Good reads from around the Web.

You can’t turn on the TV or read a business website without stumbling across an economist these days. The financial crisis took these nerds-turned-superstars off the sidelines and onto the front pages.

Why did economists become our go-to pundits? Because we demanded explanations for what happened in the meltdown, and economists fell over themselves to give them.

Sadly, as my post of the week from The Atlantic explains, while economists might be pretty good historians, they’re rubbish at proposing useful actions or predicting the future:

Imagine you are the Royal Physician in England some time during the 14th century. The prince is sick, and you’ve been summoned to help. You call in two experts for advice. The first says: “Use leeches to suck out the evil humors.” The second says “No, you must bleed him to get the evil humors out.” They start to argue, insulting each other in nasty epistles. “Leech guy is secretly working for the French!” alleges Bleeding Guy. “Bleeding Guy just wants the prince to die because the prince wanted higher taxes on the nobles!” Leech Guy fires back.

What’s the right move? Well, in an ideal world, you would go and get 999 patients who have illnesses similar to the prince’s and give them all a variety of household substances, such as bread mold. Then you would take careful note of who died and use statistical analysis to figure out which household substances cured disease. Thus, you would discover penicillin and invent modern medicine.

Sadly, this is not what you do, because a) if you proposed it, you would be led off to the dungeons and beheaded b) it’s the 14th century and you have no concept of the scientific method and c) you don’t really have the right tools for that experiment, anyway. Instead, it’s bleeding or leeches. So you take your best guess and you pray you’re right.

The economic situation we find ourselves in today is a little bit like the example above.

I’m skeptical when I hear an economist explain what’s going to happen in the economy. After many years of reading their opinions, not one has struck me as generally right.

Some, such as the perma-gloomy Nouriel Roubini, seem to be like the sacrificial virgins of our forebears. When the market falls they are given airtime to appease the Dark Lords of Doom, but once the Apocalypse is postponed, they’re returned to the dungeons.

Lots of investors say they don’t take economists seriously, but my experience says otherwise. From 2009 to 2012 I was regularly emailed economic predictions – invariably pessimistic – from investors I know. Comments left on this blog were similar.

Like porn stars, somebody must be using their services and paying for them, whatever they say in public, or else the economist industry wouldn’t be so big!

I rarely include economic prophesies in Weekend Reading. But I do think economists can be helpful to get a view (not *the* answer, and not a prediction) on what’s already happening in the economy, or in a specific sector.

Economists are most useful at explaining recent changes on the bottom-up level – the pent up demand for UK housing, say, or the way that employment is rising despite the weak economy.

Just don’t let them get their crystal balls out.

[continue reading…]

Time flies when you’re running a high-yield share portfolio that – by design – you only look at once every few months or so.

Just one year ago my demo HYP was celebrating its first baby steps.

And those steps had been of the clumsy and stumbling kind.

The portfolio’s value was down 6.6% (ignoring income) since I’d had the bright idea to put £5,000 into it back in May 2011. The wider market was down by roughly the same amount, too, and so was the basket of three investment trusts that I picked for a second benchmark.

A year and a bit on, however, and things are looking far brighter. That’s share investing for you!

Below I’ll report how the terrible twos weren’t so terrible for my demo portfolio, which has grown nicely over the last 12 months.

Before that, I’ll share a few links to answer some of the questions you may have.

• How I picked the shares in the portfolio.

• Why I’m NOT reinvesting the income

• The chosen benchmarks for the HYP

• Why I don’t intend to trade this HYP much

You can also read and bookmark all the articles about this HYP.

Note: I stress again this is a demo HYP. It is not a reflection of my entire investment strategy or asset allocation – it’s a small real money side portfolio created for interest and education for us on Monevator. Please don’t get hung up on the £5,000 invested figure, as that was just what I chose to commit for tracking purposes. In real-life I wouldn’t consider running a HYP like this with less than £20,000 invested, and £50-100,000 would be more like it.

The HYP valuation: Two years (and a bit) in

So where do we stand after year two? That’s the critical question, and sadly I forgot to ask it until four trading days had passed since the anniversary of the last snapshot on 10 May 2012.

What a muppet! I put real money into this demo to make it easier to track, and I keep forgetting to check-in on the anniversaries.

Last year I overcome my forgetfulness by painstakingly recreating the entire portfolio from historical prices and then crosschecking them with a second source.

This year I’m afraid I didn’t have the time. May was just a madly busy month.

So instead, I’m going to report where the portfolio (and the benchmarks) stood at close of play on 16 May 2013. That’s a few days more than a full year.

It’s not a big difference – the UK market moved less than 1% in the interim – but I suppose I can’t now be quite as outraged as The Accumulator gets about sloppy reporting from funds. It’d be a tad hypocritical.

Anyway, here’s where the portfolio stood at the close of 16 May 2013:

Company	Price	Value	Gain/Loss
Aberdeen Asset Management	£4.73	£505.62	102.3%
Admiral	£12.62	£179.30	-28.3%
AstraZeneca	£33.90	£271.49	8.6%
Aviva	£3.47	£195.35	-21.9%
BAE Systems	£4.06	£308.54	23.4%
Balfour Beatty	£2.26	£171.23	-31.5%
BHP Billiton	£19.12	£199.33	-20.3%
British Land	£6.39	£267.16	6.9%
Centrica	£3.87	£306.62	22.7%
Diageo	£20.51	£411.57	64.6%
GlaxoSmithKline	£17.08	£323.81	29.5%
Halma	£5.26	£353.70	41.5%
HSBC	£7.49	£284.89	14.0%
Pearson	£12.04	£264.67	5.9%
Royal Dutch Shell	£22.86	£257.06	2.8%
Scottish & Southern Energy	£15.93	£300.48	20.2%
Tate	£8.62	£351.85	40.7%
Tesco	£3.74	£226.46	-9.4%
Unilever	£28.40	£357.39	42.95%
Vodafone	£1.97	£291.50	16.6%
		£5,828.00	16.6%

Note: The portfolio was purchased on the morning of 6 May 2011, with £250 invested into each of 20 shares. All costs (stamp duty, spreads, and dealing fees) are included.

By the one year mark on 10 May 2012, my invested capital had fallen from £5,000 to £4,670. By 16 May 2013 it had grown back to £5,828.

That means we saw a year-on-year capital gain of roughly 25%.

Looking through the portfolio’s holdings, I still regret picking two insurers, though that’s hindsight speaking. On a brighter note, Tesco had recovered substantially – it was down 22% last year on my initial purchase price. (Since this snapshot it’s fallen back again. Every little helps? Not here!)

The big winner of the year was Aberdeen Asset Management. Its share price doubled on the back of rising markets.

If this portfolio does well over time then critics will say I was lucky to pick shares like Aberdeen. Such criticism is valid, but it’s also missing the point. This is an actively constructed portfolio, not an index fund. It will have a skewed result. That’s the risk you take, and that you’re potentially paid for.

Also I have never seen a portfolio of shares that didn’t show big gaps between the best and worst performers after a couple of years. The same would be true in an market cap weighted index fund, for that matter.

Buckle up! After 5-10 years the gap will between the leader and the laggards in this demo HYP will be several hundred per cent or so.

Benchmark 1: The iShares FTSE 100 tracker

As outlined in my benchmarking article, I will compare the progress of my demo HYP against two alternatives – a cheap ETF, and a trio of investment trusts.

Remember all these returns will be capital returns only, as with the demo HYP.

The ETF benchmark is a hypothetical £5,000 that was invested into 836 shares1 of the iShares FTSE 100 tracking ETF ISF, acquired via Sharebuilder.

As previously discussed, the ETF shares were notionally bought at £5.98 per share. The (tiny) purchase costs were taken into account, and there was no stamp duty to pay.

Here’s where the ETF stood at close of 16 May 2013.

Company	Price	Value	Gain/Loss
iShares FTSE 100 ETF	£6.72	£5,614.54	12.3%

Note: Prices from Yahoo.

The ETF has not yet recovered as much as the HYP from its first year fall. Not surprising given the dash for yield we’ve seen in the markets in the past 18 months.

Benchmark 2: A trio of income trusts

I also follow three income investment trusts as an alternative to the HYP.

Again I assumed these were bought via Halifax Sharebuilder, and again I averaged the opening and closing prices on 6 May 2011 to get the initial buy prices. Stamp duty and a penny spread on each trust’s price were factored in.

Here’s where a hypothetical £5,000 pumped into these three trusts stood on 16 May 2013.

Trust	Price2	Value	Gain/Loss
City of London IT	£3.65	£2,000.26	20.0%
Edinburgh IT	£5.92	£2,086.25	25.2%
Merchants Trust	£4.80	£1,878.14	12.7%
		£5,964.65	19.3%

Note: Prices from Yahoo.

Equity income trusts have been on a tear this year – it’s that chasing dividend income theme again. Discounts have closed, and in many cases income trusts have stood at significant premiums to their assets for long periods.

This has boosted the share price return of the trusts over this period, and thus the performance of this basket over the demo HYP. The situation will likely reverse if dividend income goes back out of favour, and the trusts fall to a discount. They will have many shareholdings in common, after all.

I think investment trusts are a good halfway house between being an enthusiast who fancies managing a portfolio of shares, and a passive investor who invests via an ETF or tracker fund.

So far that’s playing out with a superior return for the trusts, even after their management costs.

The trusts offer a more stable return than the DIY portfolio, too. They are more diversified. They also hold a cash buffer to top-up payments in the lean times.

If you want the same safety net for your own portfolio – perhaps because you plan to live off investment income – then you need to build-in your own cash buffers. This will effectively delay when you can start drawing an income by 6-12 months, since you’ll need a tranche of cash to load up your buffers.

Income comparison

So much for capital, what about the all-important income?

• For the HYP, I simply added up all the dividends I received over the period 11 May 2012 to 10 May 2013.

• For the hypothetical ETF and trust holdings, I went through the dividend records (via the Digital Look and the iShares website) and added up their payments due over the same time frame.

Here’s what each system generated in income over the year:

	2012	2013	Change	Purchase yield3	Current yield4
HYP	£181.95	£229.19	26.0%	4.6%	3.8%
ETF	£155.05	£172.11	11.0%	3.4%	3.1%
Trusts	£183.56	£245.52	33.8%	4.9%	4.1%

Note: Yields are rounded to one decimal place.

This is the first full year where all payments made were due to the portfolios, which is why some of the year-on-year gains in income are so large. (Last year’s income figures were subject to a few ex-dividend dates that fell before the investments were made).

This means we can now see exactly what each portfolio paid out in income over the 12 month period.

So far the trusts are doing very well on an income basis, too. We’ll have to see what happens over the longer term.

Needless to say, the current yields on all three portfolios are still much higher than you’d get on bonds or cash.

Finally, while a HYP is an income strategy and I wouldn’t recommend it for total return, I know many of you are curious about how the demo HYP would grow if you reinvested the dividends each year.

That’s a whole new kettle of fish (or more accurately a can of worms) which I’ll look into in a follow-up post.

1. Well, 835.87 to be precise. Halifax Sharebuilder let’s you buy fractional holdings of shares. All my demo HYP shareholdings are fractional, too. I use the fractional shareholdings in the return calculations. [↩]
2. I’ve rounded these here for clarity, but have used the exact price in my spreadsheet. [↩]
3. The last 12 months of income divided by the initial £5,000 invested. [↩]
4. The last 12 months of income divided by the portfolio value at year end. [↩]

A close relative of mine has reached retirement age and she needs help with her finances. The situation is not great:

• A settlement left her with a modest pot that must last her the rest of her life.

• She now handles her own financial affairs after decades of delegating that trust.

• While she can shish-kebab a bargain at 20 paces and haggle like a souk trader, she has no experience of the complex financial decisions she now faces. Tripwires are everywhere.

• She’s terrified of the stock market and sits mostly in cash. Like most people, she can’t equate inflation’s slowly corrosive impact with her eventual ruin.

• Tentative consultations with financial advisors have taught her enough to be wary.

• She’s scrambled by a fad-hungry media that treats investing like fashion. The constant switchback of advice leaves her prey to so-called ‘experts’ who offer to make sense of it all.

The reality is she has run out of track. The pot struggles to generate enough income in a low-interest rate world. Inflation is eroding it, but equities are too risky: there’s no crumple zone to absorb a stock market crash.

Spending less is the only emergency lever left to pull (and it’s not like the ambition level was particularly grand to start with). It’s too late to work longer or save more.

What a mess

As the holes in the safety net widen and more people are increasingly being left to fend for themselves, DIY investors like us will need to fill in the gaps.

It’s an unnerving responsibility. My own retirement is many years away, so plenty of the details can be left to ferment in a tank marked ‘the distant future’.

But in this role, precision guidance is needed. My relative’s problems need definite answers but, as it turns out, a caring amateur can do a better job than a careless professional…

As I excavated the stack of valuation statements, brochures, and key feature documents, I uncovered a haphazard clutch of active funds and insurance bonds full of stuff that my relative would never have chosen for herself.

It turns out she is 20% in equities. Plus every shade of corporate bond right down to junk, distressed companies, futures, and the same high-yielding UK blue chips in fund after fund – HSBC, BP, Glaxo, Vodafone, Royal Dutch Shell, BAT, and so on.

The usual suspects staff the top 10 holdings in no less than eight of her funds! That’s more redundancy than in the Greek civil service.

The incoherence of it all makes me angry. There’s no strategy, no sense of an architect who has carefully designed an investment machine that operates in all weathers, while taking into account the needs and abilities of its owner.

It’s just a Katamari ball of a portfolio that has rolled around picking up whatever sounds good and pays juicy commission to previous advisers.

Meanwhile the key feature documents all play the same soothing marketing lullaby:

Achieve a sustainable level of income combined with the prospect of long-term capital growth.

Beautifully chosen words that press the retiree’s happy buttons while amounting to absolutely naff all.

The brochure risk indicators offer further reassurance with middling scores that tell you nothing about the risks of putting eight near-identical funds in the same portfolio! Like state propaganda, it’s so much window-dressing that provides cover for misdeeds.

You could blame it all on my relative for not having the nous or desire to rigorously research and question all that they have been told.

Or you could imagine yourself next time you’re handed a bill for the repair of your car. Squinting at the list of meaningless charges and hoping that the reason you can’t see any cowboy hats is because you don’t know any cowboys.

So what to do…?

The primary goal of the strategy I’m working on for my relative is to meet her minimum spending needs while removing as much risk from the equation as possible.

The impact of inflation, stock market volatility, tax, the state pension and a long-lived retirement all need to be taken into account.

The product costs need to be dramatically reduced and the advisors who are still siphoning off commission must be unhooked. I’ll need to be wary of any exit charges here.

Annuitisation is looking inevitable, but a rump of the portfolio will remain to cover the unforeseen.

I want to keep this rump simple so my relative can understand what each component part is for. Hopefully this will provide some kind of defence against future temptations to mess. Maintenance needs to be a doddle, too.

Fancy stuff like desired spending needs and legacies can be dreamt about once we’ve secured the minimum spending floor.

I’ll report back once I’ve firmed up the strategy. In the meantime please do let me know in the comments below about your experiences in this realm – either securing your own retirement or the retirement of someone close to you.

I’d be fascinated to learn what others have done in this situation.

Take it steady,

The Accumulator