This week’s best post, then some other good reads from the Web.

There is never a time when the inflation question doesn’t hang in the air like a speech bubble above the head of Charlie Brown.

But you’d have to go back to the 1980s to find a time when it was such a consistent theme in economic and business discussion, and to the 1970s to find it being talked about so regularly around the dinner table1.

With deflation run out of town via quantitative easing, fears of inflation hold the floor. And this particular combination – inflation plus indebted governments spending money they don’t have – has been the perfect backdrop for the latest 18-month run in the decade-long gold rally.

As the post of the week, from Simple Living in Suffolk, explains:

That’s one of the beauties of gold – it has value because of what it is, not what it represents or who issued it. Time and bad government policy gnaw at the value of that twenty pound note over time, but like the Fallen, time does not age gold, nor does it turn to rust.

It is one of the last atavistic race-memories of a time when the value of currency was inherent, not symbolic, a throwback to barbarous times, of swapping animals and goods and even human beings.

The author, ermine, thinks he’s got his gold allocation wrong, and since he wants to someday barter it for ethanol, dog food, and a few feral goats come the meltdown, I’m inclined to agree.

No dusty barter-town trading post is going to swap your gold ETF for a slave girl and half a dozen kumquats in the post-ATM era. It will be shiny metal teeth and wedding rings all the way.

Of course, while I love ermine’s historical and personal perspectives, I’m not half so gloomy about the outlook myself. Provided I see some daylight in any 48 hour period, I see gold for the bauble it is.

I also happen to believe that – contrary to what the gold bugs believe – it’s the pointlessness of gold that has allowed it to become so valuable, not its incredible virtues.

When gold really was important, the US government banned private ownership of it. Now Tesco will trade your gold. Every little helps (the gold price).

Then again, I’m only human and maybe a little barbarous at heart, so I can’t help wishing I owned a Krugerrand or two. I also note that the Chinese and the Indians are still mad for the stuff.

There’s more of them than us, which is the best reason to buy gold of all.

The best of the rest of the blogs

• Victorian values – A Grain of Salt
  
• What is market timing? – Oblivious Investor
  
• Winning the loser’s game – Investing Caffeine
  
• The MMR vaccine and weak incentives – Weakonomics
  
• The entrepreneur-for-sale has a new venture – Central
  
• How to buy Facebook shares – Consumerism Commentary
  
• My WTF fund – Investor Junkie
  
• Book value – The Psy-Fi blog
  
• Fast food value meals – Dough Roller
  

From the mainstream media

• Phds: Not worth the money and effort Vs Masters – The Economist
  
• Young Americans: Fatter waists, thinner prospects – The Economist
  
• Why the government can’t stop bank bonuses – Peston/BBC
  
• Record 0% credit card terms [but watch fees] – FT
  
• Merryn tots up her usual bearish litany – FT
  
• John Lee’s end-of-year portfolio results – FT
  
• Self-assessment tax deadlines for 2011 – Telegraph
  
• More UK tax scrutiny to come – Independent
  
• The case for Russia and Eastern Europe – Independent
  
• 5 green ways to save money – Independent
  
• Self-build a home for £150,000 – Guardian
  

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1. Not least because families don’t eat around the dinner table anymore! [↩]

This is no easy time to be a passive investor. Sluggishness and sloth are on the run, hounded by the January urge to FIX EVERYTHING NOW! Gym membership is soaring, joggers are pounding the streets, and the magazines are touting 10 easy steps to a faster, fitter, slimmer you.

Well, you won’t find any of that nonsense here. Instead, let’s kick back down a gear with the world debut of the Slow & Steady passive investment portfolio.

The Slow & Steady portfolio is a model portfolio for Monevator that aims to illustrate how new private investors can overcome some of the difficulties associated with passive investing in the UK. In particular, we’ll use the portfolio to offer clear strategies for investing relatively modest sums without incurring injurious costs.

I’ll report back periodically on the portfolio’s performance, and hopefully it will develop into a useful long-term project.

Note: This is just an exercise. It’s no more than my own response to the practicalities of passive investing in the UK, according to the assumptions laid out below. The Slow & Steady portfolio is not intended as a real-world solution to any individual’s investing needs (including mine). You can see an archive of all the posts in this model portfolio series, including the latest updates.

The assumptions

No model portfolio would be complete without a set of assumptions to make it dance. Here are mine:

• Time horizon: 20 years.

• Initial contribution: £3,000 lump sum.

• Regular contribution: £750 per quarter.

• Investment vehicle: Index funds only. No trading fees incurred. ETF/Vanguard trading fees are prohibitive at this level of contribution.

• Fund selection: Index funds are chosen on the basis of availability to UK retail investors on an execution-only basis. The cost of the portfolio will be kept as low as possible by choosing funds with the lowest Total Expense Ratio (TER) available without paying trading fees.

Each fund will track a benchmark index that is appropriate to its role in the portfolio’s overall asset allocation.

• Asset allocation: The portfolio will not cover every asset class due to its relatively small size and the lack of suitable tracker products available. The core of the portfolio is invested in UK equities and developed world equities.

The Developed World ex-UK allocation is split into four separate funds because a single, suitable fund is not available. Further explanation here.

Emerging markets are included for additional geographic diversification and as an expected returns booster. UK Gilts should help to diversify the equity risk inherent in the portfolio.

The 80% allocation to equity should be considered aggressive and is a reflection of the long time horizon and my personal risk tolerance. The allocation to equity will be adjusted as the time horizon shrinks.

• Purchases: All funds can be purchased from TD Direct Investing or iWeb.

• Rebalancing: the portfolio will be roughly rebalanced to the target asset allocations whenever new money is added.

• Tax: The portfolio is assumed to be held in a tax-sheltered stocks and shares ISA. Fund ISAs from Interactive Investor are fee-free.

• Dividends: All funds chosen are accumulation funds. Accumulation funds automatically reinvest dividends back into the fund (in contrast to income funds which distribute dividends back to the investor).

• Performance: I shall report back on the portfolio’s performance once per quarter.

The Slow & Steady passive portfolio

Here’s the portfolio mix that these goals and assumptions have delivered:

UK equity: 20%

HSBC FTSE All Share Index – TER 0.27%
Fund identifier: GB0000438233

Initial purchase: £600
Buy 173.31 units @ 346.20p

Developed World ex UK equity: 50%

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

North American equity: 27.5%

HSBC American Index – TER 0.28%
Fund identifier: GB0000470418

Initial purchase: £825
Buy 439.77 units @ 187.6p

European equity ex UK: 12.5%

HSBC European Index – TER 0.37%
Fund identifier: GB0000469071

Initial purchase: £375
Buy 77.4154 units @ 484.4p

Japanese equity: 5%

HSBC Japan Index – TER 0.28%
Fund identifier: GB0000150374

Initial purchase: £150
Buy 222.7171 units @ 67.35p

Pacific equity ex Japan: 5%

HSBC Pacific Index – TER 0.37%
Fund identifier: GB0000150713

Initial purchase: £150
Buy 60.88 units @ 246.4p

Emerging market equity: 10%

Legal & General Global Emerging Markets Index Fund – TER 0.99%
Fund identifier: GB00B4MBFN60

Initial purchase: £300
Buy 557.7245 units @ 53.79p

UK gilts: 20%

L&G All Stocks Gilt Index Trust – TER 0.25%
Fund identifier: GB0002051406

Initial purchase: £600
Buy 379.03 units @ 158.3p

Total fund purchases: 7

Total cost: £3,000

Trading cost: £0

Right, that’s all there is to the Slow & Steady portfolio for now. We’ll check back in a few months time to see how things are going.

Take it steady,

The Accumulator

I am not so foolish as to expect anything from any asset class in 2011. All markets are unpredictable, especially in the short-term.

That said, a money blogger is duty bound to make a stab on the outlook for asset classes, however futile. Otherwise he risks losing all his readers to more excitable blogs that promise gold will hit $10,000.

Also, while expensive looking assets can always get more expensive and cheap ones even cheaper, in the medium term these things tend to revert to the mean.

Mechanically rebalancing your portfolio is a sensible way to take advantage of this. If you’re a more active investor though, you’re forced to employ your judgment. So with all these caveats in mind, here’s some thoughts:

• UK shares look reasonable value, with the FTSE 100 on a forward P/E of about 13, and not too pricey on a longer-term basis. I’m worried by growing fund manager optimism, rising gilt yields, and potential sterling strength. Set against that there’s clearly plenty of retail money sat on the sidelines, and corporate earnings are strong.

• Overseas shares are a mixed bag. US shares have done well in 2010 – they’re more expensive than the FTSE 100, but arguably more exposed to mid-cycle growth. European shares might be a decent contrarian bet; Germany has done very well, but Spain and Italy have slumped. Japan looks cheap as ever. Please do remember currency risk if you invest abroad.

• Emerging markets are starting to look frothy, but as I wrote in my article on emerging market funds, such trends can take years to play out. I’m not chasing performance, but I’m not selling the exposure I’ve got, either. Beyond that I think buying the likes of Diageo and Caterpillar offer a cheaper way to benefit from global growth.

• Government bonds have looked expensive for two years: I was right in 2009, and wrong for most of 2010. With the 10-year UK gilt yield now up to 3.6%, they’re becoming better value. I’d probably have a nibble at 4% (previously I wanted 5%, which incidentally you can now get on perpetual Consols).

• Corporate bonds don’t offer much appeal – I’d rather buy shares. Some of the bank preference shares may still be bargains, if you’re after long-term income, but make sure you know the company-specific risks you’re taking on.

• Cash isn’t returning much compared to inflation; even Zopa interest rates have crashed. Nevertheless I can see myself saving more cash in 2011, particularly as I’m over-invested in shares. Cash is the king of asset classes.

• Gold fans talk a great game, but it’s a complete wild card. I wish I hadn’t sold my Gold and General Fund back in 2007 – not so much for the performance since then, but so I wouldn’t have to worry about whether I should buy some now to protect me from the indisputable currency games going on. There’s a lot of fear and momentum in the gold price, in my view.

• Commercial property didn’t do much in 2010; bellwether Land Securities is flat on the year, though some of the smaller outfits have done better. I continue to think the big REITs are an attractive asset class that offer some protection from inflation, plus an income, for a fair price. The headwind is fears that banks will dump their written-down property at bargain levels, but I think that’s probably in the price.

• Residential property remains my bête noire, with the London bubble seemingly immune to even global recession. If I was buying a home outside London, I’d probably buy now on a ten-year fix to lock-in low rates. But whereas the froth has come off in the provinces, prices in London are already back to 2007 levels. It seems unsustainable, but I’ve been wrong about that for years. I wouldn’t buy an investment property anywhere in the UK at current yields, but parts of the US might get attractive if the pound strengthens.

For me then it’s a murkier picture than at the start of 2010, in that the big fears are still around, but it’s harder to buy cheap assets that reflect those uncertainties in their price.

Personally, I’m minded to stay near-fully invested, but to save new money and dividends into cash and to possibly rebalance my portfolio towards more sensible asset allocation as the year progresses.

As ever, Monevator house policy is that the average investor will do better with a cheap and largely passive diversified portfolio from day one. Please take all this speculation therefore with a pinch of salt, wherever you might read it.