Good reads from around the Web.

Most of us know passive investing in index funds is the best way forward for the vast majority (even if some of us continue to pick stocks for kicks, or just out of sheer pigheadedness…)

Passive investing is the least effort and the lowest cost way to invest, and yet it’s also the most likely to deliver nearest to the market’s long-term returns.

However there’s a snag, which is that there are not hundreds of inspiring passive investing books out there filled with witty one-liners.

Active investors can turn to Warren Buffett quipping about being like an over-sexed guy in a harem in a bear market, or Peter Lunch warning that you should invest in companies that any idiot can run, because “sooner or later, any idiot will run it”.

Passive investors? They have Vanguard literature boasting of a 0.01% cut in annual charges.

Oh, and Smarter Investing by Tim Hale, which I’ve almost come to blows over with my co-blogger.

While I agree his Best Book Ever is the number one route map for UK passive investors, I’ve never managed to read more than three pages without dozing off.

Get a quote

I’m biased, but I’ll add that my co-blogger, The Accumulator, is slowly amassing a nice collection of witticism about index investing. Perhaps one day they’ll be collated by a fan overburdened with time for future generations to enjoy.

Until then we can turn to the American Enterprise Institute. It sounds like a spoof corporation from a 1970s dystopian movie, but the Institute gets a thumbs-up for bringing this quote to my attention:

“Building a portfolio around index funds isn’t really settling for the average. It’s just refusing to believe in magic.” – Bethany McLean of Fortune

I also liked this one:

“I own last year’s top performing funds. Unfortunately, I bought them this year.”– Anonymous

There’s even one from the aforementioned stockpicking legend, Peter Lynch:

Thereʹs something to be said for the dart‐board method of investing: buy the whole dart board.” – Peter Lynch, Fidelity Magellan

However the list is not comprehensive, and it does boast a few bore-fests. For example they missed a trick by not including this quote from the master:

“By periodically investing in an index fund, the know-nothing investors can actually outperform most investment professionals.” – Warren Buffett

Perhaps we should do our own roundup of insights about index funds someday, with a focus on the snappy. Having such quotes to hand is not just for fun – distilled wisdom can be a useful touchstone in a tight spot.

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The last few months have been as gentle as a lullaby for investors, with pretty much every asset class gently floating up.

Even emerging markets are back in favour, swelling by 6% last quarter – a gain that’s underlined by the lagging indicator of numerous media sites now banging on about BRICs.

Even so, the emerging markets remain uniquely in the red out of all the asset classes we’ve invested in since we started the portfolio some three years ago.

Overall our model portfolio has endured very little hardship over that time, aside from trailing the FTSE All-Share by some 2% a year. Every market we’ve owned bar the US and Europe has underperformed the UK equity market.

Diversification has seemingly cost us over this short period. But the point of an asset allocation strategy is that you stick with it through the years – and even the decades. We believe it will prove its worth when the weather changes.

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £850 is invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

Our little growth engine has made another £400 since our last portfolio update.

That means we’re up over 18% on purchase and have averaged a 8.28% annualised return.

Here’s the portfolio lowdown in spreadsheet-o-vision:

Dividends

Interest and dividends brought in £77 last quarter, as we accepted the tribute of entrepreneurs and the Government for the gracious favour of our capital.

We reinvest this income straight back into our portfolio via accumulation funds that automatically put that money back to work.

Here’s how the income totted up this time:

US equity tracker: £26.56
European equity tracker: £6.34
Japan equity tracker: £5.51 (It all counts!)
Pacific equity tracker: £9.98
Emerging markets equity tracker: £9.21
UK Government bond index: £19.64

Total dividends: £77.24

Leave it alone

A switched-on passive investor is rightly paranoid about cost – this being one of the few factors she can directly control that makes a material difference to the bottom line.

So I’ve been wondering whether the Slow & Steady portfolio should switch to the incredibly cheap family of index funds available from Fidelity after that firm’s most recent bout of price smashing.

Fidelity’s Ongoing Charge Figures (OCF) are now among the best in every category, and you get an extra discount when you hold them on the Fidelity platform:

Fund name	OCF	OCF at Fidelity
Fidelity Index UK fund	0.09	0.07
Fidelity Index US fund	0.1	0.08
Fidelity Index Japan fund	0.12	0.1
Fidelity Index Pacific ex Japan fund	0.15	0.13
Fidelity Index Europe ex UK fund	0.12	0.1
Fidelity Index Emerging Markets fund	0.25	0.23
Fidelity Index World fund	0.2	0.18

Note: OCFs are percentage figures.

The current annual cost of our portfolio’s funds is 0.18%. If we drafted in the Fidelity funds then this would fall to 0.13%. That’s a near 30% reduction in costs.

Sounds tasty!

But let’s keep some perspective – it only amounts to a £7.50 annual saving on our portfolio’s approximate £15,000 value.

That’s definitely not worth the bother. Moreover, it doesn’t take into account tracking error – the additional costs a fund spews like exhaust fumes, and which aren’t measured by the OCF.

Some of the Fidelity funds are very new, so they don’t have a track record that we can even probe.

But one we can look at is the Fidelity Index UK fund, and here the apparent advantage of this fund over our current UK holding is certainly not as wide as it first appears. The 0.08% OCF advantage is reduced to a miniscule 0.01% rounding error once tracking error is accounted for, according to Trustnet’s charting tool.

So for the moment, I’m not going to make any changes. But that isn’t to say you wouldn’t do perfectly well with these Fidelity funds.

New transactions

Every quarter we lay another £8501 at the feet of the money gods.

We use Larry Swedroe’s 5/25 rule to trigger rebalancing moves. All’s quiet for now, so there isn’t any need to sell any outperforming funds.

Instead we’ll divide our cash as normal between our seven chosen funds, as per our asset allocation strategy:

UK equity

Vanguard FTSE U.K. Equity Index Fund – OCF 0.15%
Fund identifier: GB00B59G4893

New purchase: £127.50
Buy 0.646 units @ £197.48

Target allocation: 15%

Developed World ex UK equities

Split between four funds covering North America, Europe, the developed Pacific and Japan2.

Target allocation (across the following four funds): 49%

North American equities

BlackRock US Equity Tracker Fund D – OCF 0.17%
Fund identifier: GB00B5VRGY09

New purchase: £212.50
Buy 154.66 units @ £1.37

Target allocation: 25%

European equities excluding UK

BlackRock Continental European Equity Tracker Fund D – OCF 0.18%
Fund identifier: GB00B83MH186

New purchase: £102
Buy 60.14 units @ £1.70

Target allocation: 12%

Japanese equities

BlackRock Japan Equity Tracker Fund D – OCF 0.17%
Fund identifier: GB00B6QQ9X96

New purchase: £51
Buy 39.41 units @ £1.29

Target allocation: 6%

Pacific equities excluding Japan

BlackRock Pacific ex Japan Equity Tracker Fund D – OCF 0.2%
Fund identifier: GB00B849FB47

New purchase: £51
Buy 23.79 units @ £2.14

Target allocation: 6%

Emerging market equities

BlackRock Emerging Markets Equity Tracker Fund D – OCF 0.28%
Fund identifier: GB00B84DY642

New purchase: £85
Buy 52.19 units @ £1.10

Target allocation: 10%

UK Gilts

Vanguard UK Government Bond Index – OCF 0.15%
Fund identifier: IE00B1S75374

New purchase: £221
Buy 1.70 units @ £130.04

Target allocation: 26%

New investment = £850

Trading cost = £0

Platform fee = 0.25% per annum

This model portfolio is notionally held with Charles Stanley Direct. You can use its monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.

Take a look at our online broker table for other good platform options. Look at flat fee brokers if your portfolio is worth substantially more than £20,000.

Average portfolio OCF = 0.18%

If all this seems too much like hard work then you can always buy a diversified portfolio using an all-in-one fund like Vanguard’s LifeStrategy series.

Take it steady,

The Accumulator

1. The Slow & Steady portfolio is virtual. It’s a model portfolio designed for discussion and to show how a passive portfolio might operate and perform on a small scale. [↩]
2. You can simplify the portfolio by choosing the do-it-all Vanguard FTSE Developed World Ex-UK Equity index fund instead of the four separates. [↩]

This is a guest article by Lars Kroijer.

From today you can invest up to £15,000 a year into your ISA. With rates on cash at historic lows, more and more people are looking to invest in the equity markets.

So is it time to find an expensive whiz kid fund manager who can turn your modest savings into millions?

Or maybe you’re the new Warren Buffett – should you get to work ferreting out some winning stock market investments?

Not so fast! (And I say that as a former hedge fund manager myself).

Getting to a great portfolio is quick and easy, but you need to make sure you’re going down the right road first.

I estimate it will take you another 300 seconds or so to read this article and discover how to create a portfolio that will deliver better returns than nearly all the expensive options out there.

Can you afford not to read on?

Don’t try to beat the market

Let’s start by accepting that you can’t outperform the financial markets. Don’t worry, virtually nobody can beat the market for long – very probably including those that sell you expensive financial products.

And you don’t need to beat the market anyway to get a perfectly good outcome from your investing.

So don’t buy any expensive funds!

Instead, I suggest you invest your ISA (aka NISA) into a simple portfolio that consists of just the following two investments, in proportions that suit your risk tolerance and stage of life.

#1: A cheap global equity tracker fund

If you are after high returns and can tolerate high risk, buy the broadest and cheapest equity index tracker you can.

You want an ETF or index fund that tracks the MSCI All Country World equity index, or something equally broad. Look at Vanguard, iShares, Fidelity, and State Street, or read previous Monevator articles for the very cheapest options.

A global tracker gives you maximum diversification at minimum price (perhaps 0.3% per year, pick the cheapest). It is probably the only equity exposure you will ever need to have, in your NISA or elsewhere.

Don’t buy funds that charge you more to actively pick a different set of stocks from the index.

They probably can’t do better than the index in the long run and the costs will eat into your returns.

#2: UK government bonds

If you want minimum risk, buy UK government bonds with a time to maturity that suits your time horizon. So if your horizon is 10 years, buy 10-year maturity government bonds, and so on.

If the bonds don’t match your time horizon, then you either end up trading shorter term bonds until your 10 years are up (which is an expensive headache), or you take unnecessary interest rate risk with longer term bonds.

UK government bonds are the highest credit quality security in the country, and this leg of your portfolio aims to give you security, not returns.

Again, you can get your bond exposure via an appropriate ETF – which saves you trading the bonds yourself. And again you should pay very little for it, perhaps 0.15% per year.

Look at the same cheap tracker providers for your bond fund as you did for your equity exposure. These companies are market leaders for a reason.

Blend your equity and bond exposure to suit

If like most people you want an exposure in between the two, mix the stock and bond ETFs accordingly.

• For a young person who can take a higher risk, perhaps a 75%/25% equity/bond split.

• For someone closer to retirement, perhaps a more conservative 25%/75% equity/bond split.

Whatever your exact split, this simple, low cost, two security mix portfolio will in my view provide you with a less complex and better risk/return profile than 95% of portfolios out there today.

Investing your ISA doesn’t have to be difficult or expensive to be effective.

Lars Kroijer’s Investing Demystified is available from Amazon. He is donating all his profits from his book to medical research. Alternatively, read his Confessions of a Hedge Fund Manager.