Good reads from around the Web.

I first feared signs of a UK and US government bond bubble back in December 2008, writing:

With these crazy yields on government debt it’s getting too expensive to be a bear.

I believe the West can avoid deflation, and so I’m buying cheap equities, not expensive government debt.

At the time UK 10-year gilt yields had recently fallen below 3%, and short-term US treasury yields had briefly turned negative, which meant investors in them were effectively paying the government to hold their money.

I saw this pile into bonds as a sign of the extreme gloom and panic in the market, and worried that it would unwind with costly consequences. Equities looked much more attractive.

A good call? Not exactly.

As regularly readers will know, I have no problem admitting my own mistakes. But this was a case of half-right, but at least half wrong.

Equities have indeed done very well since December 2008. If you’d put your money into a UK FTSE 100 tracker and reinvested dividends at the time of my post, you’d now be more than 60% up.

I was right, too, that investors were clearly ultra-fearful (which was exactly why we had a great opportunity to profit from the stock market).

But there’s no denying I was wrong about those low bond yields being unsustainable. Money has kept piling into bonds of all shapes and durations for the past five years. The initial bond mania turned into a mass exodus from equities, driving yields ever lower.

As this graph from the Fixed Income Investor site shows, UK government bond yields approached 1.5% in late 2012.

It’s a small consolation that nobody reading this in the UK has never known such tiny long bond yields, and virtually nobody would have thought them even possible a decade ago.

Just another reminder of how hard it is to fathom the markets.

That was then, this is now

As we start 2013, there’s a lot of renewed chatter – and even fear – that this great bond bubble could finally be about to burst.

A sharp move up in yields last week in the wake of the US fiscal cliff resolution is being seen as a catalyst for this long-awaited unwinding.

There’s good reason to expect yields to rise, and hence bond prices fall. Ten-year gilt yields of less than 2 to 3% make little sense in an environment where inflation is running ahead of that. Unless we go into another big recession or even a depression – and hence see deflation – then sooner or later people will get fed up with the value of their bond holdings being eroded in real terms.

As a consequence, The New York Times is one of many outlets reporting that the bond craze could run its course this year:

“Mathematically, it’s next to impossible to get the kind of returns on bonds you’ve seen over the last few years,” said Kate Moore, the chief global equity strategist at Bank of America.

When the turn does ultimately come, it is likely to cause pain for at least some of the people who have been investing in bonds in recent years.

“You don’t want to be the last one out the door when the trends turn,” said Rebecca H. Patterson, the chief investment strategist at Bessemer Trust. “All good things come to an end and we want to make sure we’re in front of it.”

An article on a blog called Mutual Fund Observer puts these fears more colourfully:

We’ve been listening to REM’s It’s the End of the World (as we know it) and thinking about copyrighting some useful terms for the year ahead.

You know that Bondpocalypse and Bondmageddon are both getting programmed into the pundits’ vocabulary.

[We also suggest] Bondtastrophe and Bondaster.

It’s this kind of fear that has prompted Telegraph writer Ian Cowie to take what he says is the biggest bet of his life:

Contrary to the conventional wisdom that people should raise their exposure to supposedly low-risk bonds and reduce shareholdings as they get older, I did the opposite and sold all the bonds in my company pension to buy shares.

Now that’s an ultra-risky move, and not one that many advisers would recommend.

I don’t own any government bonds, but I’ve got 25-30 years ahead of me (touch wood!) before I’ll likely be required to live on my savings.

I could ride out another savage bear market. Could Mr Cowie?

How to deal with the bond bubble

That said, I do feel for you if you’re in your later years and you’re trying to decide what to do in the face of these extreme markets.

Anyone retiring since the mid-noughties has already had to decide whether to turn their pension pot into an incredibly low-yielding lifetime annuity.

Now the next round of retirees face the possibility of their retirement pots being cut down to size, if and when those low yields finally reverse.

However it’s important to remember a few things.

• Firstly, most long-term pension savers would have already benefited from the rise in bond prices over the past few years. You can’t really enjoy the proceeds of a bubble and then cry foul when it bursts.

• Secondly, even this kind of seemingly extreme bond bubble is not the same as an equity bubble. We have looked before on Monevator at the consequences of a crash (see the links below). While you wouldn’t exactly order one for yourself and a double helping for the lady, it’s very hard for a bond crash to be as catastrophic for an individual as an equity slump.

• Finally, most Monevator readers probably only have 5-40% in government bonds. A 20% holding in bonds falling by a quarter is still a 15% holding in bonds – and it would very likely come with a stronger rise in your equity holdings. Meanwhile your bonds are protecting you from bigger downside risks, like a 60% fall in the stock market.

What am I doing? Right now I prefer cash to bonds when it comes to cushioning my portfolio. But deciding between them is not a risk you have to take.

Remember cash and bonds are not the same thing.

Perhaps the biggest risk of the bond bubble bursting is a disorderly market that sees institutions and others scrambling for the door at once. Given that Central Banks have been mighty buyers of bonds due to QE, any sudden unwinding could get very messy.

But you and I don’t have any good way of knowing how likely that is, or even what we should do about it.

Staying diversified, rebalancing as necessary, and not trying to be clever is likely to prove the best approach for most in the long-term.

More reading from Monevator on bonds and the potential burst:

• Should passive investors dump their government bond funds?
• How would you really fair in a bond market crash?
• At what yield are government bonds actually worth buying?

[continue reading…]

I am all for New Year’s Resolutions. Cynics scoff that January 1st is just another day in an arbitrary human calendar, but they’d be better off resolving to be more open-minded in the New Year.

True, there is evidence that goals can be counter-productive, whether you’re trying to lose weight or make a million.

But that fact is I’ve never met a successful person who doesn’t set use goal-setting as part of their motivational toolkit.

In my opinion, the key is what goals you choose, and why you choose them.

Many people – and many businesses – set ambitious and arbitrary goals that run contrary to what they’ve achieved to date. To me, this seems more wishful thinking than motivating or even helpful, whether you’re trying to halve your weight or double your income.

Better to set smaller, more manageable targets in areas where you already have some momentum.

If you do want to achieve something altogether new, then you should start slow. Resolving to attend a piano lesson once a week might be a good goal. Learning to play the piano isn’t.

Here are three tips to help you make resolutions that deliver what you promise.

1. Make resolutions you really care about

Don’t draw up a laundry list of tweaks that you believe would lead to some perfect life. It won’t, and you’ll beat yourself up when it doesn’t.

You’re trying to change yourself with these resolutions – which is the hardest thing a person can do. Treat the challenge with the respect it deserves.

I suggest you pick at most three goals that would make the biggest positive impact on your life.

Financially, you might vow to do one big thing, such as:

• Get out of debt.

• Ensure you’re on track for a well-planned retirement.

• Get over your fear of investing by starting with small regular contributions.

• Create a second income stream that delivers £50 a month. (£500 a month can come later!)

The ideal goal excites you when you think about achieving it, but feels a little daunting, which is exactly why you have backed away from it before.

You want to get somewhere worth reaching, but a good goal is in sight, not up in the sky.

2. Be specific: Aim for the goal, but focus on the journey

A powerful goal is important, but the key to achieving it is the choices and steps you make every day.

If you declare “My goal is to lose weight and save money by eating out less” even as you eat a meal at your favourite Indian restaurant – fashioning your third Naan bread into a mini-snowplough to mop up the last of the chicken korma – and then you celebrate your decision by returning to the same place at the weekend, then let’s face it, you’re not serious and you’ll fail.

Don’t drop dead before you start. Translate your goals into small, actionable steps that you can carry out each day, and then take those steps to achieve your aim.

For example, you might break down the goal of ensuring you’re on-track for retirement as follows:

1. Work out your net worth.
2. In a spreadsheet or investing tool, divide that net worth into different asset classes.
3. Factor in any regular savings you already make.
4. Calculate how your investments could grow with typical returns by retirement.
5. Estimate the annual income the final sum could generate (4% of the total is a good benchmark).
6. Estimate what state benefits you can also expect.
7. Add (5) and (6) together to get your retirement income estimate.
8. If it’s not enough, figure out how much more you need to save.

Many people will find (6)+(7) is less than a seaside cottage and all the cream scones they can eat, which is where a vague “retire well with a pension” goal becomes an action plan to do something like:

1. Find an extra £250 a month, either by earning more or spending less.
2. Open an index tracker fund in a tax-exempt account (a pension or an ISA).
3. Contribute the extra £250 a month to that tracker fund until you retire (maybe rebalancing towards bonds in the later years).
4. Resolve to keep buying every month, regardless of bear markets.

The point is to translate your goal into doable actions.

3. Little setbacks are better than big failures

Human beings seem wedded to failure.

We all slip-up. I work fewer hours than I plan to, get out of the city less than I vow to, and I still haven’t learned to sail or scuba dive. If robots ever take over the world, they’ll do it by following their program, rather than immediately heading to the pub.

Since you’re going to have setbacks – spending too much one month, or eating an extra sausage – you have to get into the mindset that small failures are okay, provided the bigger mission is still on track.

If you don’t do this, your goal will blow up at the first misstep, and it could take some of you with it.

The scared and self-defeating part of yourself would just love to get you off the hook by throwing in the towel. Don’t let it. The fear of failure looms large for most of us, but it clearly isn’t all-powerful. If it were, we’d never achieve anything.

Calmly accept you’re human. Look squarely at your setback for what it was – a small skirmish in a battle that you’ve vowed to win.

Give a nod to your human frailties, and then re-focus on your goals and succeed!

This post was updated in January 2013 with new links, and new goals in mind! Do you have any financial New Year resolutions? Share them in the comments below.

(Image by: Clairity)

In a flash, our Slow & Steady demo portfolio is two years old. Time flies when you’re lounging around.

The big news is that there are now cheaper alternatives to most of our funds, thanks to the continued de-clawing of Britain’s financial industry. As a result, we’ve decided it’s time to sell up and look for fresh boltholes.

But before we get into that, what of Mr Market? Has he smiled or frowned since last we checked in?

Mr Market – he happy. In fact our plucky little portfolio has grown every quarter this year to end up 10% in 2012 and 7.33% up since purchase. A new high!

In actual spondoolicks that means we’ve put on £200 since last quarter to take our spoils to £605.13. That’s despite a 2012 wracked by the double-dip, Euro Armageddon every second Tuesday, and onrushing fiscal cliffs.

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 £750 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 here.

We’ve put in £9,000 so far and the two years has surely taught us two things:

• The market can rise despite a perpetual pipeline of bad news.

• We’re not going to get rich anytime soon.

Despite our mild success we’ve taken a beating against our overall benchmark. The FTSE All-Share climbed 14% in 2012. And even though some of our funds exceeded this performance, our drip-feeding strategy didn’t capture the entire year’s growth. Only a quarter of our new money was even in the market for a whole year.

All change – new funds

Enough of the short-term performance anxiety, it’s time for the main event. We’re selling six of our seven funds and replacing them with lower cost models.

Since our last update, online broker TD Direct has put together an astounding offering for passive investors.

It now offers the cheapest access to index funds in the UK, unencumbered by platform fees or dealing fees. You’ve just got to make sure your ISA is worth over £5,100 or it’s set up with a regular investment facility (in which case you can have pennies in there). You can read up on the charges for yourself here.

Here are our moves:

Old fund	TER/OCF (%)	New fund	TER/OCF (%)
HSBC American Index	0.3	Vanguard U.S. Equity Index	0.2
HSBC European Index	0.35	Vanguard FTSE Developed Europe ex-UK Equity Index	0.25
HSBC FTSE All-Share Index	0.28	Vanguard FTSE U.K. Equity Index Fund	0.151
HSBC Japan Index	0.33	HSBC Japan Index C	0.23
HSBC Pacific Index	0.46	HSBC Pacific Index C	0.36
L&G All-Stocks Gilt Index	0.23	HSBC UK Gilt Index C	0.18

The total weighted TER / OCF of the new portfolio is 0.29% (plus the 0.075 weighted stamp duty charge incurred by the UK equity fund.)

That compares to 0.37% for the old version of the portfolio.

Tell my why

Where possible I’ve plumped for Vanguard index funds. These are generally the cheapest and though HSBC’s C Class funds can match them, Vanguard’s investor-friendly culture wins the tie-breakers.

I am also more confident that Vanguard will keep a tighter rein on tracking error and pass on future cost-savings to investors. History has shown that where Vanguard leads, HSBC follows.

Finally, I’m satisfied that the Vanguard funds hug the right indices and match up against my tracker selection criteria at least as well as the previous picks.

As for the new HSBC C Class funds, these are identical to the older HSBC index funds but with 0.1% of trail commission costs lopped out.

The only fund I couldn’t improve upon is the flabby L&G Global Emerging Markets fund. Vanguard does a much cheaper version, but it’s not available through TD Direct.

Word of warning!

I probably wouldn’t make this move with my own portfolio. The gain implied from switching makes less than £1,000 difference over 18 years, given the current rate of cash injection.

That could be cut if the market bucks against us while we’re sitting on the sidelines waiting for the various transactions to go through. Of course, the wind might blow in our favour or scarcely stir at all, but it doesn’t seem worth the hassle for such measly gains.

The difference with a demo portfolio is I’m not going to let that trouble my brain. What’s more, it is our sacred Monevator duty to present the best possible set-up for new investors.

What I would do in reality though is start investing new cash into the cheaper funds.

If that all sounds like a tremendous faff, then you can simplify the portfolio by ditching the separate US, Europe, Japan and Pacific funds in favour of the do-it-all Vanguard FTSE Developed World Ex-UK Equity index fund.

This is what I actually do in real life, and the few hundredths of a basis point in extra expense really aren’t worth fretting over.

You can be lazier still by buying Vanguard’s one-stop-shop LifeStrategy funds. Again, they’re a fraction more expensive than the Slow & Steady investments but a whole lot quicker to manage. Just add direct debit et voila – instant portfolio!

Rebalancing rule change

Still haven’t put you off, eh? Okay, well the switch to TD Direct also forces us to change the portfolio’s rebalancing rules.

Previously, we used our new cash to rebalance each fund every quarter. However, that brand of small-time top-up just isn’t gonna fly when TD Direct requires a minimum investment of £50 per fund.

So from now on our quarterly £750 investment dollop will be divided according to the portfolio’s stated asset allocation for the year. For example, the Emerging Market allocation is 10%, so that fund will receive £75 every quarter.

We’ll then rebalance the whole portfolio in one big shindig every year in the fourth quarter.

Just in case things go loopy in the meantime we’ll also invoke Larry Swedroe’s 5/25 rule. This is a threshold rebalancing technique that will put our asset allocation back on track if the portfolio drifts too much over the year. (See here for more on that).

Remember there is no perfect rebalancing strategy, so there’s no saying that rebalancing every year will be better – or worse – than our old tactic.

For the sake of consistency we’d rather we didn’t have to make a change. But again, plans are the first casualty on the battlefield of reality, and we want this paper portfolio to be nailed-on, reality-wise, in order to best demonstrate the power of passive investing.

Asset allocation rejig

Our original 20-year investment horizon has now ticked down to 18 years. Every year we lifestyle our portfolio by shifting 2% out of equities and into gilts.

This move will probably cost us growth but should also lower our exposure to risk the closer we come to cashing out. And while lower future growth from government bonds seems nailed on, they still have a role to play in protecting investors from volatility.

To that end, I took 1% from each of the portfolio’s big US and UK allocations to compensate for the shift to gilts.

The move to TD Direct also forces an uptick in the allocation to Japan and the Pacific from 5% to 7% each. This is done purely to hit the minimum fund investment figure of £50. That’s not the best reason to fiddle with your asset allocation, but it demonstrates how small investors have to deviate from the textbook in order to cope with the realities of the financial industry.

The 4% shift to the East came at the expense of the West. I shaved the odd 0.5% from Europe and America, and sliced a whole 3% off the UK. Essentially I’m happy to unwind the portfolio’s home bias, which is more of a psychological crutch than a necessity right now.

New transactions

Every quarter, we continue to cast another £750 into the money mincer. As discussed, this time we’re also selling off six of our old funds, buying replacement funds and rebalancing, too.

UK equity

HSBC FTSE All Share Index – OCF 0.28%
Fund identifier: GB0000438233

Sell: £1,706.49

Replaced by:

Vanguard FTSE U.K. Equity Index Fund – OCF 0.15% (Stamp duty 0.5%)
Fund identifier: GB00B59G4893

New purchase: £1,440.76
Buy 8.92 units @ 16152p

Target allocation: 15%

OCF has gone down from 0.28% to 0.15%

Developed World ex UK equities

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

Target allocation (across the following four funds): 51%

North American equities

HSBC American Index – OCF 0.3%
Fund identifier: GB0000470418

Sell: £2,264.23

Replaced by:

Vanguard U.S. Equity Index Fund – OCF 0.2%
Fund identifier: GB00B5B71Q71

New purchase: £2,401.27
Buy 14.05 units @ 17095p

Target allocation: 25%

OCF has gone down from 0.3% to 0.2%

European equities excluding UK

HSBC European Index – OCF 0.35%
Fund identifier: GB0000469071

Sell: £1,164.87

Replaced by:

Vanguard FTSE Developed Europe ex-UK Equity Index fund– OCF 0.25%
Fund identifier: GB00B5B71H80

New purchase: £1,152.61
Buy 8.35 units @ 13796p

Target allocation: 12%

OCF has gone down from 0.35% to 0.25%

Japanese equities

HSBC Japan Index – OCF 0.33%
Fund identifier: GB0000150374

Sell: £460.09

Replaced by:

HSBC Japan Index C – OCF 0.23%
Fund identifier: GB00B80QGN87

New purchase: £672.36
Buy 1111.51 units @ 60.5p

Target allocation: 7%

OCF has gone down from 0.33% to 0.23%

Pacific equities excluding Japan

HSBC Pacific Index – OCF 0.46%
Fund identifier: GB0000150713

Sell: £458.22

Replaced by:

HSBC Pacific Index C – OCF 0.36%
Fund identifier: GB00B80QGT40

New purchase: £672.36
Buy 269.91 units @ 249.1p

Target allocation: 7%

OCF has gone down from 0.46% to 0.36%

Emerging market equities

Legal & General Global Emerging Markets Index Fund – OCF 1.06%
Fund identifier: GB00B4MBFN60

New purchase: £50.27
Buy 105.56 units @ 47.62p

Target allocation: 10%

Note: I threw an extra £1 into this purchase to hit the minimum £50 investment figure.

UK Gilts

L&G All Stocks Gilt Index Trust – OCF 0.23%
Fund identifier: GB0002051406

Sell: £1,889.95

Replaced by:

HSBC UK Gilt Index C – OCF 0.18%
Fund identifier: GB00B80QG383

New purchase: £2,305.22
Buy 1940.42 units @ 118.8p

Target allocation: 24%

OCF has gone down from 0.23% to 0.18%

New investment = £751

Trading cost = £0

Platform fees = £0

Average portfolio OCF = 0.29% down from 0.37%

Phew!

Take it steady,

The Accumulator

1. Plus a 0.5 stamp duty fee. [↩]