Once more the contrast between my daily diet of media-amplified fear and the damage done to our Slow & Steady passive portfolio surprises me.
The portfolio is down just 3.5% since its peak last quarter. Essentially, we’re back where we were six months ago.
That’s despite the arrow-headed threats of stagflation, economic crisis, and a geopolitical winter converging on our positions.
We count our blessings as private investors who sleep soundly at night. As ever, you only need glance at the conveyor belt of horror on the news to gain a proper sense of proportion.
Nothing to be down about
In writing about a rare down period for the S&S – when nothing in the portfolio offers much cheer – I’m minded how rarely I’ve had to report a knock back.
The table below shows how often a World equities portfolio has historically registered a loss, depending on how often you checked in on it. (See the ‘Look frequency’ column on the left):
Albion Strategic Consulting is passive investing champion Tim Hale’s firm. This table was published in wealth manager BRWM’s regular newsletter.
The Slow & Steady portfolio has only nosed down in ten quarters out of 45, which is just 22% of the time. That compares well with the 31% chance of a quarterly loss suggested by the table.
Negative years have rained on our portfolio’s parade twice in eleven years. That’s 18% of the time versus an expectation of 23%.
We’ve lived through a benign era, which only heightens our fear that it might come undone.
Bond-o-geddon
Indeed, the long-predicted bond reckoning does seem to be upon us. Our bond fund inflicted an 8% loss in the last three months. That compounds a poor 2021.
Here’s this quarter’s portfolio carve-up brought to you by DystopiaVision:
The Slow & Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £1,055 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and find all the previous passive portfolio posts tucked away in the Monevator vaults.
The one-year return for our UK government bond fund is -6%. Layer on the current annual inflation rate of 5.5% (CPIH) and you’re looking at a real return loss of 11.5%.
Conventional UK gilts are quite capable of inflicting double-digit annual losses.
2013 and 2021 both returned a -10% inflation-adjusted loss.
Before that, 1994 brought -14% worth of bond pain.
You have to go back to the stagflationary 1970s to see big bond losses in consecutive years though. UK government bonds took a -47.6% real terms pasting between 1972 and 1974.
Nasty, but it’s not wealth-wrecking on the scale of UK stock market storms such as:
- -73% 1972-74
- -41% 2000-02
- -45% 2007-09 during the Global Financial Crisis
- -32% in a single month of the coronavirus crash
Moreover the bond losses quoted above measure the hit to long gilts. You’d have suffered less if you held intermediate or short-dated bonds.
This post on bond prices explains how bond losses (and gains) work.
It’s always darkest before dawn
People seem to intuitively understand mean-reversion when it comes to equities, but miss how bonds sow the seeds of their own resurrection.
Capital losses today mean your bond holdings will reinvest in higher-yielding varieties tomorrow.
That mechanism will eventually put you further ahead, compared to if yields hadn’t risen.
Inflation-linked bonds go AWOL
Notably our global inflation-linked bond fund isn’t covering itself in glory – despite spiralling prices in the shops and on the petrol station forecourts.
Our fund somehow managed to return -0.26% over the last quarter. How can that be?
The data below shows that investors were bidding up index-linked bonds from 2019 – well before official inflation rates took off in 2021.
Source: Royal London Asset Management
The market saw inflation coming and our fund did okay these last three years. Though it still lags all of our equity funds over the same period.
The problem is short-dated government bonds only offer so much juice. And inflation-linked bonds are battling a negative yield headwind before they can even register a gain.
Also note that our fund can drop if the market anticipates lower inflation, even while we grit our teeth when filling up the car.
A short-dated fund like this is not going to make you rich. It’s about capital preservation.
If inflation explodes then it’ll protect a corner of your portfolio while equities and conventional bonds get their marrow sucked.
From that perspective, our inflation-linked fund is doing its joyless job.
If I was an early to mid-stage accumulator then I’d likely dispense with this asset class. I’d rely on equities to beat inflation over the long term instead.
Investing in index-linked bonds is probably something that can wait until you’re on the glidepath to decumulation. Perhaps ten or even just five years out.
We have an upcoming post on inflation hedges that will investigate the reasons why.
Leave well alone
We only need rewind the clock a couple of years to recall that inflation worries were about as fashionable as a mutton-chopped general preparing to fight the last war.
Chalk it up as another piece of evidence that few can predict what’s going to happen next.
Conventional bond losses could mount. On the other hand, they could be your best refuge if a colossal recession lies around the bend.
It always makes sense to maintain a dry powder store of bonds to cushion your losses and buy equities on sale.
That’s why given the balance of risks, in recent years we’ve been advocating capping bond exposure rather than throwing them overboard.
If you own a 60/40 portfolio then perhaps you can tolerate a 65/35 or 70/30 equity/bond mix.
Your defensive asset allocation is hard to judge. Tread cautiously, and assume your risk tolerance is lower than you think.
New transactions
Every quarter we buy £1,055 of ammunition for the skeet shoot that is the global market. Our shots at glory are split between seven funds, as per our predetermined asset allocation.
We rebalance using Larry Swedroe’s 5/25 rule. That hasn’t been activated this quarter.
These are our trades:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF 0.06%
Fund identifier: GB00B3X7QG63
New purchase: £52.75
Buy 0.223 units @ £236.50
Target allocation: 5%
Developed world ex-UK equities
Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.14%
Fund identifier: GB00B59G4Q73
New purchase: £390.35
Buy 0.728 units @ £536.24
Target allocation: 37%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.29%
Fund identifier: IE00B3X1NT05
New purchase: £52.75
Buy 0.133 units @ £395.58
Target allocation: 5%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.19%
Fund identifier: GB00B84DY642
New purchase: £84.40
Buy 44.858 units @ £1.88
Target allocation: 8%
Global property
iShares Global Property Securities Equity Index Fund D – OCF 0.17%
Fund identifier: GB00B5BFJG71
New purchase: £52.75
Buy 20.303 units @ £2.60
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
New purchase: £305.95
Buy 1.83 units @ £167.17
Target allocation: 29%
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £116.05
Buy 102.608 units @ £1.13
Target allocation: 11%
New investment = £1,055
Trading cost = £0
Platform fee = 0.35% per annum.
This model fund portfolio is notionally held with Charles Stanley Direct. Take a look at our online broker table for cheaper platform options if you use a different mix of funds. InvestEngine is even cheaper if you’re happy to invest only in ETFs.
Average portfolio OCF = 0.16%
If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.
Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? This piece on portfolio tracking shows you how.
Take it steady,
The Accumulator
I think the Slow and Steady updates are up there with my favourite posts on Moneyvator, thanks once again @TA. That look/loss graph is quite something (and a powerful reminder not to check too often, not too tinker too much, simplicity is key).
I feel I’m really good at putting into and then leaving stuff my SIPPs, which are both just simple passive trackers (AG Bell’s Adventurous ETF fund of funds and another with HL where I only have L&G future world index). I’m still in the mid to long term process of overhauling my S&S ISA towards mostly Vanguard LS80, with a bit of active holdings in the form of investment trusts to itch that active scratch. Recently shifted to ii but as a result of that, ive been checking the transfer process, a new app, and uncertainty, I’ve definitely been checking my holdings more often in the last six months, often multiple times daily (i know, i know…..). Very clear that my SIPP passive funds have performed better recently (or more accurately, less bad), definitely at lot of truth in that graph from personal perspective.
Any suggestions from the floor about dropping the very human nature of checking things too often? Other than Don’t. Do. It (!) Removing the apps from a phone is one option i guess? Prehaps going completely passive is another. Still relatively early into my investing journey but in time, I’m aiming to be about 80 to 90% passive overall but quite enjoy the active side of things, teaches me about companies and the wider economy quite well I think.
Thanks again.
Thanks, once again. Have you ever published a guide about how to produce a portfolio tracking spreadsheet similar to your own?
Apologies – I should have read to the end of the post!
It seems about 6 months ago we were being told inflation was transitory. Honestly, nobody knows anything. The best you can do, in general, is exactly what you’ve outlined above, keep going slow and steady, and be diversified.
Re “our global inflation-linked bond fund isn’t covering itself in glory”
disagree!
You put a great deal of effort into switching S&S out of the
Vanguard U.K. Inflation-Linked Gilt Index Fund.
yes Royal Lon Linkers -0.26% has lost £22 that we could have kept
under the mattress but Vanguard Linkers are -5.17% on the same
period which would have lost another £400 pushing the S&S loss over 4%.
Vanguard Linkers did spike much higher than Royal Lon last year,
so over longer frames the saving might be much lower. But the S&S timed rebalancing is not aggressive enough to benefit from that spike so I still think it is better off with the lower-volatility short duration fund.
Is it time to launch a Slow and Steady ESG index portfolio for comparison?
I love following the progress of the Slow and Steady Portfolio. Thanks as always for the detailed updates.
I really enjoy the S&S updates, I also use it as a bit of a benchmark for some of my own more active choices and my asset allocation. I posted something similar on the death of the 60/40 series post, but think its interesting to look at other alternative growth asset classes, I looked at IT sector performance over last three months:
Physical UK Commercial Property (different from securities) 5.2%
Renewable Energy Infrastructure 3%
Infrastructure 2%
Private Equity -4.4%
The majority of my portfolio is passive. Generally my active equity choices have underperformed YTD, but the alternative growth asset classes have helped my portfolio over this limited period.
@ Meany – nice one. I didn’t look into the alternative history. That is interesting to know and what you would expect. The longer linkers are prone to risks that undermine their effectiveness at hedging inflation.
@ Andrew – that’s a very good idea. TI and I have been debating starting a new S&S portfolio. As in, how would it look if we were starting today. Making it an ESG portfolio would provide a strong contrast against the longer-toothed S&S.
I’m also thinking about adding 5% gold to the S&S portfolio. I’ve always been on the fence about gold but I think it’d make the portfolio more educational.
@ Whettam – that’s interesting. How are you getting your UK property exposure?
@ Thomas – haha. No worries. It is a long way down 😉
To try to get a bit more constructive about this “slump” period,
Does anyone know if it has(/can) be calculated how much
commodities(/etc like @Whettam mentions) should be added
to a portfolio to stabilize it through a slump without denting it
too hard through growth?
e.g. 88%LifeStrategy60 12%ICOM is flat YTD
I was also hoping that @TA might shift the S&S defence into
his “All Weather” portfolio. That (the defence part) is also
flat YTD. Problem is, if one shifts now, do you bake in the
bond losses which might just mean revert if you leave it?
Albion Strategic Consulting’s table shows the worst weekly loss to be 22% yet there is a 0% chance of a 20% or even a 10% loss. That seems wrong – possibly a rounding error I suppose?
@TA the three month numbers I used were from Trustnet Investment Trust sector averages, I’m always shy away from mentioning active IT’s on Monevator 😉 and seems especially ‘bad form’ on a S&S thread, but you asked!
I have several holdings:
BCPT did 11.7% in Q1 and over 60% for last year 🙂 this Trust was hit really badly by pandemic (lost over 30% in 2020), its been a long term holding for me
SLI 8.5%
BBOX 4.1% sits in logistics sector
My Active Property Securities IT TRY did -7% for quarter (but 20% for year, 13% annualised). So planning to stick with it.
always enjoy the s & s update.
@JDW If you want to avoid the temptation to check too often, just set very long, complicated passwords. That way your stuff is secure from everyone, including you.
@ Meany – just to clarify terms: if a slump means a recession then long-term government bonds are the best bet. So far, so normal.
If slump means a high, unexpected inflation / stagflationary environment then the only consistently responsive investible options have been inflation-linked bonds and something like energy commodities.
The problem is those are expensive hedges to hold when you aren’t being hit by an energy crisis / rampant inflation.
One option is to tough it out. Rely on the long-term inflation beating expected returns of equities.
But it’s impossible to say what will work for a portfolio now that won’t hit it too hard long-term. That’s trying to predict the future.
Energy commodities are spiking now but would that be worth it versus the terrible run they’ve had for over a decade? I haven’t run the numbers but it wouldn’t prove anything anyway. It all depends on what happens next.
I think you nail it when you mention the all-weather portfolio. Ultimately, that portfolio relies on allocating the bulk of your wealth to old faithfuls like equities and bonds. While smaller slugs *could* go into diversifiers that have worked in the past but aren’t guaranteed to in the future.
For example: I’ve seen nothing that would convince me to put more than 5% in gold but I could understand someone going as high as 10%.
Whettam’s UK property holdings are doing well now but imagine holding them early in the pandemic. REITs in general have trailed equities since the Global Financial Crisis.
I suspect those holdings are enjoying a rebound as the pandemic recedes. I recently researched commercial property as an inflation hedge. There’s very little evidence for it but, like equities, the asset class should beat inflation over the long run.
Plus, it is a diversifier so we might as well hold 5-10% of it according to taste.
I’ve looked into the long-term performance of many different asset classes and keep turning up the same result. Reputations tend to get built around a stellar run that proponents can point to. But investigation typically shows no consistent long-run pattern you can rely upon; or that the outperformance disappears after costs, or in the form the strategy is served to retail investors.
@ Whettam – haha. Thanks for sharing. I don’t mind delving into the active side at all where the products make sense i.e. low cost, reliably provide exposure to a good asset class that plays a strategic role in the portfolio. Afterall, the Royal London short duration linker fund is actively managed. But it was better than the passive alternatives at the time.
@JDW – actually, I make a habit of checking my portfolio regularly, usually monthly. But I’m good at not actually meddling with it. When things are bad, I want to see how bad. It means that next time things are bad, I’ll remember that this isn’t the first time, and they will eventually get better. And I’ll do nothing. And when things are good, well, it’s nice to see, but I’ll still do nothing.
In particular, I have a couple of holdings from my foolish days of share picking which I deliberately hold on to. Every time I force myself to look at the 80% loss on Funding Circle Holdings, it serves as reminder never to do it again. As it turned out, a price well-worth paying for a lesson learnt.
@TA I think this sums it up “REITs in general have trailed equities since the Global Financial Crisis.” and “Plus, it is a diversifier so we might as well hold 5-10% of it according to taste.”
I have landed on a 20% allocation to real assets e.g. property, infrastructure and renewable energy. I don’t expect these assets to outperform equities (as you say, property has recently, but only after a really bad pandemic), but I do expect them to behave differently to equities, which in my experience they do. Which I was trying to illustrate with the comparison vs equities over last three months, March 2020 was the same, different to equities and bonds. I have a very low bond allocation about 10% (short dated gilts and the RL global linkers), but I also have a guaranteed with profits policy which I view as a super bond :-), my allocation to equities is currently only about 50% (and that includes PE).
I think this is all very personal down to individual circumstances, I have exceeded the LTA and I can access my TFLS in a couple of years, so I’m currently holding more cash than I ever had before. I would definately not be holding 20% Alternatives if I was still in early / mid stages of accumulation.
Interestingly I check my portfolio most days, but I also use Swedroe rule and only top up / sell in my quarterly rebalance, if something has moved 25% from its target allocation. This stops me from trying to time market, but means I do time market 😉 in March 2020 I was holding my nose and topping up my Property, in December 2021 I was adding to my cash, etc.
I am also a great fan of these S & S portfolio updates. Thanks for keeping them coming every quarter!
I have been self experimenting with having more than 10% of physical gold in my total portfolio for about 5 years now. I am very happy with the results so far. My aim is to keep the sequence of return risk (I am planning to start drawing down from my portfolio soon) to a low level by reducing the volatility of the portfolio.
I have measured (I have been checking the valuation every week for more than 5 years) a total portfolio annualised volatility of about 6% and an annualised total return of about 9% over these 5 years. My maximum paper loss with the recent market trouble with the Ucranian war was about 2% from my previous peak in early November last year. Last week though, the total portfolio went over its previous peak.
Same as other viewer: the quarterly update is also my favourite post. I invest regularly in the Vanguard 60/40 fund therefore this post let me to compare the result but also get an insight on what’s going on and next quarter investment. Pls keep updating it even if it’s not all good news. Many Thanks.
In your update you comment on the performance of the Royal London Short Duration Global Index Linked Fund M. May I ask how you calculated the performance of the fund? Unlike other funds in your portfolio this fund is an income fund with distributions (in US $) on 31 December and 30 June. For a performance comparison with your accumulation funds, the income should be reinvested in the fund but I haven’t seen any reference to income reinvestment.
For a realistic comparison the US $ distribution would need to be converted to GB £ at your platform’s exchange rate and then reinvested into additional units with the platform’s dividend reinvestment fee deducted. In practice, if you were managing the portfolio, it would be more likely that you would add the income payments to your quarterly contribution and distribute your fund purchases appropriately, as that would reduce your transaction costs, however such an approach would not allow you to compare performance across funds. If you have been ignoring income from this fund, you will have been underestimating both the fund and your portfolio’s performance.
Sorry, I made a mistake, the income is in GB £ not US $, I was mixing it up with another fund I hold. Also, it seems like 31/12/2021 was the first actual distribution payment, other were all zero (not sure why). Anyway, the principle applies and there was a distribution on 31/12, which I received in my ii account on 4/01.
@ coyrls – yep, income is reinvested back into the Royal London fund. There is no transaction fee. See:
https://monevator.com/the-slow-and-steady-passive-portfolio-update-q4-2021/
Most quarters you beat me or it is a draw at best for me, so it is refreshing to be 7.5% ahead of the Slow & Steady portfolio for this past quarter (+4%).
Analysing why, like Whettam I currently have around a 20% allocation to property, infrastructure and renewable energy, and the vast bulk of that is in the last one which has crept up recently after a while in the doldrums.
And my UK and global equity has a dividend tilt, and is underweight USA.
So its make up has favoured the sector rotation.
What has stunned me is how poorly the iShares INXG Index Linked Gilts ETF has done this quarter. I don’t hold this presently but did a few years back.
It ended March -5.75% YTD but is pretty volatile and was -7.6% just a day before. Currently about -9% for 2022 so far. Not a great inflation hedge!
It looks like those commodity basket ETFs have finally had their time in the sun to shine as an inflation hedge and portfolio diversifier.
iShares ROLL ETF is up nearly 25% YTD.
Stirling work and a reminder of exactly why a balanced low maintenance approach is best. I have been quiet of late as I find life is more worrisome than money. All things must pass.
Keep up the good work and it is most appreciated.
JimJim
Great, sorry for missing the reinvestment. It does seem like your performance graph for the fund is without income reinvested, as Morningstar shows the 2021 return as 4.7% vs the 4.59% in your graph. Other years are the same except 2017, so maybe there was a distribution in 2017 as well.
@TA The S&S updates and the comments that follow are always interesting to read. It would be interesting to know what the comparative return would have been had you bought just Vanguard LifeStrategy 60.
@ SemiPassive – that’s interesting. Being overweight UK and underweight USA has clipped the wings of a lot of UK investors since the Great Recession. I wonder how many American FIRE-ees have been minted just by shovelling everything into the S&P 500?
The UK and Emerging Markets have being showing up as undervalued relative to the US for years now. Maybe it’s their time.
Agreed. Energy ETCs have had a brilliant year. I found myself drooling at the returns and cursing my lack of foresight. Then I comfort myself that they’ve been horrific since the Great Recession. Like the anti-S&P 500.
Re: anyone wondering why UK index-linked gilt funds may not be functioning well as inflation hedges. This post explores the reasons why:
https://monevator.com/why-uk-inflation-linked-funds-may-not-protect-you-against-inflation/
@ Coyrls – The 0.11% discrepancy you’re seeing is the difference between Morningstar’s calculations and the fund manager – Royal London. Royal London say their figures include net income reinvested. These discrepancies crop up all the time when comparing different sources.
The fund distributed in 2019 too. It wasn’t part of the Slow & Steady portfolio in 2017.
@ Onedrew – I did a very rough comparison a couple of years back with LifeStrategy 60. Slow & Steady was ahead because of a smaller UK weighting but, more importantly, because it was 80% equities in the early years. It’s only recently got to 40% bonds. Ultimately, there wasn’t a huge amount in it. I’ve mentioned this before, but I put my mum in LifeStrategy 100 years ago. She’s beaten me royally – again the difference being the bonds.
For the record, she’s not some wild risk-taker geared up to the max. The bond side of her portfolio is taken care of by annuities and the State Pension.
I’d have been quite happy with LifeStrategy personally. None of us could have known 15 years ago that US equities would dominate the next decade and a half. But the honours went to international diversification (and especially emerging markets) the decade before that.
We could definitely construct a story that the future belongs to the tech giants but I suspect the reality will be crazier. It usually is.
@TA (27) Re your mother’s portfolio, I’ve never quite understood the psychology of regarding secure income as a bond equivalent. The secure income certainly reduces the amount of income that’s needed from your investment portfolio and this income may indeed be supplemental and not needed for essential expenditure. However, as regards the asset allocation for this portfolio, my thinking is that it should still be determined by your risk tolerance/appetite and how far you are prepared to see it fall in a market crash. I don’t see how this is different from starting off with a much smaller income requirement but having to derive this solely from drawing down on the portfolio, when your mother would surely have a much more cautious asset allocation.
@ DavidV – It’s an interesting point of debate. In my mum’s case, the fixed income side of her finances entirely covers her spending.
That insight should inform risk tolerance but I take your point that it won’t do so for everyone.
The rationale case for taking more risk once income is secured underpins strategies such as the floor and upside portfolio:
https://monevator.com/the-most-important-goal-for-every-retiree/
To me it makes intuitive sense that having your needs covered by fixed income means you can afford to take more risk. It works for my mum too.
But you’re right that doesn’t mean everyone has the *willingness* to take such risk.
I have another close relative who checks the FTSE every day and feels tangible pain every time their portfolio dips. Their fixed income entirely covers their needs too but I’d never recommend floor and upside for them.
FWIW, a similar insight informs the rule-of-thumb that the young can take more equity risk. That heuristic substitutes being long on human capital for the bond side of the portfolio.
@TA (29) I suppose my risk tolerance must be nearer to your close relative’s than to your mother’s. Of course, I understand the argument that sufficient secure income to cover your needs means that you can ‘afford’ to take more risk. The counter to that is the maxim that once you have won the game you should stop playing.
I’m also fortunate that my secure income in retirement seems to cover my needs and I haven’t yet had to start decumulating my investment portfolio. I’m currently sitting at about 55% equity, 45% bonds/cash, but I’m gradually transitioning that to 50:50. So I haven’t exactly stopped playing the game, but I have set my asset allocation more in line with my risk appetite.
Haha. I think this discussion shows that in investing, for every maxim, there’s an equal and opposite re-maxim.
I take ‘stop playing the game’ to mean stop taking risk that you can’t afford and don’t need to take.
If both those conditions align then a person should definitely de-risk.
In my case, I can’t afford to switch the bulk of my portfolio into safe assets even if I wanted to. I have to keep taking equity risk in the decades ahead.
I can’t afford to lose that money. I can’t afford not to risk it. In my case the need to take risk dominates.
Reality is more complicated still. Mrs TA needs to take risk too, can’t afford to lose her pot, but it’s not clear what her risk appetite really is because she outsources it to me. A lot of couples seem to be in this situation.
Still, a healthy percentage in bonds seriously reduces the risk of losing the money because if equities were down 90% in Great Depression 2 then we’d be able to live off the fixed income side of the portfolio for years.
Meanwhile, a healthy percentage in equities offsets the risk of being ruined if bonds are shredded by inflation. Or, your annuity company goes bust.
Which brings us back to the 50:50 portfolio perhaps being much less risky – all things considered – than it looks.
I think there’s real value (and psychological benefit) to be had from looking at your entire balance sheet holistically.
My mum’s portfolio is 30:70 equities:fixed income based on the rough and ready estimation I’ve just done. But the reality is safer still when you include house equity.
My other relative unnecessarily torments themselves by focussing on a small part of the picture and viewing it purely in terms of loss.
It’s functionally equivalent to fretting about emerging markets being down when the rest of the world is up.
Zoom out and their life is extraordinarily safe and secure. They have won.
@TA, DavidV,
IIRC, the usual way to express this apparent dilemma is with two related but different terms, namely: risk capacity and risk appetite. The former being your financial ‘ability’ to take the risk; the latter your ‘desire’ to take risk.
As I see it, the Floor and Upside approach does not really require a fully-funded floor nor does it ever demand a 100% stocks upside pot either.
For info, John P Greaney recently published his 21st annual update (to the end of calendar year 2021) at: https://retireearlyhomepage.com/reallife22.html
Re #32:
As usual, Dirk Cotton had a great way of summarising the floor/upside partition challenge:
“The most important decision you will make in retirement planning is how much of your resources to allocate to the upside and floor portfolios” and “The correct balance [between the upside and floor portfolios] will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.”
Also, the full Bernstein ‘stop playing the game’ quote is informative:
“In other words, once the game has been won by accumulating enough safe assets to retire on, it makes little sense to keep playing it, at least with the “number”: the pile of safe assets sufficient to directly provide or indirectly purchase an adequate lifetime income stream.”
Bernstein, William J (2012-06-18). The Ages of the Investor: A Critical Look at Life-cycle Investing (Investing for Adults) (Kindle Locations 51-52). Efficient Frontier Publications. Kindle Edition.
@Al Cam (34), @TA (31) I knew that the ‘stop playing’ maxim had been said by Bernstein but wasn’t sure if he was its originator. I’m a bit of a Bernstein groupie, owning all three of his main investing books and all four of his shorter Investing for Adults series. I didn’t have the stamina to look for the full quote, but he probably said something similar in all of them.
TA, I think your assessment that you and Mrs TA need still to take risk means that, by Bernstein’s criterion, you both haven’t quite won the game yet and need to keep playing. Your mother and other relative, conversely, have won the game as they have already secured sufficient income for their needs (and wants?).
I think it may have been Bernstein who also said that if you already have enough income for your needs and conceivable wants, you are effectively investing for your heirs and have a time horizon that expands beyond your own lifespan. This certainly increases your risk capacity and you are free to invest this portion in accordance with your risk appetite.
I don’t have a legacy motivation, so my desired 50:50 allocation is primarily determined by my own risk appetite.
@DavidV
Like you, our needs will be [worst case: largely] covered by pensions, in due course. And, we do not really have any sort of legacy motivation either. Therefore, sometimes I wonder why bother with the upside at all – but something just keeps me interested. And it is always good to have a cushion (or two) to be able to fall back on as nobody knows what might be just around the corner.
I strongly suspect our scenario is a lot more common than is widely realised – albeit that DB-like pensions are all but gone for younger working-age folks.
I’m a big Bernstein fan too. I bet he’d love the idea of having his own groupies 😉
I love his insight about investing for the next generation. Especially because it highlights the idea that risk capacity increases when you don’t have to sell risky assets. It’s another technique to help rationalise away the volatility of the market.
Bernstein’s version of winning the game, from memory, would be something like a ladder of TIPs that perfectly match future liabilities for the rest of your life.
That is an expensive way to achieve financial independence. Much later in life, I could probably achieve it through a combination of annuities and state pension. No defined benefit pension for me though.
I don’t remember Bernstein’s views on probability-based strategies like sustainable withdrawal rates?
It’s interesting to contrast Bernstein’s approach to say Buffett’s 90:10 portfolio for his wife. In that instance, Buffett is putting his faith in the US economy. And, I assume, a portfolio so large that its income should always exceed reasonable needs.
@TA (#37):
I think Bernstein’s view of probability-based strategies is best summarised in his mini-series called “The Retirement Calculator from Hell”. Part III, called “Eat, Drink and Be Merry” is IMO the most memorable; see e.g. http://www.efficientfrontier.com/ef/901/hell3.htm
@DavidV:
In your circumstances, another way to think about your non-pension assets (to quote from Zwecher’s book Retirement Portfolios – which IMO remains the go to text for Floor & Upside) is as “the amount of dry powder that you have for creating upside, funding impulse purchases, or absorbing negative uninsured shocks” and treat accordingly.
@ Al Cam – The horror, the horror. I’ve read that piece before and conveniently forgot about it. Now I’ll have to forget about it again 😉
At least in one of those scenarios it wouldn’t be just my Gen X defined contribution pot that’d be in the shtook 🙂
@TA(37,39) @Al Cam(38) Now I’ve been going through all my Bernstein books looking for what he says about probability strategies and withdrawal rates!
– The copyright date on the article Al Cam links to is 2001 and here he is only discussing probability-based strategies and talking about 3% or 4% WR.
– The following year (2002) he published The Four Pillars of Investing. There is not much discussion of decumulation but he talks of sensible WRs of 2% to 5%.
– In The Investor’s Manifesto (2010) he advocates inflation-adjusted annuities and Social Security deferral, but regarding withdrawal from a portfolio says: “My rule of thumb is that if you spend 2 percent of your nest egg per year, adjusted upward for the cost of living, you are as secure as possible; at 3 percent, you are probably safe; at 4 percent, you are taking real risks; and at 5 percent, you had better like cat food and vacations very close to home.”
– By the time of The Ages of the Investor (2012) he has moved on to Floor and Upside with his exposition of the Liability Matching Portfolio (LMP) and Risk Portfolio (RP). There is much discussion of TIPS ladders for the LMP.
In a discussion of WRs he qualifies his 2010 figures as being appropriate up to age 65, with an additional 0.5 % for each five years above 65.
– Finally in Rational Expectations (2014) he is still expounding LMPs and RPs, but seems to have settled on 3% as an appropriate WR from a balanced portfolio for a 60-year old retiree.
@DavidV:
Part III dates from Fall 2001 and Part I dates back to Sept 1998, see e.g. :
http://www.efficientfrontier.com/ef/
Re: Floor & Upside – are you familiar with Zwecher’s 2010 book I mention at #38?
Also, there is some credible (and from memory rather technical) criticism of the use of a LDM (to implement LDI) by individuals (rather than statistically significant groups of people like, say, members of a pension fund). A good example is called “LDI Misapplied – Income Portfolios and Liability-Driven Investing” by David Blanchett, et al. However, I am struggling to find a link to it.
Great to see Bernstein’s thinking evolve over time. Thanks David V.
Given Bernsten starts from the premise that US Government debt is riskless, it’s hard to argue against his viewpoint. Pfau also advocates for a floor and upside portfolio (a “safety first” strategy) with a reverse mortgage twist to defend against selling equities in a bad sequence of returns scenario.
I’d hesitate to call British Government debt riskless but I’d still prefer to use a safety first strategy if I could afford it – which I can’t.
One way to achieve it in my position is to keep some money trickling in by picking and choosing small paid projects. Essentially wringing a few more drops from my shortening human capital. TI has long advocated this approach and I’ve come to realise it’s got much to recommend it.
@TA (#42):
In due course, your state pension(s) will provide you with a floor. This may (or may not) cover all of your needs then, but it certainly is flooring – which, incidentally, can be purchased at extremely good rates by the self-employed. Thus, you do really have a functioning safety-first approach.
Keeping the “pennies rolling in”, as you point out, is a sound approach in the interim.
@Al Cam(41) I am familiar with Zwecher’s ‘Retirement Portfolios’ book by reputation and reference from numerous other publications, but have never read it or even seen a copy.
I searched for the Blanchett paper you referenced but, like you, could not find it. I understood the gist of its contents from a discussion on Bogleheads that my search threw up.
Finally, I’m sorry but the translation of LDM eluded me.
@DavidV
My bad – LDM is a typo by me; I should have said LMP as in [your #40] Liability Matching Portfolio. Sorry.
I bought the Zwecher book years ago – and do not recall it being terribly expensive at the time. It is not cheap now though – perhaps you could borrow it from a public library (if any still exist).
I have no idea why the Blanchett paper has disappeared, although I do know he has moved employer. Perhaps somebody has a clean copy they could make available?
Having said that, IMO the chatter at:
https://www.bogleheads.org/forum/viewtopic.php?t=232016
– which is what I assume you are referring to – is pretty complete.
Here is a small optimisation to reduce costs of funds by way of an example. I hold VFEM in my pension and ISA which pays dividends in USD. I use interactive investor for this. In the pension the cash appeared as USD and the platform wanted to charge 1.5% for the FX. So I invested it in VDEM which is the same fund, but you can buy it in USD. But any withdrawals from the pension need to be made in GBP so there seems to be no way around the 1.5% FX charge – short of transferring the whole thing to another platform that does not charge for FX. I had another fund for the EM and small segment of the market and they discontinued the whole thing in GBP so I ended up with a lot more USD and the same problem. For the ISA they convert the VFEM dividends from USD to GBP and charge the 1.5%FX without even telling you. The reason is that you can only hold GBP in an ISA apparently. So my solution to the USD dividend problem is to buy an accumulating version of the fund – VFEG in this case – that Vanguard does the FX and hopefully does not charge 1.5%. The business of whether a platform charges for FX and indeed what sort of buy / sell spreads they have is yet another factor in platform choice. I guess this is more of an issue e.g. for high yield funds, but still I thought it was worth making people aware of. If I am missing a trick please let me know.
I love that global small caps and emerging markets are staples in this portfolio. Those two asset classes are typically forgotten.
@ Barn Owl – thank you for that insight. I agree this can be a substantial hidden cost for some. I’ve been meaning to write a post about it for ages but haven’t gotten around to it. I think you’ve given me just the push I need.
It would be interesting to know what currency conversion fees Vanguard charge. At least the performance of their fund is benchmarked against an index that includes dividends. It’s fair to assume that index doesn’t include FX fees in its results so it’s not in Vanguard’s interest to gouge its customers with high FX charges.
Vanguard tell me that they don’t charge extra FX fees. Once you get beyond a certain amount their percentage fee is capped. Last time I looked it’s very close on costs between Interactive Investor and Vanguard for large accounts – it depends on how much you trade since Vanguard don’t charge for that and II do. The other issue with platforms is buy sell splits for “zero fee” trading offers.
Can’t wait to see how the portfolio has performed this quarter, given the change in global markets
Really enjoy the S&S updates and your thoughts alongside them.
Quick question if I may, why did you choose the Vanguard gilt fund over say the iShares version? The iShares is slightly cheaper & has performed slightly better (or should that be slightly less poorly). Could it be a difference in respective durations? (I can’t immediately find the duration of the iShares fund to compare). Regards
@ Malcom – Really glad you enjoy the S&S updates, thank you for taking the time to say.
Yes, you’re right the iShares fund has a slightly lower duration which is to its advantage right now.
Last time I did a big bond fund comparison the same factor put the Vanguard fund ahead:
https://monevator.com/best-bond-funds/
I tend not to worry about quite marginal differences in cost and performance advantage between very similar funds. Those temporary advantages are quite often reversed soon enough.
It’s like watching two evenly matched cars in a race. One will pull ahead briefly but then be reeled back in by the other.
So I’m happy with a fund as long as it’s competitive against its rivals and it’s fulfilling the role I need it to in my portfolio.
Hope that makes sense!