What caught my eye this week.

Out of sympathy with those who can take no more of the national pantomime, I decided to run my Brexit-themed introduction as a separate article this week.

(There’s a pretty good conversation developing in the comments, so you might take a look if you only tend to read us via email.)

Fewer than six weeks to Christmas!

[continue reading…]

[Trigger warning: Off the cuff Brexit thoughts ahead. Reading is optional! My blog, my thoughts, and I’ve started so I’ll finish. Just click away and you needn’t be troubled by it! Nor will you feel forced to be rude about me in the comments.]

A few days after the Referendum in 2016, I wrote a short satire chronicling the happy state of Barry Blimp, a middle England  Leave supporter:

And Brexit is going so well! Better than even Barry might have expected.

True, the markets initially dipped 2-3% percent when the result was announced, as lily-livered Remainers sold their holdings and made enquiries about moving to Australia.

But equities soon bounced back as brave Brits like Barry stepped in to staunch the bleeding.

Article 50 was triggered immediately, and the terrified Europeans quickly caved in to all the bold Brexiteers’ demands.

Now international capital is flocking to the UK, as it sees how the nation has freed itself from the yoke of EU membership that had held it down and kept it only the fifth largest economy in the world.

At this rate we’ll be challenging China for the number two spot by Christmas!

Two and a half years on, and as fantasy has given way to fact an apology is required.

I apologize to anyone named Barry.

Back in the (sur)real world, Brexiteer MPs – including two former Brexit secretaries – are looking to thwart Theresa May’s best attempt at solving British politics’ version of Gödel’s incompleteness theorem.

They aim to derail May’s deal by employing the same meaningful Parliamentary vote won by those they once branded “The Enemies of the People”.

Just another day in Brexiteer-land.

After that Referendum

As predicted, Brexit has been an all-consuming waste of time for nearly three years1.

And it’s done this blog no more favours than the country.

I lost many readers in the Referendum’s divisive aftermath. I became less enthusiastic about writing here, too.

At least Remainers and Leavers are now united in agreeing Brexit has been a shambles.

My more constructive critics suggested I focus on the investing implications.

I see their point, but the perverse contradictions of Brexit makes this easier said than done.

Macro-economic forecasting is always fiendishly hard, and with Brexit the range of outcomes is very wide and the appropriate actions you might take at odds with each other. Assigning probabilities to the various exit scenarios feels like betting on raindrops sliding down a window pane.

The only certain advice is to be diversified. But that is always the best advice.

Even leaving aside the fickle markets, let’s consider the British economy.

The story so far

Everything that has happened so far is before any Brexit, remember. Today we still enjoy exactly the trading arrangements as we did before the Referendum.

Still, I thought uncertainty alone could take us into recession after the Referendum. I wrote a post saying so, and suggested ways to think more defensively.

But as things turned out, there was no recession. Some criticism from Leavers on those warnings is understandable.

So why did the economy keep growing, against expectations?

Perhaps I and others were wrong to be so gloomy, but there were other factors – the unexpected delay in triggering Article 50, the interest rate cut (opposed by many Brexiteers), and most of all a sudden recovery in the Eurozone, ironically enough. It’s hard to have a recession when your largest trading partner is expanding, retooling, and restocking, even as interest rates are being cut towards zero.

The weak pound probably hasn’t hurt either, although it’s squeezed importers – not least struggling retailers and restaurants.

Also, while we didn’t go into recession, we did go slump from being the fastest-grower among the leading G7 economies to the slowest:

Source: Full Fact

If you’re a hardcore Brexiteer who wants maximum sovereignty then this economic hit – and even the chaos of a No Deal exit – may well be worth it.

I can respect that point of view, though I think maximum technical sovereignty is a hollow victory in our incredibly integrated world (we’re already seeing that in the compromises May struck with Brussels).2

But for the rest of us, it’s a bit sickening to imagine where we might be now had Remain won.

With Europe recovering and the rest of the global economy motoring, we’d likely have seen a mini-boom. Higher real wages, and politicians focused on all the important issues they’ve been forsaking for the phony Brexit war.

Maybe we’d even have made more headway with the public finances.

Pounding the point home

As for our personal finances, so far Brexit has appeared to be a boon for well-diversified British investors based in Britain.

This is due entirely to the sharp fall in the pound – something Brexiteer MPs reliably fail to mention when citing a rise in the FTSE 100 as proof the market is fine with Brexit.

As is now well understood, global equity trackers mostly hold overseas assets. Three-quarters of the revenues of the UK’s largest companies come from abroad, too.

So the sharp fall in the pound on worries about what Brexit means for Britain has actually boosted both the London market and many a diversified Monevator reader’s net worth.

Of course, that’s measuring your net worth in sterling terms, as most of us do.

On the global stage we’re poorer than before the Referendum, due to that plunge in the pound. This loss of purchasing power is showing up at the margins in higher import prices including food and fuel, and in Britain becoming a less lucrative market for EU workers.

You’ll also have felt it if you’ve holidayed abroad.

Investing in the face of Brexit

Having made it thus far intact through the Brexit saga, what should investors do now?

Well, in terms of your personal finances, I think a safety first review is in order. Even Brexiteers admit crashing out without a deal in March will be disruptive. At the other end of the spectrum the forecasts are dire.

Either way, given Hard Brexit has become a very possible – if still less likely – outcome, make sure you’re sandbagged against any potential storms.

I think my original post on actions to take ahead of a possible recession is worth reading.

What about investing specifically?

Passive investors

The good news for well-diversified passive investors is they needn’t do much, if anything.

Indeed the entire Brexit saga has been another notch on the bedpost for strategies like our own Slow & Steady passive portfolio.

One of many benefits to getting your equity exposure via a global tracker (or a basket of large geographic equivalents) is you diversify away country-specific risk. This inoculates you against the dreaded ‘Japan syndrome’ – the possibility that a particular country’s stock market goes down not for a brief bear market but for an investing lifetime.

True, with the bulk of its earnings generated overseas, the UK’s FTSE All-Share is less at risk of this than most indices. But it is still good practice for hands-off passive investors to follow the global money, as we’ve explained before, and it has served you well in the face of Brexit.

Most passive portfolios will also own a chunk of UK government bonds (gilts), which have held up well.

Of course gilts have not benefited from the weaker currency, but that’s fine. A good portfolio is about balance. Bonds are not really there for return, and you’ll be happy to have some exposure to the pound if Brexit is resolved amicably and sterling rallies.

Beyond those two lynchpin holdings come corporate bonds, commercial property, foreign bonds (typically hedged) and more exotic fair such as emerging market and small cap funds, gold and commodity ETFs, as well as factor funds.

These should all be relatively small allocations, and so in the short-term they shouldn’t be determining how your portfolio fluctuates as Brexit progresses. Their aim is rather to gain a small edge over the long-term.

Active investors

When I started this post I thought this would be the biggest section. Now I’ve got here though I find myself thinking there’s little to constructive say to my fellow naughty active investors.

I can only tell you what I’ve been doing.

Note: This post should be taken as a talking point, not as advice as to what you should do yourself. I am far less sure as to how things will unfold than I was even in the financial crisis! See below for more.

Firstly, I am shifting my portfolio allocations around a lot – daily – as things change. This has a big cost in terms of friction and hassle, but, well, that’s what I’ve signed up for. (See this for more. And again I don’t advise it!)

Right now I have the smallest allocation to UK -listed companies – my traditional stock picking ground – I’ve had in 15 years, though it’s still above benchmark weighting. I’ve been especially wary of most UK-focused firms.

Percentage-wise I’m the least exposed to equities I’ve ever been as an investor, although mostly for reasons other than Brexit.

I hold huge (for me) wodges of cash as well as a handpicked and changeable collection of bond ETFs. I’m 6% in gold ETFs (hedged and unhedged).

Diversify, diversify, diversify!

For two years now I’ve also invested with one eye on the exchange rate, which has been an extra headache.

Several times I’ve increased my UK focused holdings when the outlook has looked brighter.

The pound looks undervalued, and I fear a sudden reversal if Brexit pessimism proves unfounded.

But mostly the traffic of UK holdings from my portfolio has been outbound.

This snapshot of the biggest fallers from the FTSE 100 mid-afternoon yesterday gives a good idea why:

To make matters even more complicated, many UK-focused companies are probably falling due to the growing chance of an interventionist Jeremy Corbyn government.

In fact active investors trying to position their portfolios in light of the various Brexit outcomes have to think about at least five credible scenarios (my guesses on the likely impact in italics):

Hard Brexit – Clearly now possible given the universal dislike in Parliament of Theresa May’s deal and the time left before we’re meant to leave. Bad for UK-focused shares, unclear for gilts, very bad for the pound, good for overseas earners/holdings, could see interest rates may go higher or lower.

May’s Deal (previously Soft Brexit) – The deal on the table pleases nobody (leaving aside the fact that it’s not even really a deal, just a divorce settlement and an outline for how to proceed). In the short-term at least it’s a far worse arrangement than we have now in almost every respect. But MPs might end up voting it through anyway because it’s better than Hard Brexit. Okay for UK-focused shares, unclear for gilts, good for the pound, bad for overseas earners/holdings, interest rates probably go higher.

A New Amazing Deal With Unicorns – Perhaps the Government will somehow get more time to come up with something better. I don’t believe anything much better is possible, given the contradictions of Brexit and the EU’s position, but who knows. Great for UK-focused shares, unclear for gilts, good for the pound, bad for overseas earners/holdings, interest rates probably go higher.

Second Referendum / No Brexit – Does anyone believe Leave would win a Referendum if it was held tomorrow? Brexit was blatantly mis-sold, which you’d think would be enough to reverse Leave’s slender majority. I worry about the democratic impact of not Brexiting, given how it’s been spun up as The Will of the People, but that’s for another day. Still unlikely, anyway. Great for UK-focused shares, unclear for gilts, great for the pound, bad for overseas earners/holdings, interest rates probably go higher.

General Election – Possible now, and I think Jeremy Corbyn would have a fair chance of winning. It’s unclear what the Labour party’s approach to Brexit is. Yes I know what they say, but are, for instance, the fantastical ‘six tests’ really meaningful? Bad for UK-focused shares, bad for gilts, bad for the pound, good for overseas earners/holdings (short-term), interest rates may go higher or lower.

As you can see, describing Brexit possibilities as a binary outcome doesn’t really cover it.

Moreover as these possibilities come to seem more or less likely, their consequences are brought forward or discounted on a moment to moment basis.

Traders might thrive in such an environment (though I’ve seen little evidence of that) but it sure makes the fundamental company-level analysis I mostly employ extremely difficult.

Passive is a great alternative. If I could click my fingers and do it all again I think I’d put everything into a Vanguard LifeStrategy 60/40 fund the day before the Referendum and not look at my portfolio until this is over!

How are you invested?

Finally, remember our recent discussion of mental accounting in all this. In particular factor your home into your thinking about your exposure to recession and market risks, assuming you own it.

If you’re concerned that your global trackers mean you’ll be hit should the pound rise, your house may comprise a huge proportion of your wealth that effectively hedges against that possibility.

On the other hand if you’re a stock picker who has mainly been buying cheap UK-focused shares, the opposite could apply. Your house could fall 20% or more in some Hard Brexit scenarios. Why take the risk of all your shares going the same way?

How have you been investing through Brexit? I am sure – indeed I hope – we’ll hear passive investors say “drama, what drama?” That’s what this site exists for!

But I’d also be curious to hear how fellow travellers along the dark side of investing are approaching the conundrum.

1. If you count the campaigning beforehand. [↩]
2. I also don’t believe it’s what motivated a majority of the 52% in the Referendum. But let’s not start that again. [↩]

People say odd things about the 100 to 1,500% returns they’ve made from home ownership.

• They say no financial value is created until they sell.

• They say even if they did sell they’d only buy another home, so the gains still don’t count.

• They say it isn’t real money, or it’s funny money, or it’s paper money.

• House price falls don’t count either, because of the ‘unless you sell it’s not real money’

• They also say a home isn’t an asset because you have to live somewhere. Useful things can’t be assets? (I debunked this in a different post.)

What you’ll notice if you observe this as only an obsessive property-loser like me could – green eyes pressed up against their fancy bi-fold doors, watching them toast their non-existent mortgages – is how the line varies.

Some clearly do believe their house price gains are real money, because they’ll inform you they foresaw stratospheric rises when they bought a bedsit in Balham in the early 1990s for £20,000 that’s now worth £500,000.

When such gurus speak I get out my notebook and learn all I can. It’s not often you meet prescient financial wizards.

More often, thankfully, I hear the ‘only paper money’ sentiments offered not unkindly as a consolation to people who don’t own their own home.

Yet saying your six-figure house price gains aren’t real comes across as about as self-aware as a supermodel giving tips on succeeding on Tinder by wearing a hat.

What anyone normal sees if you got onto say the London property ladder 25 years ago with a £10,000 deposit and a £100,000 mortgage is you now own an asset worth perhaps £700,000 – a gain far north of half a million quid.1

Agreed, the homeowner will have paid a mortgage on top – but remember the We All Have To Live Somewhere clause.

Non-homeowners pay rent, moving costs, and they go to IKEA, too.

We can quibble about the precise numbers, but given landlords (i.e. professional homeowners) aim to profit from renters, it’s clear owning over the long-term isn’t usually a bigger financial burden than renting a similar property.

The net result is Person A bought and owns an asset worth maybe £700,000.

Person B didn’t, rented instead, and doesn’t.

Yet I’m told Person A is not better off than Person B, because it’s not real money.

Have I got that right?

Mental accountancy: The number of the beast

I’m having fun, but this isn’t really a post about the specifics of house prices, or the rights and wrongs of the market – or even sour grapes!

(And yes, I do still owe you an article on why I did finally buy my own flat. It’s coming. Prepare for an anti-climax.)

Today I’m more focusing on this mental accounting people do.

Mental accounting is why they say their home is not an investment, and that house price gains and losses aren’t real.

Their mental accounting is also what can make them sound so insensitive when they tell you they’re not really better off, because when they sell this £1m property they’ll only have to buy another bloody one.

In reality they could sell-up, rent, and have all that cash in the bank, or in a diversified portfolio of shares.2

But the house equity lives in a different mental bucket, so they rarely see it that way.

Mental accountants I have known

I have a close friend who is of the ‘house gains aren’t real money’ mindset.

Helped by a chunky family-funded deposit, he bought his first flat in a gentrifying part of South London in the late 1990s.

A bighearted person, he has often acknowledged his good fortune in getting help onto the ladder. He even charged me a mate’s rate rent as my landlord for a couple of years, which I didn’t expect and appreciated.

Yet he has shrugged off the growing value of his property assets over the years – even as the equity came to dwarf his other savings and any sensible multiple of his income – due to the ‘needing somewhere to live’ theory.

I saw things differently (increasingly so, as prices got away from me) and said so whenever the subject came up.

Things came to a head recently when he suggested I finally join him on one of his incredibly regular foreign holidays.

I’m also currently single and childless, he said – why not enjoy myself? After all, now I’d finally bought my own flat too I could surely let my hair down.

That – ahem – triggered me.

As tactfully as I could after 20 years debate and several glasses of wine, I pointed out that to buy my flat I’d had to find more than £500,000 from somewhere that he had never had to.

He might not consider his price gains real. But the price rises are very meaningful to someone who has to pay them in today’s market!

In short, he could take a couple of hundred holidays costing £2,500 or so over the next 25 years – maybe 5-10 a year – before I’d be in the same position as him.

Not my finest hour, granted, but there’s only so much you can take of someone saying it’s meaningless trivia that they live in a property that would today cost them roughly 20-times their income before you snap.

His mental accounting met my mortgage budgeting, and there were fireworks.

But…

…it’s actually worse than that. Because I’m sure you saw what I did there.

What earthly reason did I have to set holiday costs against the gains on his flat?

There is no good reason. I was just mentally bracketing them together in the moment to wallow in my martyrdom for a few minutes – and perhaps to get out of an expensive holiday without resorting to voicing environmental qualms or my tightwad tendencies. (I see them more attractively, of course!)

I was fudging the figures for both of us. Instead of his housing equity I could have mentally positioned my investment portfolio against his meager ISAs and booked us both tickets to go.

But sadly I’m only human (my exes may disagree) with the same fit-for-the-savannah mind as everyone else.

And achoring, framing – many of behavioural finance’s Greatest Hits – all featured in that exchange.

More mental accounting

Examples abound:

• I’ve friends who say they have no savings. Over time I’ve learned (out of concern) most have fairly sizeable pensions. They don’t count these as savings, because they’re locked away for old age. But they are savings. If they didn’t have them, they’d have to start acquiring them.

• An active investor will sell half of a share holding that has doubled, and consider the residual investment to be free and losable – even though they’d baulk at working overtime for weeks to earn the same amount. See also Las Vegas gamblers and crypto-currency investors after the bubble burst. Sorry, your losses are real money losses.

• Passive investors will say a market decline doesn’t affect them because they are in it for the long-term. But there’s no guarantee the market will come back – or thanks to sequence of returns risk do it before they want to start spending. If your portfolio halves, it halves. You’re poorer, for now.

To be clear, I believe the passive investing mindset is the right way to go for most.

For that matter I’ve nothing against active investors diversifying out of winning shares, or gamblers resorting to mental accounting trickery to get some money off the table.

The key is to be aware when you’re doing it – because mental accounting can cause problems.

Consider an emergency fund. In my book, that’s a wodge of cash set aside to deal with emergencies.

Yet others will say their emergency fund is covered by their credit cards, or a share portfolio that they’ll sell down if they have to.

Such a strategy to meet cash needs may be right for them (I don’t advise it) but it does not have the characteristics of an emergency fund.

Share portfolios fluctuate, unlike cash.

Credit limits can be cut – perhaps just when you need the cash, and in the worst case for the same reason. And if you’ve just lost your job and need ready money fast is that really the time to go into debt?

Even an allocation of cash in a portfolio that’s mentally accounted for as doing double-duty as an emergency fund might lead you astray.

Perhaps you’ll own few to no bonds because of that cash. Then the market crashes, there’s a recession, you get a lower-paying job – and while you do have the cash to see you through, you didn’t enjoy the counter-balancing benefits you might have had with bonds, because instead you had cash moonlighting in two roles at once.

Worst case is you sell your shares at the bottom, because as you withdraw and spend cash from your portfolio, what’s left comprises an ever-higher proportion of equities that are falling in value, until you get scared you’ll lose everything. If your emergency cash had been mentally accounted for and separate in its own savings account, you might have ridden it out.

The truth is you never had an emergency fund. You had a flawed mental model.

There are also societal consequences of mental accounting.

You might choose to think of your home equity as paper money or not an investment, because you have to live somewhere, or because the costs and time involved in selling make it somehow not an asset in your view.

Fair enough, your call.

But the widespread acceptance of such thinking leads to the situation where as a society we’re asked to have sympathy for cash-poor pensioners rattling around wholly-owned five-bedroom family homes in the midst of a housing crisis, when they could sell up, downsize, and be flush with spending money.

Holding your finances to account

I try to counter my mental accounting with a giant spreadsheet.

This consists of a master sheet that details my best current estimate of my net worth from all sources.

Sub-sheets cover things like my share portfolio, my cash accounts, my unlisted investments, my flat, my mortgage, and other bits and pieces.

Some of the underlying sheets are updated automatically via the Web, others occasionally manually updated by me. The master sheet pulls from all of them.

Like this I can ‘bucket’ my money and investments as our brains seem to want us to do, but I also keep track of the true big picture.

I can also create novel perspectives on my financial status, by dividing various numbers by others. For instance I can work out my own debt-to-equity ratio, my liquidity position, or how exposed I am to property versus shares.

I break out what’s sheltered from taxes, and how, and what’s not.

In recent years I’ve even included an estimate of how exposed I am to different Brexit scenarios via the investments I’ve made (including my flat).

Some of this might seem wonky. But the point is I have many different angles on my finances – conventional and unusual – so it’s harder for me to delude myself.

If you do this, you might realize you’ve got more money tied up in your property than your pension, for example – or vice-versa.

You might see the £5,000 you keep in cash earning 1% that feels like such a drag on your returns is really just a small proportion of your total wealth including all your assets. It may be revealed as a small price to pay for the security of having cash on tap if required.

And if you don’t think your house gains are real money because it’d cost you to move, then fine, apply a discount of 5-10% on the appropriate sub-sheet. That’ll be a more accurate version of reality than pretending it’s still 1997.

Bottom line: However it’s wrapped up, whatever it’s earmarked for, whether it’s easy to get hold of or a right pain – it’s all the same real money.

Share your own examples of mental accounting in the comments below!

1. In practice you probably moved a couple of times, but of course those wonderfully untaxed gains go with you. [↩]
2. I’m not saying they should – again, this post isn’t about the rights and wrongs of property ownership. It’s about how people think about it and other assets. [↩]