What caught my eye this week.

Over in the world of active investing, there’s a changing of the guard taking place. Or at least there is if you believe one of the leading guardsman.

More on him in a moment. Let’s focus first on the man in the red corner, cruising for a bruising – yesterday’s hero Neil Woodford.

Woodford made his punters richer for decades. But after a rotten run he’s now less popular than a Tory in a European Election.

According to ThisIsMoney:

Nervous savers pulled cash out of Neil Woodford’s flagship fund as it lost £560 million of its value in just four weeks.

Money in the once-feted Equity Income Fund dropped from £4.33 billion in April to £3.77 billion this week, research firm Morningstar said.

The fund looked after £10.2 billion of investors’ cash at its peak in 2017, nearly three times the current amount.

Woodford is a value investor, and those sort of stocks have been on the ropes for a decade.

A decade!

Is value dead? Even the passive factor-based investors have fretting, although some leading lights have suggested value’s long hibernation is all the more reason to own it.

As one, Wes Gray of Alpha Architect, put it earlier this month:

Don’t get rid of your value because it hasn’t been working, but arguably get more of it – if your goal is to try and beat the S&P 500 over the next 20 years.

Which brings us to the blue corner – where man of the moment James Anderson of the Scottish Mortgage Trust is having none of it.

Heavyweight champion of the world

Anderson is the Woodford of right now. Not in the way he invests, but rather in the way private investors name check him and his fund when you say passive investing is the best way to go for most.

In other words his fund has been winning for many years.

Scottish Mortgage’s Trust’s underlying investments are up about 500% over the past decade. The shares have done even better, registering a 600% gain as a discount has turned to a premium. That’s a staggeringly good run, even after remembering the US tech-heavy Nasdaq index has itself soared more than 300% over the same 10 years.

Now, I could take this quick post in various different directions here. For instance, I could do a bit of a beneath-us sniggering at individuals who don’t understand the hard part in active fund investing is to find the funds that will do well in the next 10 years – as opposed to shining a light on one of the best and best-known performers of the past.

Or maybe to offer a gentle reminder that zero sum games such as active investing can and often do have huge winners – and equally losers – and hence Scottish Mortgage hasn’t somehow broken the case for going passive.

But the trouble is I can’t snicker too loudly… because I’m also a bit of an Anderson fanboy.

No, I don’t currently own shares in his trust. But I do like to read his reports. Say what you like about active investors, they write far more interesting guff than passive funds can muster. (Of course they do, it’s part of the marketing!)

Anderson is particularly readable. He’s got a whole theory about how most listed companies are set to be disrupted into irrelevance by the technological revolution that’s barely gotten started. It’s thought-provoking, and I recommend an occasional peruse however you invest if you’re at all interested in technology and change.

The question though is whether Anderson has really identified a breach in the value-growth continuum – whether it “is different this time” – or if instead he’s just the latest incarnation of a growth investor grown fat and full of hubris before a bust.

Boxing clever

The latest Scottish Mortgage annual report [PDF] tackles the question head on:

It has been an investment commonplace for long decades that growth investing is a chimera. Value investing, especially as articulated by Warren Buffett, has risen to the status of the one true faith. Yet over the last decade growth indices have substantially outperformed their value counterparts.

Moreover this trend has principally been driven by the shares of a cohort of major internet platforms that have defied all predictions of doom based on the strains of growth from an already large base or assumptions of a short competitive advantage period.

What’s going on? According to Anderson, modern technology platforms – from Google to Uber to Microsoft – can now scale efficiently to an almost indestructible size, while venerable companies are being outmoded out of existence.

Value will therefore not come back from the dead because this time many value-style companies are going to be finished off once and for all.

And if that’s true, then Neil Woodford won’t be coming back either.

But if it’s not – if things aren’t really different this time any more than all the last times – then Anderson and Scottish Mortgage Trust may well be terrible places to put capital for the next decade, as finally we see a reversion to the mean, a swan dive for growth, and a value resurgence. (This could happen due to high share price valuations coming down, incidentally, even as the growth companies themselves prosper.)

Of course with a global tracker fund, you own both the growth Goliaths of today and the potential down-and-out value Davids of tomorrow.

Chalk another win for passive investing, and then settle down to watch the fight.

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The life expectancy of a couple is much longer than any pair of individuals – more than a decade longer. If you’re taking responsibility for a retirement plan for two, you need to know what the odds are that both or one of you may make it to a ripe old age. Long life can drain your portfolio like Facebook drains the battery of an aging smartphone.

We’ve already looked at how to find good life expectancy data for individuals. But we need to go one step further to see how two hearts make one financial strategy.

(This counts for romance on Monevator.)

Survival probability

When you’re joined at the financial hip, it’s a big mistake to look at life expectancies separately. This table from a retirement research paper by Dr Paul Cox of the Birmingham Business School shows why. For a heterosexual couple:

The 50% chance that one of our two lovebirds still needs money by age 95 is much higher than the 33% probability for females, or the mere 25% for the males circling the drain.

And that’s for a UK couple born in 1950 who’ve reached age 65. For a matching set of Gen Xers, born in 1970, Cox calculates that the chances of one of them still being in business at:

• Age 95 = 60% probability
• Age 100 = 36% probability

Cox thinks the probability of one member of a couple surviving to age 95 and 100 is increasing by 3% every five years.

So individual life expectancies fly about as well as a paper aeroplane. Gambling your future security on a 50-50 bet of making age 95 won’t look smart if there are still bills to pay, your portfolio has waned, and you haven’t had the decency to fall off the log yet.

We need to settle upon a pragmatic degree of failure. For example:

“We’ll plan for a 50-year retirement because we accept a 10% chance that one of us will stagger on beyond that point, and a 90% chance that neither of us will.”

Then we need to personalise those odds with a projection of our shared life expectancy.

Enter the Longevity Illustrator

The Longevity Illustrator constructs survival probabilities for couples using US Social Security data. That’s good enough for our purposes – we’re looking for a plausible time horizon not a palm reading.

Enter your age, gender, and health deets, then watch your possible futures unfold in a few graphs.

Here’s the key table for an everyday couple – retirement planning obsessive, The Accumulator, and reluctant financial case study, Mrs Accumulator:

Our acceptable failure rate is 10%. The bottom row shows a 10% chance that one of us will last 50 years beyond our retirement date. I accept that Mrs Accumulator is the bookies’ favourite.

There’s a 10% probability that both of us could last 42 years. I need to target a portfolio size and sustainable withdrawal rate (SWR) that can provide a dual income for at least that long.

It does sting a little to see there’s only a 50:50 chance we’ll both be around for 30 years. We’d better make the most of the time we have.

Dr Cox’s work helps us put some UK context around that table:

Between ages 80 – 84 two thirds (65%) of all men and one-third (30%) of women are part of a couple. At age 85+ one-half (48%) of all men and 1 in 8 (13%) women are part of a couple.

The large drop in the proportion of women living in a couple is because the proportion of widowers rises.

This life expectancy post explains how to find UK mortality data suitable for your year of birth if you want to go the extra mile. You can calculate your own survival probabilities with the formula I’ll share in a bonus appendix below.

You should reduce your SWR if you need to live off your portfolio much over 30 years. There’s good evidence you should increase your equity risk if you want your wealth to last 40 to 60 years.

What does failure look like?

It’s important not to overdo fears of eating dog food in retirement. Failure rarely looks like bankruptcy. In practice the chance of living long enough to run out of money is smaller than it seems because it depends on two events:

The probability that your portfolio fails.

And

The probability that someone is left alive to rue the day.

For example:

There’s a 10% chance that one of you survives 50 years.

There’s a 10% chance your portfolio runs dry given your chosen SWR.

The probability that both events occur together is 0.1 x 0.1 x 100 = 1%.

That’s a 99% success rate. That’ll do me.

Besides, even a 1% fail case doesn’t necessarily mean you run out of money. It means you’ll need to lower your spending along the way to prevent your portfolio ebbing away.

That will probably happen naturally when your portfolio only has to support one of you – assuming your next move isn’t to shack up with some asset-less Condo Casanova. (I recommend prohibiting that in your relationship agreement.)

Still, one person can rarely live half as cheaply as two, as the Pensions Policy Institute warns:

The proportion of pensioners living alone has increased as a result of divorce becoming more prevalent at older ages and increased longevity leading to widows and widowers living for longer.

Living alone tends to decrease income due to the loss of a partner’s pension and reduce living standards as a single person requires more than half of the income of a couple to maintain the same living standards.

Hmm, divorce, yes, that’ll screw things up, so be nice.

Watch out, too, if the new State Pension is a fundamental part of your retirement calculations. Most people will inherit the square root of naff all from that quarter when their partner dies.

Finally, if your data points to long life then put an annuity on your ‘to do list’ for your early seventies.

Annuities are currently the best financial tool we have for buying lifetime income cheaply, aside from the State Pension. There are pitfalls to avoid, they are much misunderstood, and you need to live well into your 80s to come out ‘ahead’, but annuities are a great way to live long and prosper.

Take it steady,
The Accumulator

Bonus appendix: Survival probability calculation for a couple 

Take the probability that you will be alive in 50 years, for example:

Jill = 25% chance
Jack = 10% chance

The probability that both of you will be alive in 50 years:

0.25 x 0.1 x 100 = 2.5%

To work out the probability that either of you will be alive in 50 years:

The chance that Jill will be alive but Jack will not: 0.25 x 0.9 x 100 = 22.5%

The chance that Jack will be alive but Jill will not: 0.10 x 0.75 x 100 = 7.5%

The chance that at least one of our pair will be alive in 50 years:

2.5% + 22.5% + 7.5% = 32.5%

Check out more investing maths fun with Monevator!

What caught my eye this week.

Like anyone who understands the mathematical case for index funds, I find the attacks against them almost universally spurious.

As Rick Ferri wrote this week on Forbes:

The truth about index funds must be repeated often because lies are constantly being told. They are successful because they are good. Those who cry wolf either don’t know the truth or have a strong financial incentive to ignore it.

Happily, the message seems to be more than getting through. The Abnormal Returns blog noted this week that with US equity passive and active strategies now having equal amounts of trillions under management, the question is how much further passive investing can grow.

Before we get carried away, I’d note that much of those ‘passive’ trillions are in ETFs. And ETFs are often used as trading vehicles by fund managers. So it’s unclear to me whether more than 50% of invested money really is lying on a metaphorical sun lounger, accepting the market’s return while its owner does something more interesting instead.

Nevertheless, the direction of travel is clear. Ever more investors are passively accepting what the market gives them – minus tiny fees – and building long-term financial plans around that reality.

What’s the catch?

This brings me to an interesting opinion piece in the Financial Times – and also to the only push back against the rise of index funds I’ve ever found persuasive.

Starting with the latter, occasionally someone says something like:

Index funds make all this too easy. I can put my money into an all-in-one passive equity and bond fund, leave active investors to make all the hard decisions, and take 8-10% a year? It is too good to be true. Stuff like that usually ends badly in the financial markets.

And this touches a nerve because… I sort of agree. When something works too well investing, with too little downside, well, sooner or later it usually blows up.

Now of course index funds do come with downside. Shares definitely go down as well as up!

I hear people, especially in the US, saying stuff like “I play it safe with my S&P 500 index fund and don’t take too many risks”.

That is a ten-year bull market speaking.

But let’s put normal volatility to one side. There is still an inherent tension with index funds in the strategy being the easiest AND cheapest AND biggest AND YET it relying on a shrinking supply of people doing the most expensive thing, which also happens to be the hardest, for overall lower returns.

Then again, tension-schmenshion – active investing is a zero sum game. That won’t – can’t – change.

So how does too-good-to-be-true resolve itself?

Let them eat bonds

Back the FT article [search result] where author John Dizard compares confident equity investors to the indolent aristocrats of the French Revolution, adding:

The retirement savings/investment industry is promising the creation of a class of notionally idle, ie retired, people which will be at least an order of magnitude larger as a share of the population than la noblesse.

This group would be with us for decades alongside a stagnant (at best) working-age population.

At the same time Prof Siegel and the equity cult would ‘reform’ state entitlements so those without equity portfolios have to perform real work up to and even through their 70s.

The statistical construct of eternally compounded 6 per cent-plus investment returns has allowed upper middle class people to believe this Disney movie.

Doesn’t Dizard have a point?

At least active investing looks like work.

At least in the old days a saver giving their money to a fund manager looked like a risk-taking investor.

And at least ducking in and out of the market in a futile effort at market-timing looked like skill, risk, and reward at play.

Sure in reality we know the market’s aggregate return is the same, whether the money is investing passively or actively, ignoring fees.

But if the woeful politics of the past few years have taught us anything, it’s surely the importance of optics.

Perhaps the Achilles’ Heel in the kind of dial-it-in global-tracking we champion on Monevator could be political backlash, rather than bogus mathematics?

I’m not convinced but it’s worth a ponder.

What do you reckon?

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