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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…]

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A graph showing the rollercoaster journey of portfolio returns.

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:

XIRR formula example to generate a money-weighted annualised return

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:

=SUM(((1+XIRR(B1:B4,A1:A4,0.05))^(((DATE(2019,12,28)-(DATE(2020,6,29)))/365))-1))

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

XIRR formula generating a year-to-date return

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.
  • 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

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Weekend reading: Triage

Weekend reading logo

I reluctantly updated a lot of the technology that runs Monevator this week. And of course things broke.

For instance, pagination and numbering has come unstuck on the longer comment threads. For now we’re either showing up to 200 comments at once on (nearly all posts) or else the most recent remainder (the broker comparison table, and a couple of old Brexit ding-dongs).

If you spot any other bugs please do let us know.

Also, as detailed below I’m going to experiment with keeping these Weekend Reading comments Covid-free.

We’ve had a great discussion here over the past few months for those who’ve wanted it. But more than a few readers feel it’s now crowding out the investing chit-chat, which is the primary reason anyone comes to Monevator.

Ideally us diehards will continue debating, but only on this older thread please.

Be warned: Given the state of travel with the pandemic and the economy I’ll likely do a dedicated virus post again at some point over the next few weeks. It’s just too important to our finances to leave off this site entirely.

But for now I’m going to have to delete Covid-related comments on this post. Apologies in advance. Please comment (even if about this new comment policy) on the other thread please.

Have a great weekend!

[continue reading…]
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Watch out for the capital gains tax turnover trap

A funny meme image to illustrate the CGT reporting trap

Long story short: This post won’t apply if you invest entirely within ISAs and pensions. Try to!

Most people rightly believe capital gains tax (CGT) is not a tax they’ll pay.

Buy-to-let landlords may face a CGT bill when they sell up, due to the size their one-off property gains.

But private investors in shares and funds can usually buy and sell within tax shelters – ISAs and SIPPS1. This avoids CGT altogether.

By using shelters you also sidestep the hassle of reporting to HMRC all your trades and profits.

The ability of ISAs and pensions to swallow your cash contributions like Pac-Man coming off a crash diet means even the mildly wealthy need not pay CGT.

Okay, so you may have too much money to shovel it all into tax shelters in a particular year. An individual’s pension and ISA combined can take as much as £60,000 annually though2, so even for moderately high earners, this usually only happens with an inheritance, a bonus, or when a bank heist pays off.

Once your allowances are used up, you may decide to invest in shares and other assets in unsheltered accounts. Cash in the bank is paying diddly, after all.

Fret not!

Paying CGT on future gains is still far from inevitable.

Gimme unshelter

For one thing you can offset some capital gains with losses. (And if you never have any of those then you’ve little to glean from us!)

There also exists a fairly generous annual CGT allowance. As I write it’s £12,300 in total realised capital gains in a year.3

If you have unsheltered shares, funds, or other taxable assets and they go up in value, you can exploit your CGT allowance to defuse your gains over one or more years by reducing your holding piecemeal.

It’s a faff and when markets rise quickly you can be left with a lot of defusing to do. Let’s file that in the Nice Problem To Have folder.4

Always use tax shelters to the fullest extent possible – even if you believe you’ll never exceed your annual CGT allowance – because, well, you never know.

I have an unsheltered holding that has gone up ten-fold in barely five years. At the current pace it’s going to take me until my sixties to defuse it.5

The CGT allowance could be reduced or scrapped, at some point. We shouldn’t take it for granted.

For now though, CGT is an optional tax for most people, at least with some forward thinking.

Sympathy for the Devil

All that preamble is a reminder as to how CGT works – a gentle reassurance.

Because like those teens in a horror movie who arrive at an abandoned campsite with beers, bikinis, and a fatal disdain for the ravings of a madman who warned them not to sleep overnight at Lake Morte…

…there’s a trap!

As pitfalls go, it’s very minor. Nobody will lose a limb. Possibly not even any money, depending on how penalty-happy HMRC is.

But it’s still something to be aware of.

Here the crucial section from the official guidance:

You do not have to pay tax if your total taxable gains are under your Capital Gains Tax allowance.

You still need to report your gains in your tax return if both of the following apply:

  • the total amount you sold the assets for was more than 4 times your allowance
  • you’re registered for Self Assessment

The trap, you see, is a reporting issue, rather than an issue of taxes you’re mistakenly evading.

Harlem shuffle

At the time of writing the CGT allowance is £12,300.

This means that if you sell ‘chargeable’ assets that in total are worth more than four times the allowance – £49,200 – in a year, then you should report all your taxable gains that year to HMRC.

That is assuming you’re registered for self-assessment tax returns, which I’m confident most people who find themselves in such a position will be.

The first thing to note is that you don’t have to have breached your CGT allowance for the sale(/s) to be reportable.

If you sold an unsheltered shareholding you bought for £50,000 for £50,001 – a mere £1 gain – then you should report the trade to HMRC on the relevant supplemental pages of your tax return, because you’ve disposed of more than £49,200 worth of chargeable assets.

Even more slippery, it’s the ‘total amount’ that matters.

Let’s say you only have £5,000 in your non-ISA dealing account. You use that money to day trade, because you’re a silly billy.

You’d only have to turnover your portfolio every ten weeks or so – in terms of total sales – to again breach that total disposal limit of four times the allowance in a year.

Turning over a portfolio like that is quite easily done if you trade a lot – and especially if you’ve more than my illustrative £5,000 in play.6

A platform like Freetrade7 with its zero commission makes manic trading much more practicable than in the old days, with only stamp duty and spreads still payable on each trade.

So you can easily see how a trigger-happy trader could get to the point of having to show their workings to HMRC on a tax return.

Wild horses

In my experience very few people know about the four times reporting clause.

Indeed I once spoke to a very senior figure in a Fintech firm that was moving into share dealing who had no idea it even existed! (I was querying him about his plans for helping clients with any tax reporting, which is often still poorly done by platforms.)

What would happen to you if you breached the limit and didn’t report the relevant disposals to HMRC?

I’ve no idea. I’m not a tax expert or an accountant.

I can’t recall hearing about anyone getting into trouble. If you know differently, please comment below.

However a good rule to live by is Don’t Piss Off The Taxman. Personally I live by the letter of the tax law. I need my beauty sleep.

Easily the best course of action is to do your investing within ISAs and SIPPs. The paperwork and record-trawling required to report a string of trades for CGT purposes is tedious in the extreme.

It could be even worse if you haven’t kept your own records. You might discover your broker has deleted the old details of your trades. (I’ve seen this happen after platform mergers.) Without your own records you’ve yet another problem to deal with.

If you have sizeable sums that need investing outside of tax shelters, then the reporting rule is another (minor) thing to keep in mind when you decide how and what to buy, and when to sell.

  1. Self-invested personal pensions. []
  2. Simplifying in the case of pensions, where for example limits are determined by your earnings and prior contributions. []
  3. In the UK, ‘gains’ means you actually sold the asset for a profit – as opposed to simply owning something that is showing a paper profit. []
  4. One snag with this strategy is if you become a forced seller – perhaps because a company you own is taken over and your shares are bought for cash. This can crystalize a CGT liability that you had planned to defuse over several years. Annoying! []
  5. Again, the Nice Problem To Have folder tends to fill up quickly when you’re making capital gains. []
  6. Cover your ears, but my *sheltered* portfolio turnover is approaching 400% this year! Remember, unlike my co-blogger The Accumulator, I’m a crazed active investor. I don’t recommend it for most. []
  7. Affiliate link. []
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