This is a guest article by Lars Kroijer.
From today you can invest up to £15,000 a year into your ISA. With rates on cash at historic lows, more and more people are looking to invest in the equity markets.
So is it time to find an expensive whiz kid fund manager who can turn your modest savings into millions?
Or maybe you’re the new Warren Buffett – should you get to work ferreting out some winning stock market investments?
Not so fast! (And I say that as a former hedge fund manager
Getting to a great portfolio is quick and easy, but you need to make sure you’re going down the right road first.
I estimate it will take you another 300 seconds or so to read this article and discover how to create a portfolio that will deliver better returns than nearly all the expensive options out there.
Can you afford not to read on?
Don’t try to beat the market
Let’s start by accepting that you can’t outperform the financial markets. Don’t worry, virtually nobody can beat the market for long – very probably including those that sell you expensive financial products.
And you don’t need to beat the market anyway to get a perfectly good outcome from your investing.
So don’t buy any expensive funds!
Instead, I suggest you invest your ISA (aka NISA) into a simple portfolio that consists of just the following two investments, in proportions that suit your risk tolerance and stage of life.
#1: A cheap global equity tracker fund
If you are after high returns and can tolerate high risk, buy the broadest and cheapest equity index tracker you can.
You want an ETF or index fund that tracks the MSCI All Country World equity index, or something equally broad. Look at Vanguard, iShares, Fidelity, and State Street, or read previous Monevator articles for the very cheapest options.
A global tracker gives you maximum diversification at minimum price (perhaps 0.3% per year, pick the cheapest). It is probably the only equity exposure you will ever need to have, in your NISA or elsewhere.
Don’t buy funds that charge you more to actively pick a different set of stocks from the index.
They probably can’t do better than the index in the long run and the costs will eat into your returns.
#2: UK government bonds
If you want minimum risk, buy UK government bonds with a time to maturity that suits your time horizon. So if your horizon is 10 years, buy 10-year maturity government bonds, and so on.
If the bonds don’t match your time horizon, then you either end up trading shorter term bonds until your 10 years are up (which is an expensive headache), or you take unnecessary interest rate risk with longer term bonds.
UK government bonds are the highest credit quality security in the country, and this leg of your portfolio aims to give you security, not returns.
Again, you can get your bond exposure via an appropriate ETF – which saves you trading the bonds yourself. And again you should pay very little for it, perhaps 0.15% per year.
Look at the same cheap tracker providers for your bond fund as you did for your equity exposure. These companies are market leaders for a reason.
Blend your equity and bond exposure to suit
If like most people you want an exposure in between the two, mix the stock and bond ETFs accordingly.
- For a young person who can take a higher risk, perhaps a 75%/25% equity/bond split.
- For someone closer to retirement, perhaps a more conservative 25%/75% equity/bond split.
Whatever your exact split, this simple, low cost, two security mix portfolio will in my view provide you with a less complex and better risk/return profile than 95% of portfolios out there today.
Investing your ISA doesn’t have to be difficult or expensive to be effective.
Lars Kroijer’s Investing Demystified
Comments on this entry are closed.
Although it makes sense to me to use bonds to try to reduce risks and volatility, what about the possible downward slide of bond values as interest rates rise over the next few years?
For passive investing I think Lars has it about right, but I know many investors (including myself if I invested passively) who would add in cash to reduce risk rather than just tilt between stocks and bonds, both of which are volatile.
@Nyul — That has been ‘imminent’ for at least 3-4 years now. 🙂 Even the greatest bond legends (e.g. Bill Gross at Pimco) have called it wrong. The government bond markets are the deepest and most liquid in the world. All opinions on bonds are in the price. (And yes, that includes the impact of government QE measures — bond traders can still front run these measures, and have done so).
Do you or I or the man on the Clapham Omnibus really know better than this market?
I suspect FWIW that it’s very likely bond prices will be lower and yields higher in five years today. But the great thing about passive investing is you don’t fret about listening to the opinions of me, nor of anyone else. You just set, rebalance annually or similar, and otherwise forget.
The idea is not to avoid losing money on any particular asset class. The idea is to make good returns for a low level of risk for minimal effort and without costs sapping your returns.
For more on the government bond conundrum, which we’ve covered many times, you might find these posts worth reading. 🙂
Hi TI
If funds are the persons bag then how about just 1 investment for even more simplicity. Your ‘young person’ might consider the Vanguard LifeStrategy 80% Equity Fund with a TER of 0.29%. Your ‘retiree’ might want either the Vanguard LifeStrategy 60% Equity Fund or Vanguard LifeStrategy 40% Equity Fund also both with a TER of 0.29%.
As you know I’m far more complicated than that but the above strategy in both a NISA (up to £15,000) and SIPP (up to £40,000) would IMHO get people much further than any Financial Advisor and/or Active Fund Managers ever will.
Of course which wrapper company to place it in is another decision as they are also going to eat some of your pie also. Although you also have that base covered. When the fund is small it’s the best % based mob and as it grows at some point you transition to the best flat fee crowd.
Personally I’m finding that ETF’s are becoming the way to go if you really want to minimise fees. VWRL could be had for 0.25% and VGOV for 0.12% for example. Put a reasonable amount into a TD ISA and your young person is up for total fees (ignoring initial trading costs) of 0.22% which is a lot lower than the fund option. The SIPP is a bit more complicated but it will be 0.22% plus either the wrapper annual flat fee or %.
The other advantage is that for those of us who aren’t PF addicts/hobbyists is that the annual maintenance would sum to a grand total of about 15 minutes.
Cheers
RIT
Thanks for those thoughts guys.
Yes, there is more than one way to a simple portfolio, but talk about too many of them and you’re on your way to recreating the Monevator website rather than trying to publish a very quick and short post to reach a lot of people. 🙂
Great to have other ideas in the comments though.
LifeStrategy is of course grand but to explain it you have to effectively explain stocks and bonds anyway. (Plus whenever we write about LifeStrategy I get emails asking if we’re a front for Vanguard! Hah. Still trying to get even a display advert out of them. They do like to keep costs low. 🙁 )
As for other simple portfolios and the case for cash, I’m still happy to suggest my standard 50/50 stocks/cash split:
http://monevator.com/what-should-a-new-investor-do/
The key IMHO is to get people exposed to a good chunk of low-cost equity for the long-term, but to do it in a way that share price wobbles don’t scare the living daylights out of them. 🙂
does anyone know of best-buy platforms for junior ISAs?
The writer is incorrectly stated to be yerself on the byline when its actually written by someone else
I’m surprised I’m the first pedant to notice this seven comments in…
@Neverland — Hmm, yes, I didn’t add the usual guest spiel because I wanted to grab newbie investors, but it could be confusing to regulars. Maybe I’ll create a new Guest byline tonight.
@Neverland
I did a double take, and then started to wondering if TI had accidentally “exposed” himself! 😉
Firstly this won’t be the first or last time someone says this but thanks for an absolutely terrific site which has probably helped me understand things more than any other.
A couple of questions for people who know about these things:
1. I’ve got an ISA with Cavendish/Fidelity. I have a modest monthly plan set up. However, the rules seem to say that the minimum monthly investment is £50 per fund. Does that preclude me from diversification into a small amount per month into multiple funds? For example if I put away £400 per month, does that mean the “most diversified” I could possibly manage would be 8 funds at 12.5% equally?
2. I’m totally sold on the principles of passive investing but what are people’s general thoughts on (1) corporate bond trackers, (2) emerging markets, (3) small cap tracker funds? I’ve heard elsewhere that the general feeling is that these gain an advantage from industry knowledge. Any thoughts/principles?
@Johnny
Exactly
Its the photo that drew my attention to it too…I thought….is that what the caped crusader really looks like?
Good article.
Would echo previous comment that cash is worth considering as well as bonds.
Cash will not provide a positive real yield at present, but neither will gilts unless the investor goes out beyond about 15 years. So with the more price stable gilts of short or medium term we are looking at a negative real yield with a potential capital loss when one day rates rise.
It is a difficult choice. We can only hope the capital loss will be minimal.
Hi magneto
I’ve recently had enough of derisory bank savings accounts and have switched to peer to peer lending for my cash. I’m currently achieving an average 4.7% meaning after inflation of 2.6% and Higher Rate tax of 40% I’m squeezing out a ‘positive real yield’ of 0.2%. Not much but better than going backwards with a savings account.
Of course different risk profile, DYOR etc etc.
Cheers
RIT
@Eoghan
If in one month you use your £400 to purchase 8 funds, in the next month, you could (if you wished to and Cavendish supported this) amend your regular payment to invest in 8 different funds, so your portfolio would have 16 funds at 6.25% equally after two months.
This might be a bit too much though ie changing every month, so perhaps amend less often, eg every 6 months or once a year.
@ RIT
I’ve actually done some work for a SME which was looking to raise some money off P2P platforms (no idea if they did so)
Quite frankly they were too dumb to realise how much money they were losing and we extended them no more credit than we possibly could and were quite willing to go straight to court if we hadn’t got paid
By contrast, when Mrs Neverland was there, some teenager from Funding Circle or similar was overhead telling them that they had “a wonderful business” and would have “no trouble” raising a planned six figure sum to throw down the hungry toilet of their business
Natch their bank had already turned them down for loan….
I can quite see peer to peer lending being the next great misselling scandal myself
DYOR etc
Thanks for posting.
Still trying to figure out how best to move from nutmeg to DIY with trackers etc. Investment is only ~10k isa + the ~20k cash ISA I had built up before. I considered any investments (by living rent free but not free of “the ‘rents”).
Replicating my portfolio with the same etfs would be expensive so think it would have to be the tracker fund / Vanguard route.
5 year and 10 year government bond yields are lower than my mortgage rate. Is there any reason why someone with an outstanding mortgage should buy bonds rather than service their own more expensive debt?
Thanks for the post.
I am currently investing with iii. As they have introduced their fee system i try and buy 2 funds a quarter. Currently i am investing 60% Ishares World and 40% Ishares AC Far East Ex Japan each quarter. I have been considering buying into bonds to minimise volatility and mitigate some risk and this post has got me convinced to look further into it. What would be a reasonable ETF to add some balance my portfolio? I am unsure if Uk or a more Regional/Global fund would be most suitable?
Hi TI,
Some months ago my wife (aged 30 – doesn’t mind the high exposure to equities just now) recently set up a monthly drip feed to 80% Lifestrategy via CharlesStan direct. Additionally her employer also covers monthly payments into a stakeholder pension with Aviva, they have a limited number of these S2 funds as they’re called. Based on the above article should she perhaps move her stakeholder monthly investment into one of the global equity trackers in this Aviva pool? They are listed below, apologies for the lengthy list, I suppose the decisive factor is cost, although this reads 0% for each? Can’t figure that out.
Aviva Pension Alliance Trust Sustainable Future Absolute Growth S2
Aviva Pension Alliance Trust Sustainable Future Corporate Bond S2
Aviva Pension Alliance Trust Sustainable Future European Growth S2
Aviva Pension Alliance Trust Sustainable Future Global Growth S2
Aviva Pension Alliance Trust Sustainable Future Managed S2
Aviva Pension Alliance Trust Sustainable Future UK Growth S2
Aviva Pension Alliance Trust UK Ethical S2
Aviva Pension BlackRock Aquila 50:50 Global Equity Index Tracker S2
Aviva Pension BlackRock Aquila 60:40 Global Equity Index Tracker S2
Aviva Pension BlackRock Aquila 70:30 Global Equity Index Tracker S2
Aviva Pension BlackRock Aquila Consensus S2
Aviva Pension BlackRock Aquila Corporate Bond Index Tracker S2
Aviva Pension BlackRock Aquila European Equity Index Tracker S2
Aviva Pension BlackRock Aquila Japanese Equity Index Tracker S2
Aviva Pension BlackRock Aquila Over 15 years Gilt Index Tracker S2
Aviva Pension BlackRock Aquila Over 15 yrs Corp Bond Tracker S2
Aviva Pension BlackRock Aquila Over 5 yrs Index-Lkd Gilt Tracker S2
Aviva Pension BlackRock Aquila Overseas Eq Consensus Tracker S2
Aviva Pension BlackRock Aquila Pacific Rim Equity Index Tracker S2
Aviva Pension BlackRock Aquila UK Equity Index Tracker S2
Aviva Pension BlackRock Aquila US Equity Index Tracker S2
Aviva Pension Corporate Bond S2
Aviva Pension Deposit S2
Aviva Pension European Equity S2
Aviva Pension Gilt S2
Aviva Pension Global Bond S2
Aviva Pension Global Equity Income S2
Aviva Pension Global Equity S2
Aviva Pension Index Linked Gilt S2
Aviva Pension International Index Tracking S2
Aviva Pension Long Gilt S2
Aviva Pension Managed High Income S2
Aviva Pension Mixed Investment (0-35% Shares) S2
Aviva Pension Mixed Investment (20-60% Shares) S2
Aviva Pension Mixed Investment (40-85% Shares) S2
Aviva Pension Pacific Equity S2
Aviva Pension Property S2
Aviva Pension Stakeholder With Profit 3 S2
Aviva Pension UK Equity S2
Aviva Pension UK Index Tracking S2
Aviva Pension US Equity S2
@magneto i think that the point of gilts and cash is not necessarily to provide a positive inflation adjusted yield but to ‘lose-you-less’ when in a bear market and your portfolio takes a hit.
@RIT which P2P did you go with? I’m of the mind to only take the plunge when they sort out the ISA status as this will make them a lot more attractive. Its certainly a risky asset class though and I wouldn’t bet the house on it
Hi Paul – without knowing much about Aviva there are generally tons of hidden fees in the financial industry and as you point out it is safe to assume the actual fee is not zero. Incidentally I never understood why some firms show zero fee – they are almost rubbing you in the face with the fact that they make money in a less transparent way which is bound to irritate many customers. A friend once outlined to me how his bank make fees in 5-6 different ways with one of these principal protected products (those where you make some money if markets go up, but are guaranteed to not lose money). All this to say that if you have a simple and cheap custody account with a couple of Index trackers / ETFs you’ll save a bundle in the long run for essentially the same exposure. Cheers
The Rhino July 2, 2014 at 10:00 am
@magneto i think that the point of gilts and cash is not necessarily to provide a positive inflation adjusted yield but to ‘lose-you-less’ when in a bear market and your portfolio takes a hit.
Yes that is fine when accumulating, but take the case of a retiree in the drawdown stage with non-equities at say 60% of the portfolio, then negative real bond/cash yields are a hell of a drag on portfolio performance.
Hence the trend by many to forsake a full allocation to fixed income and up the exposure to high yield stocks, but that room is getting crowded. The Residential Real Estate room is also getting crowded.
There are no easy answers. Let us hope for better times.
Cracking article, Lars.
This is a great site, which is deservedly attracting more and more followers, but it’s a pity you can’t read stuff like this in the money pages of the mainstream press.
@The Rhino
My research suggested that their were only 2 viable alternatives – Zopa and RateSetter. RateSetter was best for me.
may be best to use both? hedge your bets?
@magneto
for sure its not ideal, and negative real returns on fixed income assets/cash are not the norm so hopefully it will get better/revert to mean
but chasing returns by going heavy on equities could smash you pretty hard as well as a retiree living off a portfolio if the markets take a dive – maybe leaving you wishing you’d taken a smaller hit from your cash and gilts on the chin?
best to stay diversified across all the assets and weather the storm as best you can
easy to say – very hard to do..
@mageneto — It’s a difficult time, no doubt, and a difficult decision. Bonds and cash were always a lousy long-term investment versus equities over many decades, but over shorter timescales the apparent return differences didn’t seem so vast as they do today.
However, and it’s a big ‘however’, true passive investors don’t attempt to second guess markets.
If bond yields are low, then in economic theory that implies that equity returns will be relatively low compared to the past, too. And, equally, that if you are getting say a 5% dividend yield on a a portfolio of shares then the excess income is not ‘free’ — you are taking on more risk than you think, or perhaps the capital returns will be poor.
Personally I don’t 100% believe in pure theory and I’m willing to have a punt (as you may know for my sins I invest actively) but you should realize when you make these capital allocation decisions that millions of other people are looking at exactly the same data as you, and it’s all in the price.
It never ceases to amaze me how many people in blog comments, on forums etc, see bonds as a 100% nailed-on appalling investment over the next coming years without any trace of humility. Did these people also predict the huge bond bull market that began in the early 1980s when inflation was headed off the charts? I highly doubt it! 🙂
As I say, I’m an active punter and I too hold no bonds currently. I prefer cash, and/or various exotic things such as peer-to-peer, retail bonds, some inflation-linked things I own, and of course equities.
But I do so with my eyes open to the fact I may well be very wrong. Remember my rule: Risk cannot be created or destroyed, it can only be transformed from one form of risk to another. 😉
@N — Interesting question. I think it depends on your emotional outlook, and how much you have in equities relative to your net worth (among many other factors). And also on how well you are able to see your personal finances ‘holistically’.
I have a spreadsheet that pulls in absolutely all my assets and liabilities across the piece, excluding sundry chattels. (I don’t include my MacBook Pro in it, for example, let alone my tropical fish tank. I wouldn’t know whether the latter was an asset when it eats money like a liability!)
Equally I have invested through bear markets adding new money after my portfolio halved.
i.e. I know I can stick with it in the depths of a crash (not easily, but I can do it) which would give me confidence that I could dispense with the bond element of a portfolio in favour of paying off debt, as you suggest, in your shoes.
However not everyone (a) sees their finances holistically, even if they should (i.e. the vast army of people who belong to the “my house is my home not an asset” brigade) and/or (b) could look at their equities halving with an even-keel — even if they would have had the same equity exposure if they’d kept the bonds, as without.
Personally I think mortgage debt is the only good debt, but I’m not sure I’d use it to buy low-yielding bonds. I’d pay it down instead. But your mileage may vary.
I have had my first foray into P2P lending recently….I say foray but in truth I’ve had no takers for my offered £3k at 3.9% for one year. This was meant to be a taster before committing a larger sum (I was thinking 20k) in a couple of months. With Ratesetter you post your loan offer or match directly with a lenders requirement. They have a fund theoretically set aside to cover non-payments and boast of no lender having ever lost out. (Although noone had ever lost out with LTCM, Bernie Madoff, Equitable Life, Enron, Bear Stern….all of which had arguably better risk control and consumer protection….Madoff excluded)
Unlike (I think) others there appears to be no option within Ratesetter to select the credit worthiness of your borrower for a better or worse rate.
Of course there are no guarantees and in truth I’m questioning if the gains outweigh the hassels and risk (especially once you take off top rate tax). I think P2P has a place If your eyes are wide open to the risks and you’re only committing a small portion of your ‘fun’ portfolio. The hunt for yields takes you weird places.
Inside an Isa would be nice but it’s the capital gain shielding in an ISA which is of real value to me rather than the income tax shield as such the higher potential gains to be had from equities suit my ISA better.
For the mean time, my 3.9% remains untapped. I’d say “any takers?” but offering to lend money to a Monevator reader is, I suspect, likely to be a somewhat fruitless exercise.
Thanks again for a great site!
@Bob
I went for Ratesetter too, only my ‘foray’ was for just £1k. I posted it up for the 3 year loan @ 4.5% and it was snapped up within 24 hours.
Perhaps consider splitting the £3k into smaller parts?
Rob, that split means you’re putting around 25% into Australian stocks every quarter.
That’s a big tilt!
Actually, it’s more like 27% (forgot to add in the Australian component of Ishares World!).
Re: Ratesetter, I believe the one month rollover is the sweet spot and lend exclusively in that segment. Around 2% annualized and your cash back in c. 4 weeks. In today’s brave new/old world, that’s not bad.
Overpaying mortgages: we had a flexible mortgage – we could overpay and then borrow the money back later. Wonderful – but people at MSE now warn that the borrowing back bit may be at the pleasure of the provider. So nowadays I’d probably consider an offset mortgage instead.
“what are people’s general thoughts on (1) corporate bond trackers, (2) emerging markets, (3) small cap tracker funds?”
(1) I considered it, but after soliciting opinions on sites such as this, cooled. It probably does nothing that I couldn’t get from a combo of equities and Gilts. I have a hankering to hold a TIPS ETF in an ISA though.
(2) dunno
(3) Trackers are maybe the wrong way to hold small caps? Tracking is, I suggest, for large, liquid, well-researched equities.
@N – I’m with The Investor, mortgage being the only debt that’s “ok” to have. But I went for the “paying it off” option and you can’t beat the feeling that you can never get a visit or phone call from the bank!
Don’t forget to factor in £3 for getting a copy of the updated shiny, clean title register from the land registry website – the best £3 I ever spent 😉
Just to follow up my comments on bonds above, Rick Ferri has posted a useful piece showing how the ‘obvious’ move to stay away from anything other than short-term bonds has hit a US investor’s returns in the past few years:
http://www.rickferri.com/blog/investments/the-risk-of-short-term-bond-funds/
@TI – not entirely sure if you’re serious or not re. tropical fish?
If you are, there are plenty of ways to save money that take it from a liability to an asset in relaxation 🙂
I recently gutted a high tech/high faff tank and stripped it back to a minimalist tank with a soil base. Now saving myself about 2 hours/week and £30/mth from the original fancy incarnation.
Aquarium ‘investing’ goes passive?
RIT
Interested in your comments on LS 80% , why do you suggest only £40k for a SIPP? I’m considering switching most of my. SIPP to LS 80%, which is considerably more than £40K
@ David – the £40k refers to your annual contribution allowance into a SIPP, ie the max you can contribute into your SIPP each year, not the size of your current SIPP.
I have started a sipp and currently have an all world equity tracker. I would now like to buy bonds. Is there a case to be made for diversifying away from just holding gilts, eg, half gilts and half vanguard hedged global bond fund??
@Newbie — Have a look at the following article below. I’ve also answered your equal weight question you asked. Please do have a play with the Search function in the top-right, as sadly we don’t have time to fully answer questions to the level required on all these old posts. Cheers for stopping by!
http://monevator.com/bond-asset-classes/