Our Slow and Steady model portfolio was especially designed to minimise costs and hassle for small, passive investors right down to its rebalancing strategy. But how exactly does that strategy guide our new purchases?

The Slow and Steady portfolio is rebalanced as a matter of course on a quarterly basis with cash from new contributions.

So every three months, fund purchases are automatically calibrated to return the portfolio to its target asset allocation:

• UK equity: 20%
• Developed World ex UK equity: 50%
• Emerging market equity: 10%
• UK gilts: 20%

N.B. Developed World ex UK equity is split between four funds (due to the lack of a single, no-trading fee fund in the UK) as follows:

• North American equity: 27.5%
• European equity ex UK: 12.5%
• Japanese equity: 5%
• Pacific equity ex Japan: 5%
• Total: 50%

Rebalancing is the act of pruning back your risk. Without it the portfolio could mutate into a much hairier beast if, for example, the emerging markets fund went on the rampage. Over years, the portfolio could end up with a much higher percentage of its value bound up in this risky asset class than the envisaged 10%, if we did stood idly by.

So when it’s time for the portfolio’s quarterly £750 new contributions, we buy more of the under-performing funds and less of the out-performers, and take advantage of mean reversion.

Rebalancing slo-mo replay

The first time the Slow and Steady portfolio was rebalanced its market value was £3,017.84

It’s important that the rebalance takes into account the new cash added, so:

£3,017.84 + £750 = £3,767.84 (total portfolio value after drip-feed)

How much of this total should then be allocated to each asset class?

A quick example should do the trick. The target allocation for UK equity = 20% of £3,767.84.

£3767.84 / 100 = 37.6784
37.6784 x 20 = 753.568

So we want £753.57 of UK equity in the portfolio once the new cash is added.

The value of UK equity in the portfolio prior to the new cash = £607.10

£753.57 – £607.10 = £146.47

£146.47 is the amount of UK equity we should buy to ensure the asset is rebalanced to its target allocation of 20%.

That calculation is repeated for each fund in the portfolio to determine how much of each asset class we need to buy.

Eventually the portfolio will grow too big to be entirely rebalanced by new cash. At that point we’ll need to sell assets that exceed their target allocation and use the proceeds to pump up assets that fall short.

That won’t cause the Slow and Steady portfolio any trading cost pain though (the bane of rebalancing) because we’re cannily invested in index funds that don’t trigger broker fees.

Take it steady,
The Accumulator

A short hallelujah to the weather, followed by some choice reading from around the web.

Incredibly, it’s sunny in London. What a difference it makes after all the snow, slush, and arctic blasts of what seemed a six-month winter.

Like health, you can’t really buy the weather. Yes, you can buy an aspirin, and yes you can emigrate to Australia. But you can’t dial up the sun on demand like a Domino’s pizza.

One quick way of re-appreciating your good fortune, weather-wise, is to visit a loved one in hospital. A person who can’t leave, ‘ideally’ (as in ideally for this experiment to work, not for your unfortunate acquaintance).

I’ve noticed long-term hospital residents often stare out of the windows when it’s sunny. Or at other times they turn their back on it, and seem unable to bear what they can’t enjoy. The more fortunate are wheeled to sit in some sunny spot besides the bins and the smokers on crutches, to feel the warmth on their skin. It’s a foreign holiday for them.

The incurable and the dying seem to inhabit windowless, weather-less rooms – I’ve seen this more than once in NHS hospitals. Perhaps there are logistical reasons. Perhaps it’s cruel. Or perhaps it’s some long ago learned wisdom about how best to let go.

[continue reading…]

It’s time for the first trading update of the official Monevator, passive, model portfolio: The Slow and Steady portfolio.

The portfolio invests purely in index funds. The first purchases were made on December 31, 2010, with an initial lump sum of £3,000.

Another £750 of regular contributions are drip-fed in every quarter, and the latest purchases were made on April 1. An auspicious day if ever there was one.

In its first three months of life, the portfolio has inched up 0.59%, which amounts to a cash gain of £17.84. Who ever said passive investing isn’t a shortcut to fabulous wealth?

Actually, this move to profit is quite a turnaround, because I took a sneaky peek at the portfolio a few weeks ago, and it was haemorrhaging like an undercover cop in a Tarantino movie.

Events, dear boy, events

The markets were on something of a tear at year-end when we fed our initial lump sum into the financial wood-chipper. Since then we’ve been battered by bad news:

• UK economic contraction in the final quarter of 2010.
• Fears of overheating emerging markets.
• Devastating floods in Australia.
• Triple catastrophe in Japan – quake, tsunami, nuclear crisis.
• Middle East uprising – the wisdom of the crowds writ large, but bad for short-term economic stability.

The upshot is that the Japanese fund has been hammered, the emerging markets have dipped too and the Australian-dominated Pacific fund has been dragged down in their wake.

The countervailing bright spot is the European fund, perhaps benefitting from belief in Franco-German determination to defend the Euro.

Scores on the doors

Here’s how the individual funds have fared over the last three months:

What does all this tell us? Absolutely nothing of significance.

It’s fun to think about the trends and events that may have buffeted our funds over the last three months, but over a 20-year time horizon we’re relying on diversification, low cost funds and the efficiency of the markets to ensure we come out ahead. There’s nothing for it but to stick to the plan.

New purchases

Our quarterly £750 injection buys:

UK equity

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

New purchase: £146.47
Buy 41.812 units @ 350.3p

Target allocation: 20%

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): 50%

North American equities

HSBC American Index – TER 0.28%
Fund identifier: GB0000470418

New purchase: £191.81
Buy 99.899 units @ 192p

Target allocation: 27.5%

European equities excluding UK

HSBC European Index – TER 0.37%
Fund identifier: GB0000469071

New purchase: £77.79
Buy 15.316 units @ 507.9p

Target allocation: 12.5%

Japanese equities

HSBC Japan Index – TER 0.28%
Fund identifier: GB0000150374

New purchase: £52.04
Buy 85.008 units @ 61.22p

Target allocation: 5%

Pacific equities excluding Japan

HSBC Pacific Index – TER 0.37%
Fund identifier: GB0000150713

New purchase: £38.84
Buy 15.813 units @ 245.6p

Target allocation: 5%

Emerging market equities

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

New purchase: £82.25
Buy 155.746 units @ 52.81p

Target allocation: 10%

UK Gilts

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

New purchase: £160.77
Buy 102.793 units @ 156.4p

Target allocation: 20%

Total cost = £749.97

Cash = 3p (Woot!)

Trading cost = £0

Remember the portfolio is rebalanced to its target allocations with the new money: a relatively straightforward task at this early stage. There are also no trading costs to worry about with the index funds used.

Take it steady,

The Accumulator