I had intended to write about something else this month.

Specifically, as I mentioned last month, I’d intended to look at the relative costs and merits of a selection of income-centric investment trusts.

Instead, I’m going to cover a different topic. Because while last month’s article was still fresh and gathering comments, I received a very unwelcome e-mail from a friend.

Another friend, David, had earlier that day collapsed and died on his farm.

Six months younger than me, David was one week short of his 60th birthday, and – I’d say – a fit and active person with a healthier lifestyle than your correspondent.

And now he’s gone.

RIP, David.

Re-thinking investment management

Frankly, it’s been something of a wake-up call.

Here at Greybeard Towers, my wife has been more than happy to leave the investment decisions to me.

Left-leaning and with a degree in Latin and Ancient History, she’s preferred to delegate investing matters to someone who a) enjoys them, and b) has academic qualifications that are – as she sees it – at least more relevant to modern-day investing than a degree in Latin.

No longer. Mrs Greybeard has now finally been introduced to her long-standing SIPP, and has made a couple of trades1. She also now understands a little more about where all our collective investments are, in terms of which platforms and providers, and how much is invested where.

Still to come: why specific investments are where they are.

Further down the line, she obviously also needs to know what to do with those investments if I suddenly pass away, leaving Monevator readers sadly sobbing into their portfolios.

Trackers vs. Investment Trusts

Some of this, I’ll admit, was in my mind as I read the comments on last month’s article, in which I described how I was gradually transitioning my SIPP portfolio away from low-cost trackers and towards income-centric investment trusts.

Especially so in the case of those comments decrying income-centric investment trusts, and advocating various passive strategies – ETFs, trackers, and so on. And specifically, those posts that were advocating going all-out for a total return approach, where in retirement we’d gradually sell off our capital in order to generate an income.

That is fine as long as the investor in question is mentally competent enough to handle the administrative burden associated with periodically pushing the ‘sell’ button to generate funds with which to pay the bills.

But this can’t be taken for granted, as I’ve seen at first hand, close to home, within my own family.

Old age and potential infirmity comes to us all.

Hence – to me at least – the attraction of a set of broadly-based, well-diversified investment trusts, which reliably deliver an income to your bank account, without the investor needing to do much more beyond simply spending the dosh.

Peace of mind

There’s a price to pay for this, to be sure. Even a low-cost investment trust has a management fee that is several times that of an ultra-competitive tracker.

And to those of you who argue that your passive-based strategies will almost certainly generate a higher overall total return, I’ve only one thing to say: I agree.

But the primary purpose of any investing return in retirement is to pay the bills. And it seems prudent to acknowledge that those bills need to be paid, whether you’re mentally competent enough to manage your investments or not.

Moreover, it also seems prudent to arrange to pay the bills for your surviving spouse or partner, should you die before them.

Especially if that surviving partner has shown no previous interest in investments.

So that’s the situation I’m trying to address. For being male, with a (slightly younger) female spouse, I don’t need an actuary to tell me that the odds are fairly reasonable that I will go first.

Facing forwards

What to take away from all this? Chiefly this: that pleasant fantasies about reaching your mid-80s, and then passing your spouse a sealed envelope containing advice or instructions about what to do after your death are exactly that – pleasant fantasies.

In reality, the Grim Reaper can arrive much sooner.

Much, much sooner.

And so I shall continue to gradually transition my SIPP portfolio into income-centric investments, believing that in doing so I’m addressing two risks.

• One, generating an income if gagadom strikes.

• Two, leaving my spouse with a straightforward means of redirecting that income to her own bank account should I suddenly keel over.

But to be frank, there’s another reason, too.

The last thing I want is for her to be faced with a situation so unmanageable that she calls in a smart-suited ‘adviser’, who might persuade her to switch the whole lot into some ghastly under-performing fee-laden ‘product’.

Meaning that having out-smarted the investment professionals in life, I can continue to do so in death, too.

1. Knowing that I was going to write about her, Mrs Greybeard predicted I’d do so in a sexist and patronising manner. So there’s no need to write a comment telling me this – it’s a message I’ve been hearing for 35 years. [↩]

Over the past 50 years, Warren Buffett’s annual letters have attracted fans far beyond the shareholders of his company, Berkshire Hathaway.

Proto-Buffetts have long devoured the master’s words for insights into how he achieved an average return of around 20% a year for half a century – and perhaps to pick up a few stock tips, too.

But recently passive investors have also got in on the action.

Warren Buffett has repeatedly recommended index funds as the best solution for the average investor – whom he defines as nearly everybody, incidentally – but lately he’s become more strident.

Just last year Buffett revealed that when he passes away, the bulk of his wife’s estate would be placed into a single Vanguard index tracking fund, with the rest in government bonds.

And here on Monevator we covered how a UK investor can copy Buffett’s simple portfolio when it comes to index investing.

Buffett’s long-term case for investing in shares

In this year’s letter Buffett was more explicit still.

He didn’t just say you could buy via an index fund if you want to invest in equities1.

He said you should invest in equities via those index funds.

True, Buffett is explicitly talking about US equities.

But I think global equities amount to the same thing as far as his argument is concerned. (Besides, as I said the other day it’s important to beware of home bias robbing your returns as a UK investor).

Compared to cash or bonds, equities are clearly the place for long-term investors to be, says Buffett:

“The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency.

That was also true in the preceding half-century, a period including the Great Depression and two world wars.

Investors should heed this history.

To one degree or another it is almost certain to be repeated during the next century.”

Of course most people have seen those long-term charts that show stock markets going up over the decades.

So why then do so many of us still horde our money in cash or bonds?

The answer is volatility – both the day-to-day fluctuations in share prices, and the ever-present risk of a stock market crash.

Buffett says:

“Stock prices will always be far more volatile than cash-equivalent holdings

Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions.”

Of course, you should always have some cash in an emergency fund.

You also shouldn’t be risking money that’s needed in the next 3-5 years in the stock market, given it’s propensity to crash when it’s least convenient.

But beyond that, says Buffett, the key is to distinguish between short-term risk caused by market fluctuations, and the long-term risk of inflation eroding the purchasing power of seemingly safer assets like cash or bonds – as well as the opportunity cost of missing out on the superior returns from shares.

Ignore the market noise

When investing in a pension over 30-40 years, for instance, I think it’s best to invest into an equity-heavy portfolio automatically year in, year out, and to try to ignore the news about the stock market – as opposed to holding a huge slug of safer assets to help you sleep at night while you obsessively track its value.

Buffett again:

“For the great majority of investors who can – and should – invest with a multi-decade horizon, quotational declines are unimportant.

Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime.

For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.”

Fearful investors in 2008 and 2009 missed out on the buying opportunity of a lifetime, Buffett points out (assuming they didn’t do the only thing worse, which was to sell out of shares altogether and never get back in).

“If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).”

Easier said than done – but that’s exactly why you get a better return from shares than from sitting snug in cash.

The rewards come with risk.

Here’s what you shouldn’t do

Buffett’s laundry list of bad investing behaviour should be familiar to Monevator readers.

Investors are often their own worse enemies, he says, and they make putting money into the market riskier than it needs to be by turning short-term volatility into longer-term capital reduction through their antics.

Buffett highlights the following investing sins:

• Active trading

• Attempts to “time” market movements

• Inadequate diversification

• The payment of high and unnecessary fees to managers and advisors

• The use of borrowed money

All of these can “destroy the decent returns that a life-long owner of equities would otherwise enjoy” says Buffett, who adds that borrowing to invest is particularly risky given that “anything can happen anytime in markets”.

Obviously I agree with all this, but I don’t suppose Buffett will be any more successful than the rest of us in trying to make people understand that the fact that “anything can happen anytime in markets” is not a reason to avoid equities, but rather a reason to invest in a way that reflects this reality.

In other words, buy steadily and automatically over multiple decades to take advantage of the various dips and to enjoy long-term compounded returns.

Some friends who’ve been asking me about investing since our 20s – and getting the same advice on getting started from me – still begin these conversations with: “Is now a good time to invest?”

Nearly all would do far better never to think about it.

The trouble with active management

Similarly, here on Monevator I forever field questions from newcomers who think it is “obvious” that investing via the more skillful active managers is the way to better returns.

And indeed it would be if (a) the active managers did it for free, or very nearly so, and (b) you could pick those who outperformed in advance.

High fees crush the returns from active managers as a group, turning it into a worse-than zero sum game for active investors as a whole.

As for picking winners in advance, let’s just say many billions of pounds has been spent over the past 50 years trying to do exactly that.

Obviously some do succeed in some particular period, either through luck or judgement. But in terms of a demonstrable, repeatable process that we can use to reliably pick active funds that can overcome their fees and beat the market in advance – sorry, no bananas.

Hence passive investing – wrong as it feels – beats the majority of active investors. So why bother trying, when you don’t need to beat the market to achieve your goals?

But don’t take my word for it when we have one of greatest active investors of all-time on hand to say the same thing:

“Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades.

A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game.

There are a few investment managers, of course, who are very good – though in the short run, it’s difficult to determine whether a great record is due to luck or talent.

Most advisors, however, are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship.”

Instead of listening to their siren songs, says Buffett, investors – large and small – should instead read Jack Bogle’s The Little Book of Common Sense Investing.

Quoting Shakespeare:

“The fault, dear Brutus, is not in our stars, but in ourselves.”

1. Reminder: Equities is just a fancy word for ‘shares’. [↩]

Good reads from around the Web.

I read at least 100 investing articles every week, probably twice as many company news stories and 30-40 RNS updates from companies reporting to the stock market.

Like every week, some of the better ones are collated below.

But let’s face it, you’re not going to enjoy any of them as much as a cartoon from Dilbert creator Scott Adams!

Adams has begun a new investing advice series:

He has actually written quite a bit over the years about investing – I’ve previously featured one of his old cartoons – and all his work offers a wry take on the world of business.

Adams advocates index funds and passive investing, obviously.

[continue reading…]