Good reads from around the Web.

We’ve written several times about the end of the bond bull market. We agreed that bond prices looked extremely likely to fall eventually as interest rates rose. But we’ve argued that even though the expected returns from bonds must mathematically be much lower than in the recent past – perhaps even negative, after inflation – there was a good case for keeping hold of your bonds, especially if you’re a passive investor.

Alternatively, if you must be different, then – while it’s not the same as bonds – cash in the best savings account is a reasonable alternative these days. Indeed it’s what I use currently for my safety net beneath the high-wire of equities.

Everyone knows interest rates are low. That’s not the point. The thing to realize is you’re not really holding bonds or cash for returns these days. You’re doing it to reduce risk.

Joe Davis of Vanguard made the point well this week:

Risk is a relative term. If someone asked you to set aside $150 a month, possibly with no return on your investment, you’d probably say, “No way!”

Yet what if you knew the alternative was losing your home and all of your belongings in a fire, flood, or other emergency, with no funds to help rebuild your life?

Suddenly, the $150-per-month payment for disaster insurance might seem like a good idea.

The same perspective can apply to bonds. If you’re considering an allocation to bonds but have been warned that this allocation may have low or even negative returns in the next few years, you may see bonds as a risky bet.

Yet by weighing the risks of the alternative — that an allocation to equities is far more likely to experience highly negative returns of –5% or more during the same period according to output from [our] model — you may begin to recognize bonds as the steady diversifier and volatility dampener they truly are when combined with a stock portfolio.

Read the whole piece – and our articles on bonds that I linked to in my opening paragraphs – for more.

The silenced minority

Now, somewhere out there a reader is set to jump to the end of this article and write a comment saying I’m an idiot who doesn’t understand bonds are sure to lose money etc etc. Bonds are the risky investment right now! And so on.

As if this has never occurred to me, or to Joe Davis of Vanguard. As if we are witless muppets doomed forever to lose our money to the cunning market.

In fact, this person1 is very unlikely to have read the Vanguard blog. They just want to make their point. Again.

But today they won’t be able to because I’ve turned off comments. Just on this post for now, as a one-off.

Most things about blogging about investing for six or seven years are great. But spending 4-6 hours writing a long and detailed post only to get these same sort of comments from the same 2-3 people (a revolving cast, they tend to wander off after a few months but are topped up by newcomers) is pretty tedious.

Please understand I don’t mean all of you who comment on articles!

There’s a great – collaborative and sometimes challenging – discussion happening on The Accumulator’s post about financial independence this week, for example. That’s community and commenting – and our site’s above-averagely clever readers – at their best. Everyone comes away smarter.

Also, I never mind people not understanding or genuinely having doubts, and voicing them. I don’t mind people disagreeing, for that matter, if they have the courtesy to actually read the article first and know what they’re disagreeing with and why they might be wrong.

But for a hardcore handful, blog commenting seems to be an excuse to try to explain what they know while only really demonstrating what they don’t.

The Myth of Sisyphus

The best of these people are at least polite – even nice – but repetitive and misguided. The worst are rude, and I need little excuse to delete their comments.

If you wonder what sort of comments I would delete, go and read either The Daily Mail or The Guardian’s comments under a contentious political story. It ain’t pretty!

Please be clear: this website isn’t a democracy. I will delete anything offensive or offensively stupid. Or that I want to, frankly, though it rarely comes to that. (Once or twice on my Thatcher post, perhaps).

It is incredibly tedious writing among the most long-winded investing posts you’re likely to find on the Internet – stuffed with more caveats and footnotes than a billionaire’s pre-nup – only to have someone pop up and say: “Your advice is reckless, anyone staying in this rigged Bernanke-market is doomed!”

Yet it’s almost worse when they make sensible sounding comments such as:

• The market goes through booms and busts, so you must always try to sidestep the busts

• Tracker funds are inherently dumb, so it’s easy to do better by avoiding their excesses

• Bonds are yielding 2%, so investors will obviously do better without them

• The market looks expensive because it’s on a P/E of X, Y, or Z, so best to get out

• Inflation/deflation is obviously coming, so it’s clear we should do X, Y, or Z

• The gold price is at $1,800 or $1,600, or $1,000, which tells you X, Y, or Z

• Neil Woodford has beaten the market, therefore it’s obvious that Joe Blog Commenter can too, isn’t it? Or do I really think Woodford is merely lucky? Or magic?

All these things sound perfectly sensible – whereas index tracking sounds idiotic at first. And of course that’s what makes their comments so dangerous.

Nobody doubts returns would be far better if you could be in the best asset classes all the time, exit the market in time to avoid crashes, and do a bit of judicious active management to juice your returns – or even to pay a well-known talent like Woodford to do it for you.

Unfortunately there is decades of data proving that all those common sense ideas will reduce returns for the majority of those who try.

That’s true whether they are professionals or simply a new investor asked to manage her own pension for the first time. Not for the gifted or lucky few, perhaps, but certainly for the majority who have historically done so poorly from investing in shares, whether from the cost consequences of active management, or from under-performance or dire market timing or worse.

On the other hand, passive investing in a widely-diversified portfolio has demonstrably delivered results that are acceptable to nearly everyone. It’s simple in principle and it gets the job done. Yet it’s under-discussed and misunderstood, especially in the UK.

So that’s why we promote it on this blog.

A family friend suggested I just ignore the handful of negative or incorrect comments tagged on to articles. “Everyone knows that comments on the Internet are nonsense,” she said.

But I feel I can’t.

I don’t want a casual reader of this website who might be about to get on the right track of lifelong investing to pick up the wrong lesson under my watch, even if it’s not from my mouth. So I can’t let these seemingly certain, obvious, and generally incorrect comments stand unchallenged. Hence I end up having the same tedious debates over again.

(What may not be apparent to a regular reader is some of this happens on old articles you probably don’t see anymore. The new articles are just the tip of the iceberg with an established site like Monevator. And then there’s email…)

Commonsense but uncommon success

Am I a hypocrite? One of these commentators asked me why I didn’t accept all his certainties about market timing and so on, given that I – as I have I always admitted – invest much of my money actively for myself, unlike my purely passive co-blogger, The Accumulator?

And that brings us to the crux of the issue.

It’s because I think the things that the active advocates call for are so difficult, so speculative, and so unlikely to work out for most people that I stress the much more sensible route of avoiding the game altogether and going passive.

Indeed if I turn out to have beaten the market over the long-term – and if it’s not luck, which we’ll never know for sure – then it will be in part because I think it’s extremely difficult to do so, not because I thought it was easy.

It’s also why The Accumulator joined the site a few years ago. His consistent passive investing message is exactly the one most people need to hear when it comes getting their investing sorted over 30 years.

In contrast, the people who claim timing markets or forecasting asset returns is easy are either deluded, or they have some other agenda to promote.

Study after study shows the generally negative impact of the kind of poor decisions they advocate. They’re simply wrong to suggest that anything other than luck or very rare and hard-to-identify skill is required to do these things.

Reading the riot act

One day I may turn off the ability to add comments to this site. I’ve seen many big websites and also a few friends do it. Mike at Oblivious Investor, for example, turned off comments a year or so ago. Negative comments are sapping the will of Sam at the Financial Samurai blog, too.

It’s not come to that yet on Monevator. The sort of comments I’m taking about are still in the minority, and the input we’ve had from readers about things like platform fees has made us all smarter.

And to be clear I’ve always been happy if someone has quietly asked us why, for example, they should hold bonds when the price can clearly only go down – provided it’s not at the end of a post that explains exactly that. If you still disagree then fine, more power to you, but don’t feel you need to tell me about it unless you see factual errors.

I’ve never been happy to be lectured in a way that ignores everything I’ve just written. It’s wearying, and I’ve genuinely never learned anything from these people.

Almost worse, I don’t think they’ve learned much from me.

So it seems an arid exchange.

This site is not for these people. It’s for the 100,000 or so visitors who now arrive at Monevator every month, the vast majority of whom can pull up a chair and consider themselves at home.

And – while it’s not compulsory – it’s definitely for the 2-3 newcomers who email me every week to say they’re pleased to have finally found the information they were looking for to demystify investing.

In fact if you’re new around here then I’m sorry you had to wade through all this. I’m not normally so self-indulgent, honestly!

Long story short, commenting on this blog is not like writing a letter to your MP or the BBC. More so than ever – because I am getting so fed up with the annoying few – it’s my house, and my rules.

So know that anything you write may be deleted on my whim. Consider this fair warning as to the comment policy on this website. I will not let Monevator turn into another poisonous bicker-fest, such as you see at the online newspapers these days. There’s an entire Internet out there if you enjoy flame wars with strangers. I don’t.

The majority of our 100,000 monthly visitors never write or even read the comments – or when they do write comments they’re the useful or constructive sort. So this doesn’t apply to you, anyway.

Some of you will feel this whole rant is ridiculously over the top. Even some of you good guys! And I don’t blame you. Unless you have a website and have to deal with this stuff, it’s very hard to understand how soul-sapping it is, and it’s hard to explain. Just to take it from me (or have a Google), or set up a website for yourself and see.

Finally, if you’d like to say something nice or supportive and can’t because I’ve turned off the comments on this post, then thank you!

If you’ve not already, please “Like” this site on Facebook via that link, or by using the box in the column to the right. That would be a nice gesture.

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1. I am not really thinking of any specific person — it is more an amalgamation of 3-4 people [↩]

The plan is to be financially independent in a decade. I can see now that it can be done. And I can see how it will be done.

The thought of it is making me tingle. This will be the biggest and most rewarding challenge of my life.

In my case, becoming financially independent (FI) requires all the things the gurus said:

• A stupendous saving rate: 67% of after-tax income.

• A moderate annual expenditure: £20,000 for the two of us.

• A final ‘retirement’ pot that can sustain a 3% withdrawal rate (the standard 4% is too risky in my view, for many reasons).

• A decent spurt of growth from my portfolio over the next decade: A 4% real return a year will do it.

The growth rate is out of my control, so let’s not worry about it here. The final pot is negotiable, which leaves the savings rate and annual expenditure target as the twin keystones of the plan.

Hitting a 67% savings rate without pauperising ourselves means the near removal of Ms Accumulator and I from the tax system.

Tax ghosts

Part one of going off the tax grid is to stick to that £20,000 annual income figure.

From next year, the income tax-free personal allowance is £10,000 each, updated annually in line with inflation.

Split between the two of us that means our entire year’s worth of spending ducks the taxman’s net. £1 of spending over that line actually costs us £1.25 – once you deduct 20% income tax.

Going tax dark part two means stuffing every spare penny we have into our pensions.

Famously, pension savings are taxed at your marginal income tax rate when you withdraw. In other words, if we each spend £10,000 a year from our pensions (in today’s terms) then we will pay 0% tax.

But the beauty is that every penny we save attracts 20% tax relief at the basic rate and 40% at the higher earner’s rate.1

That means every £1 saved is actually worth £1.25, or even £1.67 at the higher rate.

Which means that £10,000 saved is actually worth £12,500 or £16,700 and is returned to us un-gouged by HMRC, if we live within our personal allowances.2

I can’t emphasise this enough. We get an instant return of 20% or 40% from saving into our pensions (not including company matches) and, if we’re careful, it’s never taken back because we’ve danced clear of income tax.

An ISA can’t compete with that

It should take us 10 years to hit financial independence (FI) using company pension schemes and SIPPS. It would take over 13 years if we maxed out our ISAs instead.

If I was trying to hit FI in my 30s or 40s then, yes I’d be all over my ISAs. But that boat has sailed for me.

We’re in our early 40s, so we’ll be within sniffing distance of our pensions by the time the 10 years are up.

If progress is slower than I hope, then we could easily be 55 – the age at which you can begin to make withdrawals from a pension – by the time we hit our FI bullseye. In that scenario there won’t be any hanging around.

Sure, if things go spectacularly well, and I hit my numbers early, then I could be like a pirate becalmed off treasure island – so close to his booty but unable to touch it.

I’m fine with that. I intend to work on for a couple of years anyway to build up a juicy tax-free lump sum. This will be slipped into ISAs to create an emergency fund / extra tax-free income generator / travel-the-world slush fund, depending on the mood at the time.

Final thoughts

It took being able to smash my mortgage before I was able to think clearly about FI. (If you can cope with two things at once then you won’t have this problem…)

You can add even more tax relief gas if your company pension scheme supports salary sacrifice. That will spare you another 12% in National Insurance Contributions (or 2% for higher raters).

At some point in these discussions, somebody will always say:

“The Government can change the pension rules, spanner your personal allowances, or even confiscate your pension.”

To which I say: Yes, you’re right to point out the risks.3

That risk is one of many I’m taking to achieve something big in my life. I’m also entrusting my wealth to assets scarier than cash, believing I have a long and happy life ahead of me, counting on the UK not to suddenly turn into Argentina, and so on.

By all means be aware of the risks, but don’t be paralysed by them. Play the game in front of you.

There’s a good chance that any adverse pension rule changes:

• Will happen early enough for me to change course.

• Will happen late enough that I’ll be exempt.

• Won’t happen as foretold.

My chances of being left high and dry are small.

When all is said and done, the key is being able to live happily on £20,000 or less.

My prescription: Fall in love, maximise your tax allowances!

Take it steady,

The Accumulator

1. I’m not too worried about the 45% rate. Are you? [↩]
2. i.e. Save no more than our annual salary into a pension scheme, or our pension annual / lifetime allowance, and withdraw no more than our personal allowance in any given year of retirement. [↩]
3. Only last week Ed Balls gave notice of his intention to end 40% tax relief on pensions if Labour are elected. Though most will be better off if reports of a new 30% flat rate relief for all are to be believed. [↩]

Good reads from around the Web.

One of the hardest things to explain to a new investor is the benefit of rebalancing asset allocations.

Until you’ve had the “aha!” moment, it can seem like madness to reduce your holdings of investments that are doing well, to buy stuff that’s losing you money.

And then, once you’ve had the “aha!” moment – well, then it’s hard to remember what it was like before you “aha!”-ed, making anyone who doesn’t yet get rebalancing seem a bit like a child who doesn’t yet get why they need to eat.

Enter Larry Swedroe, and his short article that proves again how the magic of rebalancing works. Swedroe cites numbers from an author I’ve never heard of, Jaques Lussier, and his book Successful Investing is a Process. Here’s rebalancing in action (US data, but it’s the same principle in the UK):

An investor begins in 1973 with a portfolio that is 50 percent stocks and 50 percent bonds. For the period ending in 2010, stocks outperformed bonds as they returned 9.8 percent versus 7.7 percent for bonds.

If the portfolio was never rebalanced, the ending portfolio would have had an allocation of 68 percent stocks and the annualized (compound) return would have been 8.9 percent.

Knowing that stocks beat bonds by 2.1 percent a year was the investor who never rebalanced better off?

My own experience tells me that most people would assume you would have been better off not rebalancing due to the much higher return of stocks. Yet, a rebalanced portfolio would have returned 9.5 percent, and done so with less volatility.

In other words, the diversification benefit was sufficient to overcome the 2.1 percent disadvantage in returns. During this period the annual correlation of stocks to bonds was close to zero (0.1).

Rebalancing feels bad in the short-term, but it works over the long-term.

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