Back in late 2003, I decided I wasn’t ready to gamble all my savings1 on what seemed to me to be a crazy house price bubble.

Instead, I decided to invest most of my money in the stock market.

Given my woeful misjudging of London property prices (they went on to double) I’m probably lucky I fancied myself as a stock picker rather than a real estate tycoon.

Here are a few lines from the investment diary I began at the same time:

“I think that we are about to see the market tick up again. I think terrorism is priced into the market, that after three years the worst is over, and that now is a good time to invest, particularly for the long term. I can’t keep writing ‘touchwood’, so assume that’s a standing thing for this entire investment log!”

I intended to be a pure tracker fund investor – pretty radical back in 2003.

However I did also buy some experiment blue chip shares for income, and over time these and later small caps, investment trusts, and eventually all sorts of securities both here and abroad captured my imagination.

Active investing had weaved its magic on me.

I don’t write much about my active investing on Monevator. Mainly that’s because I think few people should do it, and that the reasons why you might are nothing to do with planning for a comfortable retirement.

I pick shares for the fun, the challenge, and because I seem to be compelled to. Most people should invest passively, but increasingly I don’t.

As Walt Whitman wrote:

“Do I contradict myself? Very well then, I contradict myself. I am large, I contain multitudes.”

With that wealth warning and the pretentious poetry out of the way, here’s a few things I’ve learned that might be useful whether you’re a passive or an active investor.2

Maybe these are all obvious to you, and I was a bit slow on the uptake. Or perhaps you need to live through some things to really understand them.

1. It will happen again

When I first started learning about investing, I thought I’d arrived late to the party. Everyone was licking their wounds from the dotcom bubble, and everyone knew Warren Buffett’s maxims about being greedy when others are fearful.

There seemed little to do but hand over my money to the robots.

How wrong could I be? If anything people are forgetting faster nowadays. Within a few years of my starting, we were neck deep again in a bear market that had its roots in excessive risk, and equities were supposedly dead as an asset class.

It’s all happened before. It will happen again. People don’t change.

2. Not everyone is contrarian

The day I left school, I walked out of the back gates while everyone signed each other’s shirts at the front. I had friends, but I was no friend of school. I hated being told what to do, what to think, and when to do it.

Throughout my adult life I’ve regularly made the case for unpopular or even unpleasant notions. I wasn’t always right, but that isn’t the point.

“Look around this table,” an exasperated friend once said. “Can’t you see that every single one of us disagrees with you?”

She meant it as an appeal to switch sides. That sort of thing just makes me dig in harder.

Lots of investors say and even believe they’re contrarians, but they’re not really – they just think the popular and cool kids are contrarians. They think this while following the crowd.

I’ve had to endure a bit of flak in real-life for my willful ways. I’m essentially unemployable in a conventional office environment.

But in investing, being awkward and independent is a boon.

3. The bear case always sounds smarter

Perhaps it’s a product of being invested in a decade defined by various crashes and calamities, but being contrarian while I’ve been an investor has often meant being positive about the future.

In my experience, many people – particularly the 50-something males who dominate investing, both professional and amateur – think being contrarian means thinking the West is doomed, that productivity is dead, that the stock market is done with, and so on.

The adage that the bear case always sounds smarter is a rare case of something I decided for myself – rather than reading it first – although I soon discovered that wiser minds had reached the same conclusion long before.

I don’t know why it’s true, but it is. People are drawn to doom mongers and see the logic in their every utterance. Just look at the almost invariably gloomy news headlines – those editors know what people want to hear.

Perhaps it’s to do with our biologically driven risk aversion3.

The irony is you can waste a lot of time and lose or at least forgo a lot of money by being a pessimist when investing.

There’s always a good home for your money somewhere.

4. It’s okay to sell shares

As a newbie, I was much taken with Warren Buffett’s supposedly favourite holding period: Forever.

Later on I learned Buffett often didn’t invest like that, and neither would I.

I still see the logic of buy-and-forget for certain kinds of portfolios, particularly if you want to be a stock picker for whatever reason and yet you only have limited time, interest, or application. (In most cases then you’d be better off being passive, but that’s another 900 articles…)

These days though, I revel in the joy of selling shares.

I won’t debate running winners versus cutting losers, or how you never went broke taking a profit. All the adages are true, and contradictory.

I’ve lost all the money I put into one company, and one share I sold is up at least 20-fold last I looked. This sort of thing happens to you if you actively invest long enough.

What I will say though is I love the feeling of going to cash. All the risk evaporated in an instant, until the next opportunity-cum-booby-trap.

If I could get 8% on cash in a tax shelter in a 3% inflation world, then for all my love of shares I’d probably go 50% cash tomorrow.

5. Compound interest works. It really does.

It’s a daunting climb when you first set off towards your investment goal, whether it’s financial freedom, early retirement – or being able to pack up work at all.

But it gets easier. Honestly!

The great thing is that your money starts to do the heavy lifting for you. Eventually your portfolio goes up and down in a few weeks by amounts that would have taken months if not years to save.

This is mathematically obvious. If you earn say £40,000 a year and you can save £4,000 a year, then when your portfolio is £80,000 in size, a mere 5% fluctuation equates to your annual savings. Over the years, your money compounds copiously.

Still, seeing is believing. I recommend it.

6. It pays to pay attention to taxes early

I’ve written a lot of posts about taxes and investing because I have a fair amount of money outside of ISAs and SIPPs, and it causes me headaches every year. I’d rather you avoided them.

Nowadays I fill my ISAs religiously, but I didn’t open any until 2003.

I’ve been shoveling money over as fast as I can each year, but it’s clear that short of retreating to an Ashram and renouncing all worldly work, I’ll never get all my money tax sheltered.

That means faffing around to try to avoid capital gains taxes, taxes on dividends, and so forth, and it has entailed long fiddly submissions to the Inland Revenue.

Utterly annoying.

Some people criticise my emphasis on reducing or avoiding taxes. Good for them if they can afford to forego the thumping great swathes that taxes will chew out of their investment returns, on top of whatever income tax they pay on earnings. It’s enormous.

I can’t, and most of you can’t either. So think about taxes early.

7. The market is not completely efficient

I don’t have much to say about this. I’ve read the literature. I know that some academics will disagree with me and say I didn’t see all the risks, or that I was being paid to supply liquidity, or whatever.

But if you’re any “good” at active investing – itself a rightly controversial subject, and in most cases probably synonymous with luck – then you eventually see too many signs of the inefficient market to put it in the same box as pink elephants, the yeti, and Father Christmas.

That’s not to say you or I can profit from market inefficiencies.

I’ll not be completely sure whether I’m a good investor for as long as I live, whatever returns I post. Some say even the acknowledged greats would need to re-run several more lifetimes to be certain.

But I am sure the market is not efficient.

8. Everyone always saw it coming

Given all the doom-mongering out there, it’s inevitable that there’s someone who predicted whatever crash or catastrophe last hit us, or whatever one is around the corner.

True, they often spoke years too soon, and there are rarely very many of them – certainly compared to the vast number of people who claim they saw it all coming once it has actually come.

It’s the same with good news. Most fund managers only bet on shares going up, so if there’s a new tech revolution or a banking renaissance or whatever, then some handful of people will have opined upon it beforehand in a note or an interview, even if most of us dismissed it as a fad.

When I began investing, I thought everyone had much more foresight than me.

Hah!

After I wised up I’d get really infuriated by this retrospective brilliance – until I realized that most of them genuinely believed their memories of their accurate forecasts to be true. Such self-delusion must be another of those cognitive bequests from evolution.

I’m sure I do it to. But I also write a blog, so at least you can see some of my bad calls alongside my good ones.

The bad entries are a usefully humbling antidote should anything be going too good for five minutes.

9. Many shall be restored that are now fallen

Ben Graham, the man who taught value investing to Warren Buffett, touted this quote from Horace:

“Many shall be restored that are now fallen, and many shall fall that are now in honor.”

Graham was talking about value stocks that come back from the dead. Horace was talking about words and poetry.

No matter, they’re both right. People are creatures of fashion, and we’re all subject to economic cycles.

As I put it less poetically: Never say never again.

10. Barring a revolution, this is going to work

While I’m an optimist when it comes to investing, I’m a gloomy old soul when it comes my personal circumstances.

I’ve few doubts that when I hit my goal of complete financial freedom, the 99% will rise up and tax or take it away from me.

Just my luck! After 30 years of capitalism, a frugal saver who happened to learn the ropes will be first up against the wall.

An indebted peasant’s revolt aside (and touch wood – illness or misfortune can strike at any time and is the sort of thing we should really spend our time worrying about), I can now see that this self-directed investing lark is very likely going to work out for me.

In fact, my problem is more likely to be remembering why I was doing it, because I’ve grown to enjoy it so much for its own sake.

My capital has increased six-fold since 2003, through a mixture of saving and investing returns. The Accumulator warned me earlier this year that there was no way I was going to liquidate a big chunk of my portfolio to buy a house – because he knows I’ve grown to love running what he calls my “DIY hedge fund”.

That tells you that The Accumulator is as astute about people as he is about cheap discount brokers. (You should hear him on Prussian military history).

I couldn’t imagine in 2003 that investing would become such a passion that a decade later I’d be spending dozens of hours a week on it, willingly and with a smile on my face.

Be careful what websites you read. Next up it could be you!

1. I’d already squirreled away multiples of my post-tax annual income. [↩]
2. i.e. This is not what I’ve learned about reading a balance sheet, or about returns on incremental capital, or about subordinated debt, et cetera et cetera! [↩]
3. Although we don’t seem to be able to apply our desire for survival to genuinely important risks, like the degradation of the environment. [↩]

Tim Hale’s classic book Smarter Investing has proved an “Aha!” moment for me and many other Monevator readers on the journey to investing enlightenment.

It answers more questions than an energy company boss before a Parliamentary Select Committee – except that with Hale the answers are usually satisfactory and the light bulbs should stay on.

Perhaps the most important question of all is: “Does the 2013 third edition contain new insights that may change a passive investor’s strategy?”

And the answer to that is: it may well do because Hale has updated his advice on bonds.

A shortage of interest

Historically low interest rates, vast amounts of QE being forced into the vaults of the financial system like fracker’s slurry, and investors clamoring for yield have put the why bonds? conundrum at the top of the agenda.

Hale’s response is – like a number of American commentators – to go short-dated and to consider diversifying your bond holdings.

Short-dated means holding bonds with maturities of between one and five years. That way the losses you suffer will be staunched in comparison to longer bonds in the face of interest rate rises.

Short-dated bonds are less vulnerable to interest rate risk because they mature relatively quickly. You get your capital back and can reinvest it in new bonds with higher yields – hastening your recovery from losses.

Hale has nixed his earlier talk of long bonds for aggressive investors intent on accumulation. The losses you risk are no longer worth the incremental returns.

Cautious investors should err on the side of short-dated inflation-linked bonds. Although this is easier said than done.

Index-linked National Saving Certificates would be the ideal bolt-hole but have been cast into deep freeze by the Chancellor.

The other options aren’t great either. Index-linked gilt trackers generally have maturities around the 17-year mark, so could be hit pretty hard if and when rates go north. And investors are so desperate for linkers that available yields are generally negative in the secondary market. In other words, it costs you to hold ‘em.

Faced with this, Hale turns to heresy, suggesting investors throw in their lot with active managers who offer short-dated linker funds.

Credit controller

Note that we’re no longer talking about investing purely in UK gilts.

The UK’s downgrade from triple-A status frees Hale to offer an additional fixin’ of global and corporate bonds scored AA and above by the credit rating agencies.

The benefits are extra diversification and yield, though Hale emphasises the importance of ensuring global bonds are hedged to Sterling. (There’s no point taking on currency risk in the portion of your portfolio that’s meant to cushion you against volatility.)

Commodities are also off Hale’s menu of acceptable assets.

He cites doubts over the counter-party risk and conflicts of interest that may compromise the structure of Exchange Traded Commodity (ETC) funds run by large investment banks.

Hale is clearly ambivalent about these risks, as he continues to make a good case for the role of commodity futures in a portfolio. However, when forced off the fence he decides that discretion is the better part of valour this time.

He has no such doubts over the merits – or not – of gold and structured products.

Hale sets about dismantling the case for both with the speed of a bomb disposal officer who wants to get home in time for EastEnders.

Outlook moderate

Hale has also downgraded the return expectations for his range of model portfolios that form the centerpiece of the book. The effect is most pronounced on portfolios with a heavy bond allocation, but the drag was enough to make me wince even on a 60:40 equity/bond allocation.

Of course, nothing is certain and Hale’s underscoring of the investing vagaries is one of the great favours he does DIY investors.

He takes pains to show that you may hit the jackpot over an investing lifetime, or you may hit the skids. Even reasonable return numbers are a 50:50 punt.

In other words, he does a great job of trying to stop investors anchoring themselves to a notional number peddled by a calculator, brochure, or book.

Sadly, this effort is downplayed in the 3rd edition of Smarter Investing in comparison to its predecessors.

I think this is a product of brevity. The 2013 edition is 100 pages shorter than the 2006 1st edition and important lessons are no longer hammered home by repeated exposure to scary graphs that plunge like the Alps.

Indeed given the paucity of UK books on passive investing, it’s worth us taking a detour to see what else has gone walkies from the 1st edition.

First edition Smarter Investing

The main reason to read the 1st edition is for several lost passages on the behaviour of UK bonds between 1900 and 2004.

My hair does a Van de Graaf every time I see the -74% real loss of the 1900s or the -73% shaft on the graph that is the 1940s.

More chilling still is the -4% real loss p.a. that occurred over the worst 30 years of UK bond investing history or the 47 years it took to recover the real purchasing power of your bonds lost during the bear market of the 1940s to 1970s.

It’s a graphical insight into the havoc that financial repression and inflation can wreak upon bond investors – a topic with particular resonance today.

What’s more, this is insight into UK historical data that you can’t get from US investing books.

That’s why Hale’s work is so valuable to British DIY investors and why I think it’s worth tracking down a copy of the 1st edition for the bond section alone.

Better still, if Hale doesn’t intend to restore these passages in a future edition, it would be wonderful to see them pop up as bonus content on his website.

The extended look at property as an asset class is also worth a read, as are stiff draughts of reality like the real return of 2.5% p.a. that investors earned from the worst 35 years to afflict UK equities.

But most of the other cuts from the 1st edition make sense, and amount to a sanding down of the material into the sleeker 3rd edition available today.

All UK passive investors owe it to themselves to read Smarter Investing in whatever incarnation. If you’ve read it already, read it again!

Take it steady,

The Accumulator

Good reads from around the Web.

According to the PricedOut campaign as quoted in The Guardian, it’s better for a first-time buyer to forgo Help To Buy, and instead rent and save for a larger deposit and a cheaper mortgage down the line:

The organisation compared the average monthly cost of renting with the cost of repaying an average mortgage around England and Wales and found that the interest rates on Help to Buy loans meant it was cheaper everywhere to rent than to buy.

In London, repaying a 95% loan at a rate of 4.99% cost £1,437 a month based on the price of a typical first home of £256,000, compared with average rents of £1,141.

The gap was smaller elsewhere, but even in the north-east where average rents were £533 a month, according to the latest LSL index figures, PricedOut said it was more expensive to service a 95% mortgage. It said to repay a loan on a property costing £104,000 would cost a first-time buyer £584 a month.

London has gone absolutely bananas. Again. I was chuckling at some investing literature the other day suggesting that a landlord look for properties that can be rented out for 1% of the purchase price. By that measure, my two and a half bed terrace in West London should rent for at least £5,000 a month!

In reality it costs me £1,600.

Who is the nutter here, me or my landlord? Property in the UK inflames passions and opinions, and there will be no shortage of people who’ll say he’s an idiot speculator at the top of the biggest bubble / Ponzi scheme in history.

I used to confidently say such stuff 9-10 years ago. Then prices doubled again.

Others, particularly the old, the traditional, and the closely acquainted with me, will point out renting gives you no asset at the end of 25 years. I’ve now been renting in London for over two decades, counting my student years1. This is no longer a purely theoretical matter.

A once in a thirty generation opportunity

The reality is that at today’s interest rates – the lowest for at least 300 years in the UK – my landlord is doing okay. In fact after the crazy price rises of the past two years in London, he’s doing far better than okay in capital terms.

As someone who prides himself on his investing nous, I can’t dismiss lightly the fact that my landlord has made at least £100,000 over the period, and I helped fund his bet.

On the other hand, if/when interest rates rise, the economics fall apart. As one Guardian columnist notes elsewhere in response to the PricedOut maths:

A £200,000 mortgage may, just, be affordable at around £1,200 a month on today’s rates. But it only needs the base rate to rise from 0.5% to 2.5% to push up repayments by £250 a month.

If rates were to rise to 4.5%, the homebuyer would be forking out £500 more a month, assuming he or she is on a mortgage that moves with the base rate.

The elephant lurking in the room in London and the South East is house price appreciation. That’s what stands ready to shit on sit on those who’d try to be too clever and sensible about what has long seemed a blatantly bonkers price boom.

It’s not always like this, nor everywhere. We have a PricedOut campaign in the UK because our house prices never properly fell. As things stand, our young people need either rich parents or extraordinarily lucky career paths (statistically speaking – it’s irrelevant that your nephew Barry got an internship at Goldman Sachs, there aren’t ten million of those to go around) in order to buy a decent family house fit for 25 years where the jobs are.

Or they need to emigrate. In the US, where property was at the epicentre of the 2008 crash, it’s a different story. Few people there now expect much more from their houses than that they keep up with inflation. If anything they’re too pessimistic, in my view.

He’s a mug, I’m a mug

My late 2011 bet to buy housebuilders instead of a new house here in London has paid off in pure return terms. The shares doubled and tripled in value in just two years. If I was a hedge fund manager, I’d be being interviewed for the Sunday supplements. Go me!

No so fast. It’s virtually impossible to keep up with the gearing benefit of a mortgage when prices are rising. The house I sit in – and rent – has gone up £100,000 in 18 months. It’s forecast to do so again over the next three years.

Making six-figures with the help of a bank is easy money of the highest order. I’ve known people who can trace six-figure returns from London property back to one decision in the late 1990s to get onto the ladder by sneakily amassing a deposit via some credit cards. They hadn’t saved much before and – bar the forced saving of a mortgage – they haven’t since.

It’s hard not to feel like dumb money in the face of that, whether you’re a 23-year old who is priced out, or a 40-year old who missed his chance because he thought he was smart enough to know better.

Prices in London are insanely high, and those who buy despite that keep making money.

[continue reading…]

1. In the mid-to-late 1990s London property was very cheap. My problem was I had no Bank of Mum and Dad, and also that I was a freelance. But no excuses, I could have bought somewhere cheap. I missed my chance [↩]