Good reads from around the Web.

Once people get beyond trying to pick stocks and embrace the ‘total investing’ religion, they typically displace their former zeal for buying tinpot miners and tiny tech start-ups into agonizing about their asset allocation.

Should they put 1.3% into gold?

Maybe 7.2% into commercial property?

Or perhaps 7.4% would do better?

This sort of finickity fiddling is a waste of time for passive investors.

Rather, in my view a cheap and simple asset allocation – such as the lazy ETF portfolios – fits the bill for most.

That is not to say that some particular mix of assets won’t turn out to have been the best choice over your lifetime.

While the data from the US suggests that different lazy strategies tend to achieve similar results over the decades (especially once you consider volatility and risk), a percentage point or two of extra growth does make a big difference to how much you end up with, due to compound interest.

However I think it’s hard, if not impossible, to know which strategy will do best in advance, even if you turn to valuation and so forth.

By all means give it a try if you love investing.

It’ll probably be more profitable than trainspotting or crochet.

But don’t feel you have to – that’s my main point.

Far better to focus on keeping your costs low and sticking to your long-term plan, whatever it might be.

Costs count – a lot

I was discussing this with a Monevator reader in the comments the other day.

He had sensibly rejected a hard-charging wealth manager’s expensive investment plan, but he still felt the need to complicate things in order to do a proper DIY replacement job.

Specifically, he started asking how much he should put into private equity and hedge funds…

Now such so-called alternative assets might have a place in the world – though that’s debatable – but any role they do have is hugely undermined by the high fees they charge.

Which is why we preach low-cost investing here on Monevator. It’s very hard for people to grasp the impact of high fees.

Again, a reader was arguing with me recently that we make too big a deal of high fees.

We really don’t. Fees are one area of investing you can control, and as Rick Ferri discusses this week the cheapest funds (usually index funds) have historically done far better than the more expensive ones.

Reducing costs therefore scores very high on the risk versus reward scale.

Cutting your costs delivers a clear and known benefit, compared to the huge unknowns and likely wealth-sapping impact of punting on fund managers or fancy but pricy asset classes, or perhaps even venturing into costlier Smart Beta trackers and the like.

Look at them go

Need more evidence? Then take a look at this very interesting article in the FT this week [Search result], which draws on Mebane Faber’s new book, Global Asset Allocation.

The FT writer John Authers says the book:

“…shows clearly that the gap between the best and worst asset allocation schemes is narrower than the gap between the highest and lowest fees.

In other words, the precise asset allocation model you use is less important than keeping control of fees.”

Authers runs through the returns from several different asset allocation models over the past 40 years, as illustrated by the following graph:

Now, you might be looking at this and thinking you’d like some of the one that went up the most – and less of the laggard!

What was all that guff I just spouted about most allocations achieving roughly the same thing?

Firstly, as I said, it’s easy to see which allocation did best in retrospect. That’s very different knowing what will happen during the next 40 years.

Secondly, some allocations are much more of a rollercoaster ride than others – look at the huge plunge in the winning red line, for example.

If you don’t care about risk at all, then the best bet is to dump all you can into shares for most of your working life and cross your fingers.

You may do terribly (especially if shares crash shortly before you retire) but the odds favour a strong result.

But many people just can’t take the deep dives that come with an all-stock portfolio.

High fees are not the bee’s knees

But anyway, I was talking about fees – and this is where Authers’ second graph is really illustrative.

He notes that a portfolio based on US bond guru Mohamad El-Erian’s portfolio would have performed the best since 1973.

But look what happens when hypothetical fees are taken into account:

Fees eat your returns for breakfast.

The impact of imposing fees is dramatic.

The drag from just a 1.25% annual fee is sufficient to pull the returns from the El-Erian portfolio beneath the return from a simple 60/40 stock/bond split.

It only just edges the worst performing strategy – the lower-returning but very stable Permanent portfolio.

And as for the 2.25% fees…

Now you might say you’d never pay 2.25%, and good for you. But I regularly field comments from readers who say we make too much of high fees.

For these people – and the many who never discover sites like Monevator, or even articles like John Authers’ – a 2.25% fee would sound a bargain to pay in order to get invested with what was the best performing asset allocation strategy of the past 40 years before costs were taking into account.

You see how it works?

[continue reading…]

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 trades ((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.)). 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.

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 equities ((Reminder: Equities is just a fancy word for ‘shares’.)).

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.”