Last year felt leaden with dread and anxiety, yet as investors we were walking on sunshine. Our Slow & Steady passive portfolio [1] rocketed up 16.3% in 2019. That’s its second-best year ever!
Perhaps the global markets don’t know that we’re sleepwalking towards disaster, or maybe things aren’t as bad as they seem?
- Our Developed World equities performed best – up 24% this year, with the US to the fore but other regions buoyant, too.
- Global Small Cap grew 22%.
- Even the dear old FTSE All-Share soared 20%, enjoying a late bounce [2] from the election result.
- Emerging Markets and Global Property both scored above 17%.
Our defensive bond holdings hardly embarrassed us, either:
- UK Government bonds (conventional) rose 7%
- Global inflation-linked bonds (index-linked) managed over 4%.
Nine years in and the portfolio has grown at 9.4% annualised per year. Call it 7% after inflation.
Here are the numbers in SuperDuper Spreadsheet-o-vision:
[3]
The Slow and Steady portfolio is Monevator’s model passive investing [4] portfolio. It was set up at the start of 2011 with £3,000. An extra £976 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story [5] and catch up on all the previous passive portfolio posts [6].
If you’re 100% in global equity trackers then your portfolio probably returned north of 20% this year. That’s worth celebrating. Equities have had a stunning decade [7]. You may well have notched up a return of more than 25% in 2016, and another 10% in 2017.
Understand that this isn’t normal. A stretch like this isn’t unprecedented, but it is extraordinary.
The bull run may well have changed your life. You may now have pushed so close, or so far beyond, your original objective that your eyes are on stalks and your ambitions on stilts.
The danger lies in pushing your luck. Forgetting you can lose after an amazing run. Reaching for more, when you already have Enough [8].
If your portfolio has grown far larger than it was say five years ago, then cool your jets and chill your spine with a few thought experiments.
How badly would a 30% loss hit you?
When we started this portfolio, a 30% loss would have cost us £900. We’d have replaced that with four months worth of cash contributions.
Now we’d lose over £16,000. That’d take fours years to replace with our current contributions, if the market stayed down – as it easily could.
How about you? Maybe 30% would cost you £50,000, or £100,000, or £500,000. It all depends upon where you are in your journey.
How long would it take you to make up for a 30% correction, if the market afterwards stayed flat?
The probability of loss is much the same in any given year. Our portfolio will be invested for 20 years. We roll the dice every year –and sooner or later it will come up snake eyes.
If an unlucky roll of the dice would now hurt you badly, then maybe you should think about easing off the accelerator if your equity asset allocation [9] is highly aggressive.
I’m not predicting bloodshed in 2020. But I do like to think about the downsides before they happen.
You have chosen wisely
We built risk management into our Slow & Steady plan by committing to selling 2% of our equities every year, and using that money to increase our defensive bond allocation by 2% every year.
This year’s rebalance will give us an asset allocation of 62:38 equities vs bonds.
That compares to our original asset allocation of 80:20 back in 2011, when we felt young and invincible.
More precisely, our model portfolio had no skin in the game back then and time was on its side.
As the years slip by, we’re less optimistic about our prospects should the market crush our portfolio for half a decade or so. Hence we dial down the risk every year while remaining pro-growth.
We haven’t really lost out either in comparison to a high-risk 100% equities strategy.
The Slow & Steady’s 9.4% annualised return compares nicely with the 10% annualised you’d have earned from global equities and the 9.5% you’d have earned from the FTSE All-Share over the last nine years.
Portfolio maintenance
Here’s the changes we’re making to our asset allocation as of the end of 2019:
- Emerging Markets -1%
- Global Property: -1%
- Global Inflation-Linked bonds: +2%
I’ve reduced Emerging Markets because we try to keep our equity allocations in line with global market allocations. Star Capital helps us do that with their regular updates on the weights of world stock markets [12].
The current weight of the Emerging Markets on the global stage is 13.4%.
13.4% x 62% (our new equities allocation) = 8.3% portfolio asset allocation.
Strictly speaking I should have trimmed Emerging Markets from 10% to 8% and been done with it. But emerging economies are under-represented by the capital markets and valuations seem decent, so I’ll knock ’em back by 1%.
That means I can cut Global Property by 1%, too. I’m happy to do that because I’ve uncovered evidence [1] that the diversification benefit of REIT equities is marginal. My plan is to reduce the portfolio’s property allocation over time.
Some people disagree with this move [13], some claim it’s active investing, and The Investor pushed back, too – cautioning that the evidence and my personal experience over the last decade could all be wrong. He may well be right and I could just leave things alone.
Some believe that a passive investor [4] must leave things alone. But I disagree. Even a passive investor must make decisions as the situation changes.
Here’s what I think about when constructing a portfolio:
- Is there a good case for including the asset class?
- Do the available investment vehicles adequately capture the benefit of that asset class?
- Are the characteristics of the asset class right for my investment objectives / risk profile?
The reason I included REITs in the first place was because the weight of expert opinion in favour of them as a diversifier at that time was near-unanimous. The evidence is mixed now, and that’s causing me to reconsider the size of my allocation.
Why not ditch global property entirely if I’m so convinced? Well, I’m not convinced. Evidence has emerged which suggests a new course, but I’m gonna take it slow. As is my way. In matters of finance (if not the heart) I proceed with caution.
The purchases are more straightforward. We’re underweight inflation-linked bonds so the 2% goes there. There isn’t a default fixed-income asset allocation that passive investors can live and die by. I’ve seen arguments for:
- 50% inflation-linked bonds.
- 100% inflation-linked bonds.
- 100% total bond market.
- Manage in line with your duration.
And that’s not an exhaustive list.
My conundrum is that with 11 years to go for the model portfolio, the main purpose of holding high-quality government bonds is because they’re my best buffer in a recession.
Conventional bonds have historically done a better job [14] in that situation than inflation-linked bonds.
In contrast, index-linked bonds are our best protection against rampant inflation [15].
I currently fear a recession far more than runaway inflation. I concede that I am making an active decision here. I haven’t got a strong rule that determines my fixed income allocation and that’s giving me license to ‘read the game’ rather than play the percentages.
Apologies for thinking out loud. I hadn’t recognised this until the thought came tumbling out of my typing fingers. It’s too late now so let’s chalk this one up to The Accumulator stumbling over a flaw in his plan. I’ll resolve to come up with a stronger rule to manage the Slow & Steady fixed income allocation over the course of the year. I’ll set out my thinking in a future Slow & Steady post, make the changes necessary, and stick to it.
Okay, to finish off the maintenance section: our annual rebalance means selling a little from all of our surging equity positions to top up our allocation to bonds. In particular, we need to transfer a wedge of our Developed World wealth into weakening UK Government bonds, just to maintain our existing allocations.
Repeat after me: “Sell high, buy low.”
One final cheery note: our average portfolio Ongoing Charge Figure (OCF) has dropped to 0.15% (from 0.17%) due to cost-cutting from Vanguard and Royal London. The portfolio’s OCF has been stuck at 0.17% for over four years, so, like the Swiss flag, this is a big plus.
For perspective, that saves us £2 per £10,000 in our portfolio, or around £10 a year at the mo’. We smash costs for kicks [16], but there comes a point where it’s not worth the trouble obsessing over what fund is topping the best-buy charts [17].
Increasing our quarterly savings
Now to face the dreaded inflation [18] beast. We must increase our investment contributions in line with inflation to stop the money monster munching away our wealth like sugar puffs.
We use the Office for National Statistics’ RPI inflation report to tell us how much less money is worth this year. Turns out RPI inflation is 2.2%. In 2011 we invested £750 every quarter; that’s £976 in 2020 money.
You could use CPIH as your inflation measure, but RPI is usually worse. Therefore I use RPI because that’s the fun kind of guy that I am.
All that best-practice jazz means we’ll invest £976 this quarter and throughout 2020. These are our trades, taking into account our annual rebalancing move [19]:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF [20] 0.06%
Fund identifier: GB00B3X7QG63
Rebalancing sale: £22.74
Sell 0.103 units @ £221.42
Target allocation: 5%
Developed world ex-UK equities
Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.14%
Fund identifier: GB00B59G4Q73
Rebalancing sale: £862.99
Sell 2.179 units @ £396.06
Target allocation: 37%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.29%
Fund identifier: IE00B3X1NT05
Rebalancing sale: £96.92
Sell 0.309 units @ £313.89
Target allocation: 6%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.18%
Fund identifier: GB00B84DY642
Rebalancing sale: £466.39
Sell 267.116 units @ £1.75
Target allocation: 9%
Global property
iShares Global Property Securities Equity Index Fund D – OCF 0.17%
Fund identifier: GB00B5BFJG71
Rebalancing sale: £495.87
Sell 212.544 units @ £2.33
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
New purchase: £1,595.88
Buy 9.124 units @ £174.91
Target allocation: 31%
Global inflation-linked bonds [21]
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £1,325.04
Buy 1261.94 units @ £1.05
Target allocation: 7%
New investment = £976
Trading cost = £0
Platform fee = 0.25% per annum.
This model portfolio is notionally held with Cavendish Online. Take a look at our online broker table [22] for other good platform options. Look at flat-fee brokers if your ISA portfolio is worth substantially more than £25,000.
Average portfolio OCF = 0.15%
If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund [23] such as Vanguard’s LifeStrategy series [24].
Take it steady,
The Accumulator