Good reads from around the Web.

The US investment advisory firm Research Affiliates made headlines this week when it predicted that American savers have a 0% chance of hitting their desired 5% or greater annual returns from a standard 60/40 portfolio over the next decade.

From Bloomberg:

Research Affiliates’ forecasts for the stock market rely on the cyclically adjusted price-earnings ratio, known as the CAPE or Shiller P/E.

It looks at P/Es over 10 years, rather than one, to account for volatility and short-term considerations, among other things.

Research Affiliates is a respectable outfit, but I’m not convinced that anything that spits out a ‘zero’ probability for investment returns should be taken as gospel. (I’m also somewhat skeptical of the utility of CAPE these days, but that’s for another article.)

What I’m sure of is that trying to do better by investing in active funds will serve most US thrill seekers poorly.

Yet as markets have climbed that has been the industry’s siren call (even as the data piles up showing ever more money ignoring them and migrating to passive funds).

Don’t beat yourself up

Remember, active investing at the stockpicking level is a zero sum game.

It’s true in theory that particularly perspicacious managers could sell out of some markets and move into others and generally juggle assets to receive better than 5% returns, but the evidence is very slim – well, non-existent – that more than a handful will manage it.

So the odds your chosen active manager will be one of the few are extremely poor.

By way of illustration, the average hedge fund returned just 0.7% in the decade ending 2014. Indexing guru Larry Swedroe has pointed out that means they under-performed every single major equity and bond asset class in existence.

Josh Brown at The Reformed Broker offered his usual robust retort to the chatter from active managers who claim passive investing “sheep” are about to be slaughtered:

If you’re a purveyor of high-cost, high-tax, high-transaction, high-bullshit, wannabe macro-genius strategies, you might want to look into the things you have so much to say about before mocking others who are doing the best they can to save and invest rationally.

You’re either pretending not to understand this in an attempt to mislead others or you’re genuinely uninformed yourself.

Save the day by saving more

As a long post by the robo-adviser Betterment spells out, the rational approach to low expected returns is not to try to find the next Warren Buffett, but rather to save more money.

It says doing better than average by even 1% a year through investing returns would require a fund investor to pick one of the one-in-three funds that beat the market in a particular year, and then successfully do it again and again for the next 10 years.

For those for whom maths is not a strong suite, let’s just say the odds of achieving that are not worth discussing further.

On the other hand, saving more is guaranteed to boost your final pot, compared to if you’d spent the money instead.

In their worked example, increasing the savings rate by just 8.5% delivered the same outcome as achieving that wildly improbable run of annually switching your money from winners to winners for a decade.

Same difference

Remember, these people are all commenting on the US market. I think our stock market looks cheaper personally and our bond market more stretched – but as always what do I know.

Anyway, many sensible passive investors are in world market trackers these days, and they are massively weighted towards the US market. So the outlook is relevant.

The bottom line is saving a few more quid probably isn’t going to hurt. The alternative responses might well do.

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Have you ever wondered who you’re borrowing money from when you go into debt?

If you think you’re being given money by a bank or credit card company, think again.

In this piece I’ll explain in one sentence who is really lending you money when you borrow.

The rest of the article will explain why it costs you more than you might think to take it.

Borrow now, and have less later

Loans, mortgages and credit cards are mechanisms through which you can borrow money. They don’t give you a penny to spend.

So where does the money come from?

When you borrow money, you’re borrowing from your future self.

Loans and credit cards turn the impossible into reality, taking money you’ll have in the future and giving it to you today. It’s an almost magical process that clouds where the borrowed money comes from, and what it actually costs.

Let’s say you want to buy a new computer. You have three choices:

1. Save up to pay for it
2. Borrow the money
3. Steal the money, or the computer

Option 3 is the cheapest, but it has practical, moral, and spiritual consequences.

Option 1 requires you to live within your means, save the difference, and delay owning a PC until you can afford it. You may even buy a cheaper PC so you can own one sooner.

If you don’t like waiting and you don’t like compromise, you’ll probably go for option 2.

In some households, option 2 is the standard choice. Such people regularly borrow money to buy everything from the groceries to their summer holidays.

Borrowing might be done via:

• A credit card
• A personal loan
• Adding to the debt in your mortgage
• Using a doorstep lender
• A hire/purchase arrangement

All these options have advantages, costs, and consequences. Smarter borrowers shop around for the cheapest method. Others take the first loan that comes along. Finding the cheapest way to borrow is a subject for another article.

The key point is that all these methods have the same common structure:

1. You borrow money
2. You must repay it

Notice it’s all about you. The agreement may be with American Express or Barclays Bank or whoever, but it’s you who has to repay it.

After the advertisements have been forgotten and the repayment is just another line in your monthly statements (and the PC no longer runs Sim City 7000 or whatever we’re up to by then), you’ll still be liable for your debts.

And where will you get this money from?

From your future self.

A study in borrowing from myself

I first realized the concept of borrowing from my future self when I was quite young. My family was by no means rich, but my dad earned too much for us to qualify for the full student grants that were available back then to pay for higher education costs.

As a result, I had to take out a student loan.

The government loan was a great deal, with a very low interest rate. Better still, I didn’t have to start paying it back until my income surpassed a certain threshold.

I even managed to save some of the loan. Writing for the college magazine kept my extra-curricular costs down, as we got free tickets to all sorts of things across London. And being young, I had little need to spend money.

Fast-forward a couple of years, and I’m into my first job. After a few months, I got a pay rise.

That was the good news. The bad news was I’d hit the level where my student loan began to be repaid. I can’t remember the exact figures, but the gist was I was worse off after the pay rise, because I’d only just gone over the payment threshold!

It was not the most motivating payslip I’ve ever received. My student self had made my working self poorer by borrowing money.

Of course, university back then was a no-brainer (unlike today) and my student loan had been spent buying an education that made me more employable for years to come. My future self got a good deal.

But this isn’t the case when you’re buying stuff or paying for services or holidays using debt. All the benefit arrives in the short-term – but you pay for it over the long-term.

Borrowing from a poorer, future you

How much money are you taking from your future self when you spend his or her money today?

Unless you use the loan to invest in education, a profitable business or an appreciating asset (such as a house over 25 years), your future self will have less disposable income to spend on things because of your decision to borrow now. Your future self will go without the money you spend today.

It’s worse than the initial cost. Your purchase today via debt will incur interest. Depending on the interest rate you’re charging your future self – via your credit card or bank loan – you could spend anything from 25% to 100% more by buying the item today, instead of waiting until you can afford it.

In fact, debt is even worse than that! Imagine that instead of going into debt, you lived within your means, saved up for the things you really needed, and invested the excess instead.

Your future self isn’t just poorer due to the cost of your debt-fueled purchase and the interest on the debt – he or she has also lost the cash you’d have amassed thanks to compound interest building up your savings.

See my article on why you should stay out of debt for cash illustrations of these costs.

This isn’t some abstract person we’re talking about. If you go into debt now, the living, breathing you of tomorrow will look at their bank statements or face unexpected urgent costs, and have less money to spend.

One day you’ll retire with less money, if you borrow to buy depreciating assets today.

You’re really sticking it to your future self by borrowing. You’ll be poorer, less able to live within your means, further from financial freedom – and probably lumbered with an old PC that needs junking.

Save now, spend later

Some readers will find this post trivially obvious. If that’s you, I’m very glad to have you reading my site – please do subscribe to get all our personal finance and investing articles.

I know from experience that other readers will find it a revelation that their debts are funded by themselves and nobody else.

That’s not surprising. The entire financial service industry tries to confuse us into thinking money is cheap and to distract us from who really pays. The 2007-2008 credit crunch is testament to that.

If the concept of borrowing from your future self is new to you, I hope it’s an empowering idea. Once you grasp that you’re only making your future self poorer by going into debt now, good things will follow.

You’ll live within your means to avoid debt, see your savings grow, and compound interest will build your wealth rather than making you poorer through interest increasing your loans.

Of course if you are 99-years old and still saving, it may be time to start spending. There comes a time when your future self has to give something back. We don’t last forever.

But in your twenties, thirties, forties and even fifties, you owe it to your future self not to leave them owing you.

Good reads from around the Web.

Have you ever tried to convince somebody they should invest passively with just a few funds? You’ll discover an interesting new way to bang your head against a brick wall.

Some people get it right away. It helps to have Monevator articles – and those recent videos from Lars – to send them to.

But very often they tell you (or you can see that they think) you’re short changing them.

It can’t really be so simple. Do you believe they’re not smart enough to invest properly? Rich enough? Ambitious enough?

Worth it?

Adding to the problem with my friends is that many know I’m a market mad investing nut job.

What am I holding back?

If it’s good enough for Nevada…

Happily, reader S. pointed me to an article in the Wall Street Journal [Search result] that may become a powerful part of my passive persuasion arsenal.

Because if my friends are worried I’m suggesting their £15,240 ISA isn’t worth “proper” investing, maybe they’ll be reassured by seeing somebody invest $35 billion using passive principles.

As the chief investment officer for the Nevada Public Employees Retirement System, Steve Edmundson works in a one story building and has no co-workers. He brings homemade lunch to work in a Tupperware box – often last night’s leftovers. He keeps spare paper clips in a tin.

And – even more like a switched-on seeker of early retirement than a Master of the Universe – he invests all his $35 billion under management passively, having fired 10 external managers when he took the job in 2012.

The strategy is doing the business, of course:

Returns over one-year, three-year, five-year and 10-year periods ending June 30 bested the nation’s largest public pension, the California Public Employees’ Retirement System, or Calpers, and deeply-staffed plans of many other states.

…although it does go a bit Monty Python:

With no one else on his investment staff, Mr. Edmundson rarely uses his conference table and four extra chairs. He volunteered his office to pension-fund employees who work for accounting or benefit calculations.

Last month, a wall went up dividing the room.

“I’m not going to complain about my office,” he says. “It was too big.”

When people write articles ‘fearing’ the shrinking of the wealth management industry due to the rise of index funds, remember Mr. Edmundson – and all the expenses paid to his colleagues who mostly added little value while earning sports cars and country homes with our money.

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