Good reads from around the Web.

I bet you enjoyed stellar returns in 2016. Most well-diversified passive investors in the UK should have got into the 20% range.

Our own model portfolio flew up 25%!

It is easy to feel like you did really well last year, but a mistake to feel special. So put off the phone call to Foxtons and forget watching Billions or even Downton Abbey for lifestyle tips.

2016 was only a great year for most British investors because the crippled pound lifted our portfolios – both in terms of overseas holdings, and also by boosting our biggest multinationals.

And a currency shift is the most even-handed lift up (or slap down) that the market can give deliver. It’s largely blind to your talents, or otherwise, as an equity investor.

This chart of the FTSE 100 in pound, dollar, and euro terms is sobering:

Source: 3652 Days

You got much richer as a global investor based in Britain in 2016 because the UK got much poorer.

In the stocks

To do relatively badly in 2016 with equities you needed to be a stock picker, with all the wide dispersion of returns that entails.

Focusing on domestically orientated UK companies got full-time small cap investor Maynard Paton a bit over 7%, which is hardly a disaster. But a few wayward decisions saw John Rosier clock up minus 4%. Veteran investor and author John Lee [FT search result] did much better (and beat the UK index) with a roughly 18% showing from his UK companies, but even that hugely lagged a global tracker.

I’m not picking on these chaps to ridicule them, incidentally. As an active investor, I enjoy their writing and insights, and as best I can tell they’re all skilled investors.

I’m simply highlighting how easily (so-called) “dumb money” trounced the enthusiasts in 2016.1

As an active investor you know you’re going to have bad years now and then. It’s the price of admission. Anyone who doesn’t is either a quant genius far above my pay grade (and theoretically prone to blowing up) or else they’re running a Ponzi scheme.

Besides, the majority of hedge funds delivered yet another lousy index-lagging year, too. Some of those guys are paid millions to deliver worse than nothing.

Pounded portfolios could recover

Returning to currency, one elephant in the room for active investors like myself, Paton, Rosier, and Lee is if and when the pound will reverse.

Normally long-term equity investors can choose to ignore currency fluctuations, for various reasons we’ll save for another time.

But the speed, scale, and political nature of the pound’s shock drop arguably means things are different today.

If the pound rallies hard, then UK stock picker’s portfolios pregnant with home bias should spectacularly outperform, all things being equal.

But all things are not equal, and for Brexit-phobes like me it’s a daily challenge not to try to see the UK markets through Marmite-coloured glasses.

As for the passive investors who hopefully make up the majority of our readers, I say enjoy those great returns.

Why not? The science tells us we feel losses twice as much as we enjoy gains – one reason so many people avoid investing in volatile shares in the first place. Perhaps taking a moment to appreciate the good times can help counteract that.

But remember the good times won’t last forever.

I’ve long been more optimistic about stock market returns than the gloomsters. But another crash someday is a nailed-on certainty, and the pound seems unlikely to fall so spectacularly again.

Remember, the long run real2 return from shares is about 4-6%, depending on who you read. When I hear even John Lee talking about a “steady, unspectacular year” which ended with a return three-times in excess of that, it does make me worry we might be getting complacent.

[continue reading…]

1. I suppose it’s only fair to hint at my own returns, given all this finger pointing. I did better than those writers cited, but appreciably worse than a world index fund in sterling terms. And much of my gains were simply due to holding a decent slug of US stocks and other overseas assets. [↩]
2. That is after-inflation. [↩]

We’re always being told that inequality is the scourge of our times. But what, dear investor, are you going to do about it?

By trying to elbow your way into the 1%, you’re only adding to the world’s woes.

Yes you pay your taxes. Yes you’ve set up a Direct Debit to Oxfam.

But wouldn’t it be more helpful if you were less wealthy in the first place?

It’s easier to cut down a tall poppy than to grow a tree. If all the rich became poor the inequality problem would be solved overnight.

So here’s a public-spirited ten-point plan to undermining your investments in 2017.

Money can’t buy happiness – so follow this strategy to get rid of it.

1. Invest in expensive funds

The easiest way to start eroding your wealth is to pay a very expensive fund manager an outrageous fee for delivering returns below what you’d get from a cheap index fund.

Over the long-term, the steady damage done by fees of 1-2% or more will gobble up a big chunk of your returns.

2. Start stock picking penny shares

One danger with using funds is most managers have some clue about what they’re doing. And as they’re paid on performance, they’re going to give it a shot.

Even if you follow a ruinous strategy like continually chasing last year’s hot fund – buying high and selling low – there’s still a danger you could make money, albeit while likely still losing to the market.

Avoid this by stock picking obscure penny shares, ideally listed on the AIM market, perhaps operating in the mining or technology sector.

Real investors know the price of a share doesn’t tell you anything about its valuation, of course. A 3p share isn’t a tinpot outfit if there are ten billion shares in issue.

So look for companies with small market capitalisations – ideally rarely traded and reporting losses for years.

3. Don’t do any research

Once you’ve found a small, loss-making company to invest in, don’t do any more research.

Buy blind.

Okay, at a pinch you might check to make sure it’s on an outrageously hopeful P/E ratio – and perhaps drowning in debt.

But don’t read its annual report or dig into its management or any of that.

4. Trade as much as you can

Adopt the attitude of an inveterate gambler reduced to the fruit machines in the seediest corner of Las Vegas.

Continually shovel money into the market, pull the lever, and if anything goes well, dump it ASAP and swap it for a share that’s down on its luck.

Thanks to modern technology you can now trade via your smart phone on the bus or in the loo at work. Keep your portfolio turning over, racking up costs and working your way into ever more speculative positions.

5. Bet big on tips off Twitter

If you’re a sensible investor used to doing proper research, it might seem daunting to trade so frequently and ignorantly in your quest for poverty.

Happily technology has come to our aid.

Day traders on Twitter are a great resource for finding terrible companies to recycle your money into. Simply chase today’s hot tip and tomorrow move on to the next one!

All the time you’ll be racking up costs and buying dud after dud after dud.

6. Peruse share price graphs and chicken bones

A great way to have absolutely no idea what will happen next to a company’s share price is to study a graph of its historical moves.

Don’t be intimidated by the jargon of chartists. Invent your own price signals by referring to your favourite characters from The Lord of the Rings.

I find a Gollum’s Bottom indicates a perfect time to buy, whereas Gandalf’s Mighty Beard means a reversal is surely at hand.

7. Always keep the news on in the background

In many people’s estimation, 2016 was one of the biggest years for political shocks for a generation. Everything from Brexit to Donald Trump’s victory roiled the market.

Um, except it duly rose after those shocking events, regardless.

Truthfully, it’s very difficult to predict how share prices will react to general news headlines, good or bad.

A barrage of media speculation does wonderfully confuse matters at hand, however, so having the news channel on 24/7 should help you in your quest to lose money.

Another tip is to play gangster rap as loudly as you can stand during market hours.

Motivating songs about whacking your enemies and banking hundreds of Gs by the hour will put you in the right frame of mind for investing in public companies.

You might want to spread the word to your new squad on Twitter, too.

Tweets like…

“Yo yo y’all! Shorties be trippin out of A & J Mucklow Group PLC like dat Nick Leeson with dem runs! Best we ballers be buying $MKLW big style!”

…will go down a treat.

This is especially appropriate if your profile picture reveals you to be a bespectacled 50-something accountant from Maidenhead.

8. Spend your dividends

Studies show that while everyone focuses on share prices, reinvesting dividends makes up a huge portion of the market’s long-term gains.

So needless to say, spend those suckers on beer, crisps, and foreign holidays.

Whatever you do get them out of your portfolio, pronto.

9. Avoid ISAs and pensions

If you’re following this advice you should be consistently losing money and have no need to worry about capital gains.

However there’s always a risk you’ll take your eye off the ball and stumble into the next multi-bagging Amazon.

If you’d invested in an ISA or a SIPP, this would be a disaster, as you’d be forced to bank the gain tax-free when you realized your mistake.

However outside of these tax-efficient wrappers you’ll at least have the comfort of seeing the taxman potentially take a big chunk of your gains.

As a handy side benefit, you could be liable for tax on any dividends you find yourself receiving, too.

(In an ISA or SIPP, those dividends would have to be received tax-free.)

10. Don’t track your returns

Finally, it’s important to avoid properly keeping track of how your strategy is performing.

This gives you the best chance of avoiding learning any uncomfortable lessons, and boosts your ability to delude yourself that you’re doing really well as you steadily deplete your wealth.

Back in Bizarro World

So there you have it – my best stab at helping investors have a rotten 2017.

Of course, some wannabe Scrooge McDucks might decide to do the opposite of everything I’ve written here.

This would very likely to improve rather than hurt their investing. But there’s not much I can do about that!

Happy new year. 😉

The Slow & Steady passive portfolio leapt up by 25% in the last year. So if you’re a passive investor who stuck to your mechanical guns then you’re probably feeling a lot better off now than back in January 2016.

At that point our psyches were screeching like fingernails down a blackboard as the major world equity markets slid into bear market territory1. The bounce back since then has made our portfolio more money in one year than we managed in the previous five.

Here’s a walk through the sunny side:

• We’re up 46% since starting six years ago.

• That’s 11.4% annualised, or around a 9% real return – far higher than the historical average of 5% we might expect from a 100% equity portfolio. Happy times.

• By way of comparison, our portfolio’s real return was about 4% annualised when we took a snapshot this time last year.

Here’s the portfolio latest in TruColor spreadsheet-o-vision:

Our 2016 barnstormers were our riskiest asset classes:

• Emerging Markets up 36% (after plunging similarly over the previous two years)

• Global Small Cap up 34%

Meanwhile our ‘worst’ performers in 2016 were…

• FTSE All-Share up 16%

• UK Gilts up 11%

…although as you can see, even our rearguard has been tremendous. Despite the fear and loathing rippling across the political spectrum, every asset class surfed the wave higher.

Our biggest holding – the Developed World excluding the UK – put on 29%.

Sure, that’s a performance buoyed by the pound tumbling against other major currencies, so our gain has been bought at the price of national impoverishment. But at least it means your financial votes count even if you feel your actual one didn’t.

Hedging against massive national gambles is a side-benefit of global portfolio ownership that I didn’t fully appreciate when I began investing.

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £900 is invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

It’s interesting to reflect on how difficult it was to feel enthusiastic about any asset in 2016, with so much negative press sluicing through our news feeds, yet:

• The ‘overvalued’ US stock market rose 34%.

• ‘Moribund’ Europe was up 19%.

• Japan was up 23% even as Abe’s arrows broke off in his hand.

I’m running through all this not to sound triumphalist, but to emphasise how disconnected results can be from the flow of media bilge lapping against our brains.

Forget trying to predict what’s going to happen next. Stick instead to a sound asset allocation strategy that will see you through thick and thin.

We kept buying on the cheap through the 2015–16 mini-bear and made out like bandits as the market recovered and soared.

It’s become very noticeable that we’re picking up fewer and fewer units for every purchase as the market tear continues. That’s why future downturns are not to be feared by accumulators. The more shares you can pick up when the market is lower, the better your gains when the recovery comes.

Portfolio maintenance

Okay, it’s time for the portfolio’s annual service. The underlying asset allocation is built on sound principles – except I’ve come to question the role of index-linked gilts (also known as linkers).

Our inflation-resistant bonds haven’t done the portfolio any harm so far. In fact they have made 22% since we bought them. But their role in our portfolio is to ward off unexpected inflation, and that’s where the linker story starts to unravel.

We’ve posted the lengthy version of my thinking previously. But in short, UK linker funds are stuffed with long-term bonds that are highly sensitive to real interest rate rises.

That potentially makes our linker fund a source of volatility rather than stability. Moreover, a number of experts believe that UK linkers’ inflation protection could be overwhelmed by their exposure to real interest rates.

Linkers still have diversification value though – and experts can be wrong. Considering all this, I’m going cut the portfolio’s linker exposure down to a 6% holding, or around 20% of our bond allocation.

I did consider adding global index-linked bonds as an alternative. They would add more diversification and less interest rate risk, in exchange for a lower likely correlation with UK inflation.

But I’ve decided against introducing extra complexity at this stage. We’ll rely on equities and property to keep us ahead of inflation over the long-term and look into more short-term conventional bond funds as our model portfolio’s time horizon ticks down.2

My, how we’ve grown

Another light winking on the portfolio dashboard is that we’ve heading out of percentage-fee broker territory.

Our portfolio is notionally held in an ISA with Charles Stanley who charge an annual 0.25% of assets. That’s around £80 a year on our current value.

A flat-fee broker, in contrast, would levy a fixed cost regardless of our portfolio’s size. They’d also add dealing charges on top.

• The breakeven calculation between the two different broker types is quite straightforward. Our comparison table can help, too.

Right now there’s little in it either way for us. But as our portfolio swells (hopefully!) then the percentage-fee will swell too. By comparison, the flat-fee alternatives will look increasingly cheap and therefore more alluring! We’ll need to consider a switch.

It’s not worth us doing anything too hasty – broker charges can change, as can portfolio values – but I’ll need to address it at some point over the next year.

Or not, if the market crashes.

Buying more bonds

We’re also committed to shifting 2% from equities to government bonds every year. This risk management move gradually curbs our exposure to stock market crashes as our time horizon shortens.

We’re now 68:32 in favour of equities versus bonds, with 14-years left on the clock. The 2% equities cutback comes from our UK fund, as part of our ongoing move away from the home bias we originally built into our allocation.

This change, plus the reduction in our holding of linkers, lifts our conventional government bond allocation by 11% to 26%. We’ll likely be glad of this if the market takes a dive in 2017.

Increasing our quarterly savings

Accursed inflation is next on our list.

If we want to invest a consistent amount every year then we must beware of inflation eroding our cash like water against a rock.

The last RPI inflation report was 2.2%. That means we need to increase our £880 quarterly contribution in 2016 pounds to £900 in 2017.

Rebalancing act

Finally, it’s time to rebalance.

Every year we rebalance the portfolio back to its target asset allocations. Again this is primarily about risk management as we automatically make slight course corrections away from assets that have soared in value recently in favour of those that are now on sale.

The upshot of this rebalancing back to our (predetermined) asset allocations is we’ll be putting a lot of money into bonds – less risky assets – and a tiny smidge into global property, which fell back a little last quarter.

We sell down a portion of our other five funds and throw in our new quarterly cash contribution to fund the rebalance.

Remember, we’re not making a judgement call here. We’re just staying in line with the asset allocation we have set.

Incoming!

Q4 was income jackpot time for our funds. They paid out £387.89 in dividends and interest, which is automatically reinvested thanks to our accumulation funds.

Here’s our income scores:

• UK equities: £78.52
• Developed world equities: £209.99
• Global small cap equities: £7.06
• Emerging markets equities: £51.76
• Global property: £24.61
• UK Government bond index: £15.96

Total dividends: £387.89.

As I say, this isn’t new money we have to invest. It is automatically been rolled up by the accumulation funds.

I just think it’s motivating to see this hidden income being accrued by our funds.

New transactions

Every quarter in 2017 we will slot another £900 into the market’s fruit machine. Our cash is divided between our seven funds according to our (freshly tweaked) asset allocation:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.08%

Fund identifier: GB00B3X7QG63

Rebalancing sale: £414.23

Sell 2.296 units @ £180.43

Target allocation: 6%

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%

Fund identifier: GB00B59G4Q73

Rebalancing sale: £24.11

Sell 0.082 units @ £292.27

Target allocation: 38%

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.38%

Fund identifier: IE00B3X1NT05

Rebalancing sale: £83.70

Sell 0.332 units @ £252.02

Target allocation: 7%

Emerging market equities

BlackRock Emerging Markets Equity Tracker Fund D – OCF 0.25%

Fund identifier: GB00B84DY642

Rebalancing sale: £175.80

Sell 130.415 units @ £1.35

Target allocation: 10%

Global property

BlackRock Global Property Securities Equity Tracker Fund D – OCF 0.22%

Fund identifier: GB00B5BFJG71

New purchase: £114.04

Buy 58.781 units @ £1.94

Target allocation: 7%

UK gilts

Vanguard UK Government Bond Index – OCF 0.15%

Fund identifier: IE00B1S75374

New purchase: £4,249.85

Buy 26.588 units @ £159.84

Target allocation: 26%

UK index-linked gilts

Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%

Fund identifier: GB00B45Q9038

Rebalancing sale: £2,766.04

Sell 14.956 units @ £184.95

Target allocation: 6%

Total dividends = £387.89

New investment = £900

Trading cost = £0

Platform fee = 0.25% per annum.

This model portfolio is notionally held with Charles Stanley Direct. You can use that company’s monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.

Take a look at our online broker table for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000.

Average portfolio OCF = 0.17%

If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.

Take it steady,
The Accumulator

1. Defined here as 20% below their peak of the previous year. [↩]
2. Assuming a shorter-term linker product doesn’t come on to the market by then. [↩]