The Slow & Steady passive portfolio [1] leapt up by 25% in the last year. So if you’re a passive investor who stuck to your mechanical [2] guns then you’re probably feeling a lot better off now than back in January 2016 [3].
At that point our psyches were screeching like fingernails down a blackboard as the major world equity markets slid into bear market territory1 [4]. The bounce back since then has made our portfolio more money in one year than we managed in the previous five.
Here’s a walk through the sunny side:
- We’re up 46% since starting six years ago.
- That’s 11.4% annualised, or around a 9% real return – far higher than the historical average of 5% we might expect from a 100% equity portfolio. Happy times.
- By way of comparison, our portfolio’s real return was about 4% annualised when we took a snapshot this time last year.
Here’s the portfolio latest in TruColor spreadsheet-o-vision:
[5]
Our 2016 barnstormers were our riskiest asset classes:
- Emerging Markets up 36% (after plunging similarly over the previous two years)
- Global Small Cap up 34%
Meanwhile our ‘worst’ performers in 2016 were…
- FTSE All-Share up 16%
- UK Gilts up 11%
…although as you can see, even our rearguard has been tremendous. Despite the fear and loathing rippling across the political spectrum, every asset class surfed the wave higher.
Our biggest holding – the Developed World excluding the UK – put on 29%.
Sure, that’s a performance buoyed by the pound tumbling against other major currencies, so our gain has been bought at the price of national impoverishment. But at least it means your financial votes count even if you feel your actual one didn’t.
Hedging against massive national gambles is a side-benefit [6] of global portfolio ownership that I didn’t fully appreciate when I began investing.
The Slow and Steady portfolio is Monevator’s model passive investing [7] portfolio. It was set up at the start of 2011 with £3,000 and an extra £900 is invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story [8] and catch up on all the previous passive portfolio posts [9].
It’s interesting to reflect on how difficult it was to feel enthusiastic about any asset in 2016, with so much negative press sluicing through our news feeds, yet:
- The ‘overvalued’ US stock market rose 34%.
- ‘Moribund’ Europe was up 19%.
- Japan was up 23% even as Abe’s arrows [10] broke off in his hand.
I’m running through all this not to sound triumphalist, but to emphasise how disconnected results can be from the flow of media bilge lapping against our brains.
Forget trying to predict what’s going to happen next. Stick instead to a sound asset allocation strategy that will see you through thick and thin [11].
We kept buying on the cheap through the 2015–16 mini-bear and made out like bandits as the market recovered and soared.
It’s become very noticeable that we’re picking up fewer and fewer units for every purchase as the market tear continues. That’s why future downturns are not to be feared by accumulators. The more shares you can pick up when the market is lower, the better your gains when the recovery comes.
Portfolio maintenance
Okay, it’s time for the portfolio’s annual service. The underlying asset allocation is built on sound principles [12] – except I’ve come to question the role of index-linked gilts (also known as linkers).
Our inflation-resistant bonds haven’t done the portfolio any harm so far. In fact they have made 22% since we bought them. But their role in our portfolio is to ward off unexpected inflation, and that’s where the linker story starts to unravel.
We’ve posted the lengthy version [13] of my thinking previously. But in short, UK linker funds are stuffed with long-term bonds that are highly sensitive to real interest rate rises.
That potentially makes our linker fund a source of volatility rather than stability. Moreover, a number of experts believe that UK linkers’ inflation protection could be overwhelmed by their exposure to real interest rates.
Linkers still have diversification value though – and experts can be wrong. Considering all this, I’m going cut the portfolio’s linker exposure down to a 6% holding, or around 20% of our bond allocation.
I did consider adding global index-linked bonds as an alternative. They would add more diversification and less interest rate risk, in exchange for a lower likely correlation with UK inflation.
But I’ve decided against introducing extra complexity at this stage. We’ll rely on equities and property to keep us ahead of inflation over the long-term and look into more short-term conventional bond funds as our model portfolio’s time horizon ticks down.2 [14]
My, how we’ve grown
Another light winking on the portfolio dashboard is that we’ve heading out of percentage-fee broker territory.
Our portfolio is notionally held in an ISA with Charles Stanley who charge an annual 0.25% of assets. That’s around £80 a year on our current value.
A flat-fee broker, in contrast, would levy a fixed cost regardless of our portfolio’s size. They’d also add dealing charges on top.
- The breakeven calculation [15] between the two different broker types is quite straightforward. Our comparison table [16] can help, too.
Right now there’s little in it either way for us. But as our portfolio swells (hopefully!) then the percentage-fee will swell too. By comparison, the flat-fee alternatives will look increasingly cheap and therefore more alluring! We’ll need to consider a switch.
It’s not worth us doing anything too hasty – broker charges can change, as can portfolio values – but I’ll need to address it at some point over the next year.
Or not, if the market crashes.
Buying more bonds
We’re also committed to shifting 2% from equities to government bonds every year. This risk management [17] move gradually curbs our exposure to stock market crashes as our time horizon shortens.
We’re now 68:32 in favour of equities versus bonds, with 14-years left on the clock. The 2% equities cutback comes from our UK fund, as part of our ongoing move away from the home bias [18] we originally built into our allocation.
This change, plus the reduction in our holding of linkers, lifts our conventional government bond allocation by 11% to 26%. We’ll likely be glad of this if the market takes a dive in 2017.
Increasing our quarterly savings
Accursed inflation is next on our list.
If we want to invest a consistent amount every year then we must beware of inflation eroding our cash like water against a rock.
The last RPI inflation report was 2.2%. That means we need to increase our £880 quarterly contribution in 2016 pounds to £900 in 2017.
Rebalancing act
Finally, it’s time to rebalance [19].
Every year we rebalance the portfolio back to its target asset allocations. Again this is primarily about risk management as we automatically make slight course corrections away from assets that have soared in value recently in favour of those that are now on sale.
The upshot of this rebalancing back to our (predetermined) asset allocations is we’ll be putting a lot of money into bonds – less risky assets – and a tiny smidge into global property, which fell back a little last quarter.
We sell down a portion of our other five funds and throw in our new quarterly cash contribution to fund the rebalance.
Remember, we’re not making a judgement call here. We’re just staying in line with the asset allocation we have set.
Incoming!
Q4 was income jackpot time for our funds. They paid out £387.89 in dividends and interest, which is automatically reinvested thanks to our accumulation [20] funds.
Here’s our income scores:
- UK equities: £78.52
- Developed world equities: £209.99
- Global small cap equities: £7.06
- Emerging markets equities: £51.76
- Global property: £24.61
- UK Government bond index: £15.96
Total dividends: £387.89.
As I say, this isn’t new money we have to invest. It is automatically been rolled up by the accumulation funds.
I just think it’s motivating to see this hidden income [20] being accrued by our funds.
New transactions
Every quarter in 2017 we will slot another £900 into the market’s fruit machine. Our cash is divided between our seven funds according to our (freshly tweaked) asset allocation:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF [21] 0.08%
Fund identifier: GB00B3X7QG63
Rebalancing sale: £414.23
Sell 2.296 units @ £180.43
Target allocation: 6%
Developed world ex-UK equities
Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%
Fund identifier: GB00B59G4Q73
Rebalancing sale: £24.11
Sell 0.082 units @ £292.27
Target allocation: 38%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.38%
Fund identifier: IE00B3X1NT05
Rebalancing sale: £83.70
Sell 0.332 units @ £252.02
Target allocation: 7%
Emerging market equities
BlackRock Emerging Markets Equity Tracker Fund D – OCF 0.25%
Fund identifier: GB00B84DY642
Rebalancing sale: £175.80
Sell 130.415 units @ £1.35
Target allocation: 10%
Global property
BlackRock Global Property Securities Equity Tracker Fund D – OCF 0.22%
Fund identifier: GB00B5BFJG71
New purchase: £114.04
Buy 58.781 units @ £1.94
Target allocation: 7%
UK gilts
Vanguard UK Government Bond Index – OCF 0.15%
Fund identifier: IE00B1S75374
New purchase: £4,249.85
Buy 26.588 units @ £159.84
Target allocation: 26%
UK index-linked gilts
Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%
Fund identifier: GB00B45Q9038
Rebalancing sale: £2,766.04
Sell 14.956 units @ £184.95
Target allocation: 6%
Total dividends = £387.89
New investment = £900
Trading cost = £0
Platform fee = 0.25% per annum.
This model portfolio is notionally held with Charles Stanley Direct [22]. You can use that company’s monthly investment option to invest from £50 per fund. Just cancel the option after you’ve traded if you don’t want to make the same investment next month.
Take a look at our online broker table [23] for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000.
Average portfolio OCF = 0.17%
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 [24].
Take it steady,
The Accumulator