How quickly things can change! Another bumper quarter for global equities has helped to chase the blues away like a glimpse of spring sun.

Our Slow & Steady model portfolio has plumped up 3.7% in the last three months. That’s on top of the 7% gain the quarter before that.

Overall, annualised returns are now back to a healthy 7%. Call it 4% after inflation. If you own an equity-heavy passive portfolio you’ll be happier still.

Here are the numbers, in Zippity-Doo-Dah-o-vision™:

The Slow & Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £1,264 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and find all the previous passive portfolio posts in the Monevator vaults.

While much of Q4’s rise was accounted for by a surge in government bonds and property they’ve both subsided a little since.

Instead we’re back to the established routine: US large caps as the motor of our passive portfolio.

Our Developed World fund had approximately 50% in the US when we first invested back in 2011. Now that allocation has climbed to over 70% – a worryingly high exposure to a richly-valued stock market and an economy stoked on government stimulus.

The Investor wrote an excellent piece for Mavens on how to think through this situation, including your options for taking evasive action.

He also turned up a Larry Swedroe article on just how hot the US market would have to run to repeat the returns of the last decade.

In short: we’d need a Tech Bubble Part II to get anywhere close.

Needless to say I won’t be selling the Slow & Steady’s equity allocation to plough it 100% into an S&P 500 ETF anytime soon.

However neither am I about to advocate for a wholesale shift into a World ex-US tracker.

American idle

For one thing, the Slow & Steady portfolio is only 28% US large caps when you take the whole portfolio into account.

And even if we did dilute the Developed World fund’s US holding back down to the 50% level where we first invested, the US large cap allocation would only be reduced to 20% of the total portfolio.

Said differently – the portfolio is already adequately diversified. If Big Tech’s future returns are sub-par, a 28% to 20% shift won’t make a huge difference.

Secondly, nobody is predicting negative returns for the US. Just that the market must surely mean revert – and that some other region must surely take the lead for a while – because the S&P 500 doesn’t win every decade.

I’ve been reading predictions like this for more than a decade. Nobody can make a strong case for any other market besides, “it’s cheap.”

Mean reversion is not a physical law. It’s a pattern found in the last 100 years of data. It doesn’t mean that cheap markets can’t get cheaper.

The Russian market looked awesome value before the Ukraine War. I’m glad I didn’t bet my shirt on those stocks.

In my personal portfolio, I siphoned off cash to deploy in emerging markets and UK equities for years because they were cheap. That hasn’t worked.

It did teach me a useful lesson about trying to outwit the market though.

I can’t do it.

New transactions

Every quarter we nourish our portfolio with £1,264 of investment fertiliser. This fresh muck and brass is split between our portfolio’s seven funds, according to our predetermined asset allocation.

We rebalance using Larry Swedroe’s 5/25 rule. That hasn’t been activated this quarter, so the trades play out as follows:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.06%

Fund identifier: GB00B3X7QG63

New purchase: £63.20

Buy 0.24 units @ £262.85

Target allocation: 5%

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.14%

Fund identifier: GB00B59G4Q73

New purchase: £467.68

Buy 0.722 units @ £647.54

Target allocation: 37%

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.29%

Fund identifier: IE00B3X1NT05

New purchase: £63.20

Buy 0.148 units @ £428.36

Target allocation: 5%

Emerging market equities

iShares Emerging Markets Equity Index Fund D – OCF 0.19%

Fund identifier: GB00B84DY642

New purchase: £101.12

Buy 53.63 units @ £1.89

Target allocation: 8%

Global property

iShares Environment & Low Carbon Tilt Real Estate Index Fund – OCF 0.18%

Fund identifier: GB00B5BFJG71

New purchase: £63.20

Buy 27.95 units @ £2.26

Target allocation: 5%

UK gilts

Vanguard UK Government Bond Index – OCF 0.12%

Fund identifier: IE00B1S75374

New purchase: £316

Buy 2.355 units @ £134.21

Target allocation: 25%

Global inflation-linked bonds

Royal London Short Duration Global Index-Linked Fund – OCF 0.27%

Fund identifier: GB00BD050F05

New purchase: £189.60

Buy 179.546 units @ £1.056

Target allocation: 15%

New investment contribution = £1,264

Trading cost = £0

Take a look at our broker comparison table for your best investment account options. InvestEngine is currently cheapest if you’re happy to invest only in ETFs. Or learn more about choosing the cheapest stocks and shares ISA for your circumstances.

Average portfolio OCF = 0.16%

If this all seems too complicated check out our best multi-asset fund picks. These include all-in-one diversified portfolios, such as the Vanguard LifeStrategy funds.

Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? Our piece on portfolio tracking shows you how.

Finally, learn more about why we think most people are best choosing passive vs active investing.

Take it steady,

The Accumulator

What caught my eye this week.

Every decade or so, some rebellious storyteller escapes out the back door of an investment bank, breaks the code of omertà, and tells all on how top-tier financial services really work.

Michael Lewis and Liar’s Poker in the 1980s. Nick Leeson with Rogue Trader in the 1990s. Why I Left Goldman Sachs by Greg Smith in 2012.

And now Gary Stevenson with The Trading Game.

Think the lovechild of Liar’s Poker and Rogue Trader combined with a dash of Thomas Piketty on the side. You won’t be able to put it down, unless you hate swearing or laughing out loud.

You’ll probably learn something, too. I certainly did.

All the usual tropes are present. The ninth dan obscenities. Wanton moneymaking. The guys who can’t say no to anything, including just another day in the office.

In some ways it’s almost a relief.

I mean, I’m as allergic to excessive wokery as the next Gen X-er, and it’s honestly nice to hear that filthy-mouthed fishwives could still find soulmates in the City, if only they could make it to the 35th floor of the appropriate temple of finance.

On the other hand, if Stevenson is to be believed – and he comes across as very believable – then the Monopoly money mentality of bankers quickly shrugged off the 2007-2009 financial crisis.

And that’s not so easy to cheer.

The remunerative mill

It’s hard to remember now how revered bankers were, before the sub-prime crash turned credit crisis.

The market was always right, we’d been told. Risk had been smoothed away. A bunch of my university peers went to work for big banks – you’d think they’d joined the priesthood.

When the financial system tottered in 2008 and 2009, they got a bashing of course. Yet how much has really changed?

Most of my complaints from 2009 about financial services – especially its ludicrous salaries – still seem true today.

Consider, say, vanilla equity fund managers. Almost all nice people as far as I can tell. They work hard, speak eloquently, and yet nearly all fail at the one thing they’re paid to do – beat their benchmark. A return an index fund can deliver for ten basis points nowadays.

These managers are still paid very handsomely, every year. Even as passive investing eats up their assets as inexorably as The Blob.

Imagine if highly-paid dentists routinely left your teeth worse than they found them – and yet still got, well, highly-paid.

Wouldn’t something change?

Maybe the high pay is inevitable. My longstanding theory is an excess income is just a perk of any job that involves dealing with a lot of money.

This sounds trite but I’m serious.

Working in the money mine

Back in school a friend’s mum had a job at the Smiths crisps factory. There were always boxes of crisps at their house.

When I volunteered in a charity clothes shop on Saturday as a student, we got the first pick of the fresh donations.

An estate agent I knew didn’t even bother to list the best doer-uppers that came to him. He did them up himself.

Get a job in the video games industry and you get free Xbox games. Work behind a bar and you’ll never be short of a drink.

Secure a role in finance and there’s money everywhere. Soon some of it will fall into your pockets. You don’t even have to do anything illegal.

There’s a scene early in The Trading Game, where Stevenson makes £77,000 for his employer in a few minutes – just apropos of a casual, random conversation with the bloke at the desk next to him. He’s not yet even a proper trader with his own P/L at this point.

Moreover just a year or two later he’s able to put on a ten-figure trade, apparently because his new boss doesn’t know what his real job is.

As Joachim Klement says in his review at Klement on Investing:

The key achievement of Gary is that he paints his colleagues and himself as both sympathetic people you want to hang out and have a beer with and at the same time people who completely lack any sense of ethics and are driven only by their unbridled greed.

And it paints a vivid picture of how – at least in the 2000s and early 2010s – major banks let these guys run rampant without any real checks on their behaviour or the risks they take.

“Money money money, must be funny, in a rich man’s world…”

Nice work if you can get it

I’m not saying financial services jobs aren’t difficult or competitive or useful. Or that people don’t work long hours and get burnout.

But I do say plenty of jobs fit that description. Everyone from hrdwrkn nurses to software developers to street cleaners.

Yet they don’t get paid six-figures in their mid-20s to do it. Not least because they don’t work with money.

Perhaps you think the free market would have flushed out this excessive self-enrichment if it wasn’t actually warranted?

Maybe, but I’d point you again to the fund managers who we all know mostly fail. They’re still coining it. It doesn’t look like ruthless capitalism at its finest.

Think too about who sets financial service salaries. Yes – other people in financial services. It’s almost a Ponzi scheme.

(This becomes very apparent if you study the accounts of any firms with big investment banking divisions, incidentally. It sometimes seems a miracle that shareholders get any share at all.)

I know I sound self-righteous. To be clear if you’re working at an investment bank and making a fortune by being in the right place at the right time, deploying other people’s money without taking any risk with your own – then truly, good for you.

I’m saying it shouldn’t happen like this. At least not so trivially.

Not that you shouldn’t do it, if you want to and can. Seize the opportunity!

In fact, I expect many more will want to if they read Stevenson’s book, the same way the Liar’s Poker expose recruited a new generation of bond traders. Stevenson’s story is so entertaining, even as it darkens.

Actually, better than reading it, hear it as an audiobook.

Stevenson – an ex-grime MC – sounds like one of the cast of TopBoy interning with Gordon Gecko. He’s poetic, compelling, foul-mouthed, and very funny. I was left feeling more informed, but also a bit dirty.

Perhaps I’ll turn to Private Equity: A Memoir next, as a cleanser. (Thoughts on that over at The Lefsetz Letter).

Have a great long weekend! Even more links than usual to get you through to Tuesday…

[continue reading…]

The Vanguard Target Retirement Funds are like an automated amusement park ride for investors.

Hand over your money and you’ll start by gliding up the rails of accumulation hill with a thrilling 80/20 equity/bond portfolio. 

You’ll probably do some loop-the-loops during those early years – and maybe even a double-inversion stall – as the market tests your stomach. 

But as the ride progresses, your investment vehicle slackens off the pace. And by the time you’re ready to retire, it’s shifted you to a much gentler 50/50 equity/bond track. 

As you coast down the final decumulation straight, your Target Fund should be about as scary as a kids’ log flume, bobbing along with a 30/70 equity/bond portfolio for a motor. 

Scream if you’ve had enough of this metaphor. 

Vanguard’s target retirement fund in a nutshell

The point is you can be hands-off throughout the journey – except to put cash in or whip it out again, depending on your time of life. 

Vanguards’ Target Retirement Funds are examples of target-date funds, which are designed to help you hit a particular goal (like retirement). Their big benefit is to mostly relieve you of tricky investment decisions such as: 

Asset allocation – You get an oven-ready, globally-diversified portfolio of equities and bonds that takes care of itself. 

Rebalancing – All done as part of the service. That’s a very good thing, as selling your winners and buying your losers is tough to do sometimes. 

Risk management – You start with an aggressive equity load-out when you’re young and have plenty of time to recover from bear markets. You gradually shift to less volatile bonds to protect your gains later on:

This is a perfectly reasonable risk management technique called lifestyling – although we do think having 70% in bonds risks under-powering your retirement. More on that in a minute. 

Underlying holdings – Vanguard Target Retirement Funds invest exclusively in Vanguard’s own passive investor-friendly range of index trackers. We’ve no objection. Other trackers are available but Vanguard has a solid range, and choosing your own is liable to bag you marginal gains, at best. 

Cost – There’s a 0.24% Ongoing Charge Figure (OCF). That’s no longer cheap for a global tracker fund. But it’s good value for a multi-asset fund that does almost everything for you bar filling in the direct debit.

All you have to do is decide when you’re going to retire.

How the target date works

Each Vanguard Target Retirement Fund comes with a target date that identifies the earliest year its investors are expected to retire.

For example, the Vanguard Target Retirement Fund 2030 is aimed at investors who plan to flick the Vs to working life between 2030 and 2034, while the Vanguard Target Retirement Fund 2035 is just the ticket if you’re planning to hold your F.U. party between 2035 and 2039.

On we go in five-year steps out to the impossibly futuristic Vanguard Target Retirement Fund 2065 – by which time The Investor will be tapping out posts with cybernetic fingers and I’ll have been uploaded to the cloud.

You’re a forward-thinking 15-year old who’s already dreaming of life on a Martian golf course from 2070? No doubt Vanguard will soon be releasing a fund for you, too.

The declining glidepath smoothes the way 

It’s the interaction of the target date and the fund’s asset allocation that controls your descent towards a happy retirement. 

The Target Retirement Fund 2030 is 61% in equities at the time of writing, with six years to go until the target date of 2030. 

The fund will be split fifty-fifty in 2030. By 2034 it’ll be 40% equities, then 30% equities in 2037 – seven years after reaching its target date. 

Here’s how each fund comes into land:

The Year of retirement in the graph refers to each fund’s target-date year. 

Vanguard has illustrated a notional retirement age of 68 but you’d still be 50/50 equities/bonds whether you actually choose to retire at age 48 or 78 in 2030 when using the Target Retirement Fund 2030. 

At the start of the journey (left-hand side of the graph) you’ll hold:

• 20% UK equity (red)
• 60% Global equity ex-UK (teal)
• 5% UK nominal bonds (turquoise)
• 15% Global bonds (brown)

Five years before retirement, UK index-linked gilts (orange) also come into play. These should help protect the portfolio from inflation.

By the time the glidepath touches down at age 75 your final asset allocation is:

• 7.5% UK equity (red)
• 22.5% Global equity ex-UK (teal)
• 3.5% UK nominal bonds (turquoise)
• 17.5% UK index-linked gilts (orange)
• 49% Global ex-UK bonds (brown)

Again, all completely sane. 

That said, the convenience you gain by ceding control comes at the cost of making compromises. 

Target Retirement Funds are superb for those who don’t want to manage their own investments, but there are quite a few drawbacks to consider.

For instance…

A rising glidepath may be better for retirees 

An alternative rising glidepath strategy peaks your bond holdings at your retirement age. Thereafter, it allows your equity allocation to rise again while spending down bonds. 

The theory is that maxing out bonds on the eve of your retirement protects you from a hideously bad run of returns (known as sequence of returns risk) that could permanently damage your pension pot. 

After that, holding a larger equity allocation should pay off if stock markets go on to deliver their typical gains. 

If this theory holds then the traditional declining glidepath as followed by Target Retirement Funds is the very opposite of what you should be doing. 

So does it hold?

The best research I’ve read on this topic comes from Early Retirement Now. 

Big ERN concludes that a rising glidepath can help when the market is overvalued when you retire. The improvement is modest but quite consistent when using US long-term historical data. 

So you may turn the retirement dial slightly more in your favour with a rising glidepath strategy. In practice it will depend on your individual circumstances and unknowable future investment returns.

70% bonds in retirement? 

Most research into optimal retirement asset allocations finds against bond holdings as high as 70%. 

Using historical global returns, we found that the higher your equity allocation, the more you could spend from your retirement portfolio. 

That said, there’s reason to believe that historical simulations of retirement spending are somewhat biased against bonds because they oversample from the worst bond bear market in history. 

Moreover, Vanguard’s target-date bond allocations include some corporate bonds. These come with more equity-like risks and rewards.

The Vanguard Target Retirement Fund 2015 holds 15% in corporate bonds1 for example. Its retirement asset allocation can be more properly thought of as 45/55 growth versus defensive assets, rather than a 30/70 split.

Even so, most retirement research suggests you need a much higher equity share than 30% in a decumulation portfolio. 

One way of handling this would be to follow a Target Retirement Fund’s glidepath until you hit the 50/50 mark. Then sell and reinvest your proceeds into a static allocation fund such as Vanguard LifeStrategy.

That way you retain the auto-rebalancing, multi-asset convenience of a target-date fund but you could maintain a 60/40 portfolio for the rest of your days with the LifeStrategy 60 product. 

Risk tolerance

There’s no guarantee that any particular Target Retirement Fund’s asset allocation matches your personal risk appetite. 

Being young is not proof that you can hack an 80% equity allocation.

Theoretically, you’ve got years to recover if things go south. But that’s cold comfort if you freak out and sell during a bear market because you’re in way beyond your risk tolerance.

Of course, you could choose the Target Retirement Fund with the equity/bond mix that best suits your risk tolerance rather than your age. But do take care to check its asset allocation serves your needs as you countdown to retirement.

If you go for a 50/50 split then you may not want to be 30% in equities when the fund powers down seven years later but your retirement is still over a decade away, for example.

Try estimating your risk tolerance or take this test to get a feel for these issues.

Are bonds enough?

Talking of risks, many investors now find it harder to stomach the words ‘bonds’ and ‘safe assets’ breezily rubbing shoulders in the same sentence given the big bond crash of 2022.

Soaring inflation and central banks hiking interest rates as if their keyboard were stuck on the ‘+’ key caused yields to spike up on even the best government bonds that year.

Which simultaneously crashed bond prices.

As a direct result, that calamitous year saw balanced funds that held more bonds actually do worse then those that held more equities – despite share prices falling, too.

That was exactly the opposite of what people thought they were buying when they dialled up their bond allocation.

FT Money editor Claer Barrett in January even described lifestyling as ‘a hidden danger lurking in your pension pot’.

Recounting the case of ‘Martin’, Barrett wrote:

Forced into early retirement after developing a disability, Martin considered what to do with his biggest pension pot. Built up with a former employer, a statement from June 2021 said it was worth nearly £200,000. So he got quite a shock last October when he found its value had plunged to £134,000, wiping nearly one-third off of his pot. How could this have happened?

The answer, as I’m sure most of you have guessed, is lifestyling. As we move towards a more sedate pace of life in retirement, so too do our investments. Unless we say otherwise, money invested in most defined contribution pensions is gradually moved out of equities as we grow older and into bonds and cash, which have traditionally been lower risk investments. However, the dire performance of UK government bonds (gilts) in recent years means they have been anything but.

Tackling this criticism properly requires a full article – watch this space – but the first thing to say is fair enough.

Bonds did do extremely poorly in 2022. It was a generational-level shellacking. Little comfort if you were someone who saw your pension pot plummet just as you entered retirement that there were warning signs, or that equities crash like that far more often.

Especially if you’re a deliberately hands-off passive investor who chose a balanced fund to do the thinking for you. And specifically so you wouldn’t have to make timing calls.

The Monevator house view these days is that a really well-diversified portfolio needs more than bonds. But equally, we don’t think the outcome in 2022 has derailed the case for lifestyling a portfolio.

Mostly it should work well. Nothing will do so in all environments.

Bonds bounce back to life

Anyway, now is a bad time to abandon bonds. That very rare crash has actually boosted the prospects for their future returns.

Vanguard noted in late 2023 that:

The good news is that bond returns have recovered this year and the long-term outlook for bonds is better than it has been for many years.

We expect UK bonds to deliver annualised returns of around 4.4%-5.4% over the next decade, compared with the 0.8%-1.8% 10-year annualised returns we expected at the end of 2021, before the rate-hiking cycle began.

In retrospect, lifestyling was certainly more problematic in the near-zero interest rate era. But so were all our other investing decisions.

Again, would the typical target-date fund customer have done better making market timing calls instead?

I doubt it.

Auto-pilot malfunction 

The final big danger with relying so heavily on Vanguard’s auto-pilot is that you forget to check if you’re still on course before the fund touches down.

Ultimately your fund will need to hit your target number by its target date.

All should be well if:

• Your fund meets or exceeds its expected returns…

• …and you put enough money in…

• …over a long enough period of time.

If performance is falling short then human intervention will be needed to increase your contributions, extend your timeline, or reduce your needs.

Tax efficiency

 A Target Retirement Fund may not be tax efficient if it isn’t entirely sheltered by your ISAs, SIPPs, and personal savings allowance. That’s because bond interest payments are taxed at income tax rates rather than dividend income rates.

Moreover, once your target-date fund’s asset allocation is more than 60% bonds and cash then all of its distributions will be taxed as interest payments rather than dividends. 

• See our post on how bond funds are taxed. 

We still recommend Vanguard Target Retirement Funds 

Despite these qualms, the overwhelmingly massive pro is that the Vanguard Target Retirement Funds are like a self-inflating survival shelter for people who can’t:

• Afford advice
• Learn the ropes
• Stay on top of their portfolio
• Make rational investing decisions

I’ve got lots of friends and family in this camp. And I would happily put every one of them in a Target Retirement Fund.

Any alternative path they’d choose for themselves is likely to be much worse.

Take it steady,

The Accumulator

P.S. Vanguard has occasionally made changes to the US version of the formula in response to market conditions. It increased the equities allocation and also broadened international exposure to equities and bonds. But the UK iterations – launched in December 2015 – have remained largely unchanged.

1. Including securitised bonds. [↩]