Good reads from around the Web.

Does the Government read Monevator: Part 4,643… According to The Guardian, the inheritance tax changes that are expected to be announced in this week’s budget have been revised.

Now, long-term sufferers readers may recall I am all for higher inheritance taxes.

I do appreciate though that I might as well believe in the redistributive powers of the Tooth Fairy, given how the tide of opinion is against taking money off dead people instead of taxing living ones who are, you know, doing useful work, building businesses, and so on.

But even leaving that aside, as I recently ranted the proposed changes to inheritance taxes to exempt the family home were foolish because of the damage they could do to the already broken property market:

…to take an asset – UK housing – that is in structurally short supply, where high prices cause daily misery for millions, and to make it even more attractive to sit in it, unproductively squatting for future gains – that is downright irresponsible.

What moderately wealthy empty-nesters living in a capacious four-bedroom house are going to downsize now, knowing that all it will do is expose the money they release to inheritance tax?

On the contrary, they will be advised to consider buying even bigger and more expensive homes to try to shield their (children’s) assets.

Mass downsizing alone won’t solve the housing crisis, but it would be a start.

Well, it seems that while Government wonks were a little slow not to think of this before, they may have come to their senses.

The Guardian reports:

It is understood the plans have now been amended to allow pensioners to move into smaller homes without missing out on the £1m relief on their former properties.

A new mechanism will mean that if someone sells their main residence and buys one that is cheaper, they will get the allowance up to the value of their previous home.

Of course, much as I jest that this blog is influencing government policy, I’m aware I wasn’t the only person who quickly appreciated the lunacy of the first plan.

So now – assuming the plan really has been reworked – let’s get thinking about the flaws of the new approach…

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This article on making Vanguard’s LifeStrategy funds the core of your lifelong investment strategy is by John Edwards, whose book DIY Simple Investing aims to get novices up to speed.

I was recently discussing financial matters with a good friend. She is articulate, exceedingly well-educated and accomplished – Oxbridge degree, large circle of friends, owns her own home in the country, a mother and now grandmother.

However, the one area of life where she struggles is personal finance.

Talking to her started me thinking. If someone as well balanced and educated as my friend gets stuck, then how many others have difficulty with everyday financial challenges – be it pensions, investments, or savings?

Many people are confused about money

When I started to do some research into ‘financial dyslexia’, I found it was a major problem for a lot of people.

Most Monevator readers are self-directed investors, I imagine, and it is easy to make the assumption that other people could easily do the same if only they chose to do so.

However this may not be the case.

Many people, for whatever reason, have a complex emotional relationship with money. This could be due to repeatedly telling themselves “I don’t/can’t do this” or it may stem from failing to grasp maths right back at primary school level, perhaps due to a single poor teacher.

It may even be down to the wrong sort of genes!

It’s all too easy for those of us who (more or less) take investing for granted to overlook how confusing, daunting and difficult it can seem to those would-be investors looking in for the first time.

More evidence: In 2014, the Open University Business School asked a cross section of the population to answer questions currently on the financial education syllabus. It was shocked by the results – over two-thirds of UK adults got basic personal finance school exam questions wrong.

Consumers also admitted that their lack of financial knowledge was stopping them from making informed decisions about mortgages (44%), pensions (43%), and even the simplest products such as ISAs (32%).

The research also suggested ignorance isn’t bliss – 60% of the 25-34 age group admitted that their personal finances caused them stress, anxiety and sleepless nights.

Another recent report suggested that one in ten people cannot identify the total balance on a bank statement, whilst 25% said they would rather live for today than plan for tomorrow.

The cost of financial advice

Those who can afford the fees can get around these stumbling blocks by employing the services of a qualified financial adviser. However after the various regulatory changes of recent years, the costs associated with advice are no longer hidden in the fund charges.

Making these costs more transparent is probably a good thing, but it does mean the fees of employing an adviser must be agreed and paid upfront.

The cost for such advice varies according to the nature of the advice, complexity and time involved.

As an example, a would-be investor starting up an investment ISA or SIPP or investing a one-off lump sum could pay between £750-£1,500, plus 20% VAT.

Understandably, many ordinary people investing modest sums may be put off by the idea of such high upfront charges.

For these individuals, it may well be a case of DIY investing or nothing.

When simple isn’t simple enough

I have written and self-published three previous books about money and investing. At the time I thought they were fairly straightforward.

My first I described as ‘A simple and easy to understand guide to savings, pensions and investments’ and my second as ‘A simple and, I hope, easy to understand guide to UK pensions’.

But when I took the opportunity to re-read these books in the light of my later findings about the depth of financial difficulty out there, it was obvious that – whilst from my own perspective those statements were true – for possibly the majority of ordinary individuals, my efforts to open up and explain the mysterious world of personal finance had failed.

My challenge was to try to step into the shoes of the novice would-be investor – to become what I had been 25 years previously when I started my own investing journey.

I wanted to try to see things from this different angle and perspective. I needed to unlearn everything I had picked up over the past two decades and then to try to write a book that would be easy for anyone to understand.

DIY Simple Investing

It seems to me that all that the vast majority of would-be investors need is a very simple, no-frills DIY strategy that provides a good chance of a decent outcome.

It was when I was researching Vanguard’s LifeStrategy funds for my own possible use that I realised these products could be the centrepiece of just such a simple all-in-one investing strategy that almost anyone could follow.

I even wrote an article on my own website about this: Vanguard LifeStrategy – A One-Stop Solution.

Now, the average Monevator reader would probably not have too much difficulty in constructing a portfolio of passive index funds and ETFs – or even shares or investment trusts.

But for those who would find such an undertaking daunting, the LifeStrategy funds provide a one-shot solution that I believe is a significant advance in making investing accessible to everyone.

A strategy for life

Vanguard’s LifeStrategy funds hit the UK market in June 2011. They are a range of low cost all-in-one funds holding an assortment of Vanguard’s globally diverse, standalone index funds.

There are five options to choose from, with the number in the name representing the equity level for each fund:

• LifeStrategy 20% Equity Fund

• LifeStrategy 40% Equity Fund

• LifeStrategy 60% Equity Fund

• LifeStrategy 80% Equity Fund

• LifeStrategy 100% Equity Fund

(From here I’ll abbreviate the funds to LS20 and so on, for convenience).

For instance, the LS40 fund holds an assortment of Vanguard’s underlying equity funds that together make up 40% total equity exposure. The remaining 60% is made up from a mixture of standalone bond funds.

The current geographic breakdown of the LS40 fund is:

Equities	Allocation
FTSE Developed World (ex UK)	19.4%
FTSE UK All Share	10.0%
US Equity	5.0%
Emerging markets	2.9%
Europe (ex UK)	1.5%
Japan	0.8%
Pacific (ex Japan)	0.4%
	—
Total	40%

Bonds	Allocation
Global bonds	19.2%
UK Gilts	9.6%
UK corporate bonds	5.7%
US corporate bonds	5.1%
European government bonds	5.1%
US government bonds	4.9%
UK inflation-linked gilts	4.8%
Japanese government bonds	3.3%
European corporate bonds	2.3%
	—
Total	60%

Total (equities + bonds) = 100%

Each of the five LifeStrategy funds holds over 1,000 assorted securities.

Which LifeStrategy fund to choose?

Investors who have a longer time horizon and are willing to embrace more risk or volatility in their portfolio in exchange for the possibility of a higher return would select a fund with a higher equity holding – say LS80 or even LS100.

Investors with a lower tolerance to risk or a shorter time span ahead of them should opt for a LifeStrategy fund with more bonds in the mix, such as the LS20 or LS40 funds.

You could also hold more than one LifeStrategy fund in your portfolio to fine tune your exposure.

For example, if you wanted to achieve a 50-50 mix of equities and bonds, you could purchase the LS40 and LS60 funds in equal measure.

The following graph gives an indication of how the various difference equity/bond blends have done over the long-term:

Source: Vanguard

Remember, it’s not just about the average total annual return, otherwise we’d all obviously choose the LS100 fund!

Volatility increases as you increase the equity mix, which in turn increases the range of returns – including into the negative zone represented by the grey areas.

Vanguard rebalancing for you

I believe the regular rebalancing of a portfolio is important and too often overlooked by investors.

To my mind it’s a great benefit of the LifeStrategy approach that the funds are automatically rebalanced by Vanguard on a regular basis.

The more that can be automated, the better.

Rebalancing ensures you are not exposed to more risk than you chose at the outset when you first purchased your LifeStrategy fund – and without you having to lift a finger.

In contrast, with most other multi-index or multi-asset funds an investor is merely offered a range of potential exposure to equities. This means you may have no idea what your actual level of exposure is at any given time.

For example in an investment offering 20-60% equity exposure, the fund manager has complete freedom to increase or reduce holdings according to how he or she reads prevailing market conditions.

As an investor, you will not know from one month to the next whether your chosen fund holds 60% equities or 20% – or anything in between.

Such a fund’s returns will also depend to a large extent on the manager making consistently good market calls.

Personally I would not feel comfortable with that strategy.

How to implement your DIY LifeStrategy portfolio

Remember, what we are after is a simple, low cost and diversified strategy that a novice investor can understand and implement with a minimum of fuss.

And with the LifeStrategy all-in-one solution, investing can be as simple as ABC:

A) Decide on your attitude to risk/volatility

B) Select the corresponding LifeStrategy fund

C) Choose an appropriate low-cost broker, and set up your automated monthly direct debit

Job done, and you can now get on with your life.

It seems to me that putting together a DIY portfolio does not come much simpler.

As we saw earlier, the LifeStrategy funds are globally diversified which helps to reduce risk. They also have reasonable costs of 0.24% (plus a one-off 0.10% dilution levy).

True, it would be slightly cheaper to hold all the underlying funds separately but it’s not very practical. For the convenience of an all-in-one fund and automatic rebalancing, the marginal additional cost is well worth it.

A strategy for life

Most LifeStrategy investors at the moment are probably planning to use the funds during the early years – the building phase – of growing their wealth within ISAs and SIPPs.

Part of this process should include some thought about your changing risk tolerance at various stages of your life.

For example:

When starting out in your 20s and 30s you could use the LS100 or LS80.

During your late 40s and 50s you could switch to LS60.

As retirement approaches in your 60s you could swap to LS40.

The beauty of the LifeStrategy option is its simplicity.

Choose your level, set up your automatic monthly payments with a selected broker and then leave it on autopilot until your fortieth, fiftieth and sixtieth birthdays, when you switch into progressively less risky funds.

What could be simpler?

The drawdown phase

Although most people will probably use LifeStrategy funds for the wealth-building phase of their investing journey, I believe the funds could be used in later years for the ‘deaccumulation’ phase, too.

Of course, at that point you might plan to move your accumulated money into more income-orientated options.

For instance, other passive funds with an income focus include Vanguard’s UK FTSE Equity Income fund or its All World High Yield ETF – both of which I hold in my portfolio.

There are also income focused investment trusts you might consider.

However, if you have been happily building your retirement pot using the simple LifeStrategy route, then why not continue with it?

In this case, instead of investing in funds that pay out a regular income, you’d plan to ‘create’ and withdraw your 3.5% or 4.0% annual income by selling units.

The average total return on the LS60 since launch in June 2011 has been just over 9% per year, on average.

This return will probably come down a little as the years pass, but using a cash buffer if necessary to cover negative return years, it should be perfectly feasible to obtain a reasonable income.

It’s also worth noting that each of the five LifeStrategy funds comes in both accumulation and income flavours, with the latter paying out – of course – an income.

For those who do not require too much income during the deaccumulation phase, it could therefore be worth considering the income version of their chosen fund.

However at the present time the average distribution yield for the LifeStrategy funds is around 1.4%, which will be too low for most investors.

That is why selling units can provide a good alternative.

Simply is best

My advice to any would-be investor is to keep things simple, low cost, diversified and to understand your tolerance to market risk/volatility and invest accordingly.

And it seems to me the Vanguard LifeStrategy funds offer all this and a bit more in a single all-in-one fund.

Naturally, I go into much more detail in my latest DIY Simple Investing book and cover other aspects that underpin this central theme.

But, in a nutshell, the essence of my book is covered above – short and sweet, jargon-free, and, I hope, a practical guide for those people who are looking for a low cost and easy to understand investment strategy.

Incidentally, the book was in part inspired by a development in my personal investment strategy over the past year or so, which has made me re-evaluate some of my earlier thinking.

Monevator has a lot to answer for!

You can read more from John at his blog – or check out his book at Amazon.

Good reads from around the Web.

One issue with chasing the so-called return premiums – that historical tendency for certain kinds of shares to deliver above market returns, even to passive investors who simply tilt their portfolios thataway – is that you have to stick with them through thick and thin.

As my co-blogger The Accumulator has advised:

…think of your value fund like a sardine net. You’ll catch some of the shoal but not the whole lot.

Some days (or years) you won’t catch anything, but when you do it will make for a nice, tasty lunch.

The point is all the return premiums – value, momentum, small cap – have good and bad years, or even decades.

Tilting towards these factors already means flirting with active management.

Ditching a premium that’s going through a cold spell for a hot one that is probably due to turn cold too amounts to French kissing one of the worst traits of active investors. You can expect your returns to dip accordingly.

Yet sadly, research suggests that actively courting disappointment seems to be exactly how many are using the Smart Beta funds designed to capture the return premiums.

Not so Smart, buddy

Take the study conducted by Empirical Research Partners and quoted by the fund managers behind The Value Perspective blog:

What Empirical has done is to look at two relationships – first, between past performance and where investors put their money and, second, between where investors put their money and subsequent performance.

As you can see from the chart below, for eight out of the 11 categories of smart beta strategies analysed, there is a very strong positive correlation between past performance and future fund flows, with those directing money towards yield-type exchange traded funds (ETFs) apparently the most prone to invest with at least one eye on the rear-view mirror.

Source: Empirical Research /Value Perspective

Uh oh! According to this research, investors in these funds aren’t reaching sober conclusions about the best way to add a little extra juice to their portfolios over the long-term.

They are just buying what’s gone up lately.

This wouldn’t matter if chasing hot funds produced higher returns.

But as the article goes on to show, that doesn’t happen at all – most amusingly in the case of mean reverting momentum funds!

As Kevin Murphy, the blog’s author says:

‘But guns don’t kill people, people do’ is a line less likely to settle an argument than provoke further discussion and yet it is not impossible to imagine an advocate of so-called ‘smart beta’ investments – strategies that try to build on simple index-tracking products by focusing in on a specific factor, such as growth, momentum or value – using a similar refrain.

“But smart beta products don’t make bad investment decisions, investors do,” they might tell a doubter.

To which we would reply – as we would to anyone trying the gun line – “OK, but they do make the job a lot easier.”

While it’s no surprise that these professionals argue you’re better off using actively managed strategies if you want to pursue a value strategy (well, they would say that, wouldn’t they?), I think their warning is well put.

Remember that all the academic research that backs up return premium investing talks about achieving incremental returns over time.

It says nothing about hot hands trading ETFs like George Soros on a stag do in Vegas.

The return premiums are whispering flighty things, with their real world performance already potentially set to disappoint those seduced by the academic findings.

Indeed some, such as Monevator contributor Lars Kroijer, think there’s no case for investing in them at all.

But if you’re a passive investor set on swallowing their lure, I’d strongly suggest The Accumulator’s lazy long-term fishing approach is the way to go.

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