitting in a nest of devices. Refreshing my feeds like a burns patient on a morphine drip.

Unshaven, short of sleep, exerting no control whatsoever…

What had I become? 

This isn’t me

I manage stock market alarmism by checking my portfolio about as often as King George III heard from the colonies. 

Why was I trying to deal with election stress by reading about every ballot drop in US counties I didn’t even know existed until last week?

The difference lies in my understanding of the rules of the game.

The Investor has rightly called out stock market analysts astrologers who invent a new story to explain every fit and cough of the market. 

Those ‘insights’ are typically about as useful as reading the omens for victory from the flight of swallows. 

The value added is clear: the analyst is a performance artist, the media is an impresario, and the audience is entertained. 

What it’s not is useful information, except for reminding me that no quantity of BS helps. 

The election analysis was different. The Red Mirage effect helped me understand why Trump’s early 700,000 vote lead in Pennsylvania was not game over. 

But my ape brain was still easily rattled by every plot twist.

I was deeply emotionally invested in the outcome because I believe this election had more riding on it than any other in my lifetime. The risk of the world superpower sliding into authoritarianism is not one I take lightly.  

Then I found the election quants.

Digging beneath the headlines, these people crunched the numbers and properly contextualised the state of the race. Their sober-minded reports – as informed and agenda-free as any I could find – helped me through the critical hours. 

This doesn’t work in the markets

As a small everyday saver I cannot tap into an equivalent real-time resource during a stock market crisis. 

I do believe that some players can beat the market. They usually reinforce incredible skill with banks of PhDs, super-computers, and machine-learning algorithms.

Crucially:

• They don’t need my money.
• They don’t share their knowledge with the internet.
• Their process does not rely on transparency. 

This is a very different environment to the election. 

I can’t expect to navigate a market meltdown in the company of a friendly insider. 

Stress management in this domain depends on fortifying my mind in advance.

I need to recognise my psychological enemies so I can reflexively avoid them, or shoot them down as they spawn like videogame baddies. 

By cultivating the right behaviours and keeping the faith when all hell breaks loose, you can pull through with minor cuts and bruises…

Let’s divide up the risks we need to manage as a small investor as we navigate a drama in the markets.

Pre-crisis

Overconfidence – Loading up my portfolio with too much risk after a market run-up leaves me thinking I’m the King Midas of investing. 

Dealing with it – Adopt a more conservative asset allocation than I think I need. Read about risk tolerance. Read about stock market history and the worst that’s happened. 

Chasing returns – Over-concentrating my portfolio into crowded trades is like boarding the gravy train after it has left the station. Think buying crypto after the internet has run rampant with stories of Bitcoin millionaires, or getting into gold after it jumps 20% in price. 

Dealing with it – Other than not doing it, I must abide by strong rules of thumb to deal with the temptation. No more than 5% of the portfolio can go into any alternative asset class. No more than I can afford to lose if I must invest in the hot new thing. 

Pennies in front of steamrollers – Some trades make you feel like you’ve joined the big leagues, but they can backfire spectacularly. Trading on margin, spread betting, contracts for difference, inverse leveraged ETFs – high-risk investing can be as intoxicating as driving a Formula One car. Right up until you smash into the pit wall.  

Dealing with it – Don’t trade in things you don’t fully understand. If you’re on an app that feels as exciting as a casino, then it is a casino. 

Mid-crisis

Panicking – Your portfolio is down 30% or worse. Everyone is freaked out. The herd stampedes. In the media, the End Of The World Is Nigh. You sell. But somehow… the market rallies? Yes, while you’re on the sidelines in cash. Loss crystallized. But in an alternative universe, you snooze through the whole thing and are absolutely fine.  

Dealing with it – Just don’t do it. Do not sell. The only plug you should pull is the one connecting you to the panic. Get off the internet. Do not look at your portfolio. Recite your safe word. Read your stock market history again. As long as we’re not losing World War 3 or in the throes of Communist Revolution, then a recovery will (eventually) follow. 

Post-crisis

Traumatised – You’re in your shell, licking your wounds, counting what’s left of your cash. You’re afraid to return to the market. Too shell-shocked to revisit the scene. The market marches on. Your portfolio slowly falls behind like a once-great country that’s lost its way. 

Dealing with it – This is the place we never want to be. It may be too late to restore your shattered confidence, and rational advice is probably misplaced. But if there is a light that can intrude upon the gloom, it is this: there is no better time to invest than when the market is cheap.

Long-term

Paying high-fees – Costs are guaranteed, returns are not. 

Dealing with it – Invest in the cheapest index trackers you can, and avoid someone else trousering your profit. 

Constantly changing the plan – Financial engineering changes more often than the fundamentals. City marketing departments fire new magic bullets at us every day: ‘The old way of doing things is dead, only our sexy new product can make you rich.’ 

Dealing with it – Don’t fall for the sales pitch. Have faith in your plan when it’s built on evidence. (A paper from a fund manager is not evidence. It’s marketing.)

Doom-casting – Projecting some negative trend into a huge wall shadow of fear. You know the sort of thing – the hard left will confiscate our pensions, ballooning debt will destroy fiat currency, and so on.  

Dealing with it – Recognise you probably didn’t worry like this until you had something to lose. Success can breed irrational dread of change to the status quo. Franklin D. Roosevelt’s memorable phrase – “the only thing we have to fear is…fear itself” – is a useful piece of wisdom to lean upon. 

Comparing yourself to an impossible ideal – Investing-wise, this foible might manifest itself as regularly checking in on an investment you once owned and sold, like you do with an ex on Facebook. (And then being consumed with regret if it thrives without you.)

Dealing with it – Don’t look back. Don’t beat yourself up. Get used to humble pie. The market makes us all eat plenty of it. 

No-risk, guaranteed returns – The surest sign of a scam. Or at the very least small print laced with booby traps that will blow up in your face, sooner or later.

Dealing with it – Run away! Head for the hills! But never forget how easy it is to fall for the dream when you’re desperate. 

Impulse control

The overwhelming complexity of the markets is an environment that few of us are equipped to navigate by instinct.

Our intuitions and gut reactions help us deal with short-term challenges that we’ve experienced many times before.

Barking dogs. Stormy conditions on the drive home.

But investing is a long-term game that confronts us with situations we have very rarely if ever confronted. 

We struggle to calculate the odds, can’t cope with the unpredictability, and draw poor conclusions from scant evidence. 

That’s why, for me, stress management in this alien place is about:

How do you manage your stress? What psychological pitfalls do you think we face as investors and how do you deal with them?

Let us know in the comments below. 

Take it steady,

The Accumulator

What caught my eye this week.

Leave aside the existential horror of watching the former leading nation of the free world look ever more like it’s LARP-ing its way through the decline and fall of the Roman Republic, and from a market-watcher’s perspective the US elections have been quite entertaining.

I’ve especially enjoyed the narratives used to explain the gyrations in share prices as the drama has unfolded.

As markets fell in October we were told investors were pricing in a Biden victory. Indeed, a ‘blue wave’ was about to seize the levers of power.

“All those juicy tax cuts will be reversed! Regulation will resume! Sell equities!”

Then as the market rose around election day we heard investors foresaw a huge spending spree by Democrat president Biden. Shares rose in anticipation, apparently.

“Mo’ stimulus, mo’ gains!”

But then Trump seemed to do be doing better than expected – and markets kept going up anyway. Oh, that was because supposedly investors love a gridlocked Washington.

“It all leaves politicians unable to do anything to upset the applecart / gravy train!”

But why were tech stocks rallying the most? Um, that was because the US Federal Reserve would have to keep rates lower for longer in an uncertain and undecided America.

“TINA 2.0: There is no alternative!”

At least when you go to a fortune teller you get a cup of tea.

Donald ducked

The reality is all this and more was being priced-in, every second. Not to mention the fact global markets had fallen 5-10% in previous weeks and to some extent were probably just retracing their losses as shares changed hands from weaker nervous investors to those happier to take their lumps.

My own pet theory is President Biden is far more likely than Trump was to try to get Covid by the throat in the US and strangle it. In the short-term that could mean a slower recovery and more government borrowing and money printing. All good for technology and growth stocks.

But who knows? The key point is narrative follows price action – at least by the time it reaches the masses. Not the other way around.

Have fun with the pundits if you must (I do) but be wary of taking any of it too seriously.

As my co-blogger said last week:

The market is the consensus of expectations on the future of a stock. Only unexpected events can shift the price. How can you predict the unexpected?

The short answer is: you can’t.

Have a great weekend.

[continue reading…]

What now? Money-weighted? Is this some new humblebrag? Where you make out you’ve got so much money that you have to weigh it rather than count it?

If only.

Tracking your money-weighted return is a commonly accepted method of measuring your investment performance, if you’re an everyday kind of investor.

For that reason, I use money-weighted returns to track the Slow & Steady passive portfolio.

Slow & Steady portfolio tracker download – We’ve had a fair few requests over the years to make the Slow & Steady portfolio tracker spreadsheet publicly available. Ta-dah! There it is at last. I’ve finally cleaned it up so it’s fit for human consumption. Please copy the template and adapt as you like for your own portfolio tracking needs.

Why am I stressing this money-weighted return business?

Because most of the returns we see in fun-time stories like “The FTSE 100 has gone nowhere for 20 years” or similar do not necessarily reflect our personal investment experience.

The financial industry prefers to report time-weighted returns, but there are many other different methods.

Money-weighted returns show a personal return that adjusts for common investor behaviour such as pound-cost averaging or crazy market-timing stunts.

Money-weighted vs time-weighted returns

It’s a clash of the accounting titans:

Time-weighted returns – This is how indices and funds typically report returns. The procedure strips away the impact of cashflows in and out of an investment. It measures how a portfolio performed over a specific length of time – with all time periods weighted equally. This makes sense if you’re a fund manager publishing your annual performance report. You don’t want to be judged on the whims of active investors withdrawing a billion pounds last quarter because Bitcoin had a good month, for example.

Money-weighted returns – This approach captures the effect of contributions and withdrawals on your returns as opposed to eliminating them. Time periods in which you have more money invested have more impact on your overall return. It’s likely to be a better reflection of your investment experience, especially if you pay in £500 a month, say, instead of £6,000 at the beginning of the year.

If you made a big withdrawal to avoid a market crash or bet large on an anticipated surge then you’d get some sense of your ‘skill’ (or good luck) by comparing your money-weighted return versus your time-weighted return.

The Investor wrote a good piece on unitising your portfolio. Doing so enables you to track your time-weighted returns.

You’re now reading the money-weighted sequel to that post and it’s only taken me five years to get around to it. (Luckily The Investor does not demand time-weighted invoices).

XIRR: the money-weighted annualised return formula

XIRR is a formula that enables you to calculate your money-weighted rate of return.

You just need a spreadsheet and a few pieces of information:

• The dates you made any contributions and withdrawals from your portfolio.
• The value of your portfolio and/or holdings.

That’s it.

Tracking your portfolio using XIRR gives you a ‘personal return’ because it’s sensitive to your specific contribution and withdrawal history. Even if you hold a one-fund portfolio, your returns will differ from somebody else with the self-same portfolio due to your different trading histories.

The example below shows you how to use the XIRR formula to produce an annualised return using Google Sheets or Excel.

Set up your columns and rows like this:

The dates formula is used in every cell of the dates column.

The XIRR formula is used in the annualised return cell that shows 16.87% in the example above.

The final rows in the formula (D17 and C17 in the example) refer to the grey ‘total portfolio value’ row.

XIRR: what counts as cash flow

• Do not include dividends as a positive cashflow. The reason is that we’re measuring total return here. So when you reinvest your dividends, their effect upon performance will show up in your portfolio’s total value.

• Dividends withdrawn from your account do count as negative cashflows because they are a reduction of your total return.

• Do not count platform fees, dealing fees, and other expenses that are taken from your account. You don’t chalk these fees up as a negative cashflow because the dosh you put in to cover them shows in your positive cashflows, while its loss is felt in your portfolio’s lower total value. The money went on some asset manager’s cigars rather than on more assets compounding for you.

• If, however, you pay fees from a separate account then do input those as negative cashflows.

• If you sell an investment to cash and reinvest it then that doesn’t count as cashflow. If you withdraw that cash from your portfolio then of course that’s a negative cashflow.

You can aggregate multiple accounts into one XIRR annualised return figure by pooling all cashflows and values using the layout in the spreadsheet example above.

XIRR: trouble-shooting

Make sure you input your positive and negative signs correctly.

#NUM! error in your XIRR annualised return cell usually means the values in the grey ‘total portfolio value’ row haven’t been changed, or the XIRR formula wasn’t adjusted when the grey row moved down after new cashflow dates were entered.

The error can also mean the estimated return ‘guess’ needs to change. The guess (see the 0.05 number in the XIRR example above) gives the formula a starting point from which it can iterate the result. Try values from -0.1 to 0.1 if you get a #NUM! Error. After that you’ll need to spelunk for an answer on the internet forums – the Bogleheads are very good on XIRR – or try our comments below.

XIRR gives an annualised return. Investments held for a short-time may look Buffett-beatingly good on this view. For example, a new fund that gains 10% in a month will show an annualised return of over 207% using the standard XIRR formula. And sure, that’s what you’ll earn if that momentum is maintained over 12 months.

Back in the real world, you can apply a year-to-date XIRR formula to show how you’re really doing.

Substitute the standard formula for this beauty:

=SUM¹^²)/365))-1))

Here’s the year-to-date formula in action:

The year-to-date formula is used in the cell that shows 10% in the example above.

The final rows in the formula (B3 and A3 in the example) refer to the grey ‘total portfolio value’ row.

Switch out the year-to-date formula once your investment reaches its first birthday.

There are variant XIRR formulas available. These include ones that let you account for leap years if you need precision like a Swiss watchmaker.

You can get a real rather than nominal return by subtracting average annual inflation for the period from your annualised return. Use an inflation calculator to help you do this.

Remember XIRR is good but it’s not perfect. Google it and you will find some complex forum debates that work through the more outlandish scenarios like Kasparov-level chess problems.

If that’s not your cup of Novichok then know that XIRR is good enough for most people in most situations but other return measures are available.

Here’s one we made earlier

Our Slow & Steady portfolio tracker template shows you how to track your annualised return across multiple funds within a portfolio (see the Cashflows tab).

It’ll also help you see how the XIRR formula works so you can use it to create your own money-weighted returns.

I recommend building your own spreadsheet that’s fully customised for your own brain. It’s a good way of keeping yourself out of mischief on dark winter nights.

Elsewhere:

• The Bogleheads do a good spreadsheet that tracks money-weighted and time-weighted returns.

• FIRE v London put together an absolute humdinger that you can plunder for more portfolio-tracking ideas.

• Morningstar’s Portfolio Manager also tracks your returns from multiple angles and sucks in their financial data too.

• Our very own Lars Koijer has put together a YouTube series on building your own spreadsheet.

Finally, my co-blogger The Investor alludes to his own legendary spreadsheet that you’ll sometimes hear talked about in hushed (/skeptical) tones. It’s unitised, because The Investor likes to pretend to himself that he woulda, coulda, shoulda been the next Warren Buffett.

Perhaps if we lobby him hard enough he’ll release it into the wild – in five more years.

How do you track your returns? Let us know in the comments below.

Take it steady,

The Accumulator

1. (1+XIRR(B1:B4,A1:A4,0.05[↩]
2. (DATE(2019,1,31)-(DATE(2018,12,31[↩]