Anybody else feeling more hopeful? Or noticing that – despite self-reporting as a rational human being – their portfolio affects their mood like the wind spins a weathervane?
Last quarter’s surge saw our Slow & Steady model portfolio roar back nearly 7% since our last check-in.
We ended up 9% for the year, all told. The reverses of the last two years have almost been undone (ignoring inflation) and suddenly the January blues don’t seem so bad.
Here’s the numbers in HappyDays-o-vision:
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 £1,264 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 in the Monevator vaults.
Check out in particular the 10% quarterly jump in UK government bonds – hitherto the portfolio villain for the past two years.
That other wealth-filching dog of late, global property, has also made amends with a near-13% rise.
Mind over doesn’t matter
The post-2021 downturn has proven once again that investing is a game played almost entirely in the mind.
It’s been a relatively mild slump. (So far, anyway…)
Yet it’s felt like an awful slog.
Perhaps the (retrospectively) easy wins of 2009-2021 skewed expectations?
Or maybe it’s because the spectacular bond fail of 2022-2023 undid the comforting but simplistic notion that government bonds are ‘safe’?
Or perhaps portfolios aren’t so much ego extensions for many of us but rather fortresses. Built to provide a measure of protection against the slings and arrows of an uncertain world.
It’s scary when your defences crumble.
And almost nothing passive investors held for the last two years worked except commodities – an asset class that had been written-off as a disaster area for more than a decade.
Get rid
When something hurts you, the natural response is to push it as far away as possible.
Buying an asset when it’s on sale is much harder than it sounds. Just consider the number of comments we received last year asking “why should I bother with bonds?”
It’s interesting then to read Vanguard’s upbeat take on battered bonds in its market outlook for 2024:
Despite the potential for near-term volatility, we believe this rise in interest rates is the single best economic and financial development in 20 years for long-term investors.
Our bond return expectations have increased substantially. We now expect UK bonds to return a nominal annualised 4.4%–5.4% over the next decade, compared with the 0.8%–1.8% annualised returns we expected before the rate-hiking cycle began…
If reinvested, the income component of bond returns at this level of rates will eventually more than offset the capital losses experienced over the last two years. By the end of the decade, bond portfolio values are expected to be higher than if rates had not increased in the first place.
Vanguard’s soothsayers believe the near-zero interest rate world has passed into history. A combination of rising government debt and aging demographics will force interest rates to settle onto a permanently higher plane.
We’ll see.
Safety in numbers
For anyone still feeling burned by the bond crash, we’ve previously made the case that buying high and selling low is as bad with bonds as it is for equities.
It’s true too that higher-yielding bonds should eventually self-heal the damage that rate rises inflicted on bond portfolios’ capital values.
Meanwhile, filling the confidence-vacuum created by imploding bonds, we’ve seen trading platforms heavily-promoting safety-first money market funds.
Cash has rarely looked more regal and I dare say that many investors now hold it as their main defensive asset class.
But the following long-term chart shows the potential opportunity cost of that approach:
Cash – as represented by the money market ETF with the longest track record I can find (green column) – failed to deliver even half the cumulative return of an intermediate bond tracker over the past 18 years.
American humble pie
The unrelenting dominance of US equities is the other key takeaway for anyone investing with 20/20 hindsight.
Who needs diversification when you can invest in an S&P 500 tracker and rule the world? Our tilts to UK equities, property, emerging markets, and small caps have all cost us dear.
So why look beyond America?
Well, here’s another forecast. This time we’re showing the 10-year real expected returns estimated by renowned fund shop Research Affiliates:
Research Affiliates places emerging markets, UK equities, and global property well ahead of the global market (All Country) when it comes to likely future returns.
And US large cap equities (not shown) are expected to deliver just a 2% annualised return.
Commodities diversification looks worthwhile if the mooted 3.4% average return is near the mark. As does persevering with index-linked bonds (‘UK ILBs’ in the chart).
Cash (in the shape of UK T-Bills, the pink column) is the only asset class forecast to post negative (nominal) returns while the cyan columns shows Research Affiliate’s nominal bond outlook.
Naturally none of this futurology tells us what will happen for sure. Research Affiliates has been predicting that emerging markets will eclipse US large caps for years, for example.
But it’s a useful reminder that banking everything on the S&P 500 is merely recency bias masquerading as an investment strategy.
Annual rebalancing time
Okay, there’s just time for some light annual portfolio maintenance.
We previously committed to an asset allocation shift of 2% per year from conventional gilts to index-linked bonds until we are 50-50 split between them.
That means this quarter:
- The Vanguard UK Government Bond index fund decreases to a 25% target allocation
- The Royal London Short Duration Global Index Linked (GBP hedged) fund increases to a 15% target allocation
Note though that our overall allocation to equities and bonds remains static at 60/40.
We also annually rebalance our positions back to their preset asset allocations at this point in every year.
After 2023, that mostly means selling off a few per cent of our Developed World ex-UK fund, and putting the proceeds into index-linked bonds.
Inflation adjustments
Next we increase our contribution by RPI every year to maintain our purchasing power.
This year’s inflation figure is 5.3%, so we’ll invest £1,264 per quarter in 2024.
That’s an increase from just £750 back in 2011. Inflation adds up.
New transactions
Our stake is split between seven funds according to our predetermined asset allocation. The trades play out as follows:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF 0.06%
Fund identifier: GB00B3X7QG63
New purchase: £114.99
Buy 0.455 units @ £252.71
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: £1572.32
Sell 2.667 units @ £589.50
Target allocation: 37%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.29%
Fund identifier: IE00B3X1NT05
New purchase: £60.22
Buy 0.148 units @ £407.35
Target allocation: 5%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.21%
Fund identifier: GB00B84DY642
New purchase: £510.22
Buy 279.665 units @ £1.82
Target allocation: 8%
Global property
iShares Environment & Low Carbon Tilt Real Estate Index Fund – OCF 0.17%
Fund identifier: GB00B5BFJG71
New purchase: £229.13
Buy 98.94 units @ £2.32
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
Rebalancing sale: £162.77
Sell 1.189 units @ £136.89
Target allocation: 25%
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £2084.55
Buy 1970.271 units @ £1.06
Dividends reinvested: £201.46 (Buy another 190.42 units)
Target allocation: 15%
New investment contribution = £1,264
Trading cost = £0
Take a look at our broker comparison table for your best investment account options. InvestEngine is currently cheapest if you’re happy to invest only in ETFs. Or learn more about choosing the cheapest stocks and shares ISA for your circumstances.
Average portfolio OCF = 0.16%
If this all seems too complicated check out our best multi-asset fund picks. These include all-in-one diversified portfolios, such as the Vanguard LifeStrategy funds.
Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? Our piece on portfolio tracking shows you how.
Finally, learn more about why we think most people are better off choosing passive vs active investing.
Take it steady,
The Accumulator
The best real life demonstration of passive investing strategy on the internet, in the world, ever.
Happy New Year, keep it up 🙂
Thanks for sharing. I followed your posts regularly and put it in practice. For example, regularly invest to Vanguard lifestategy and find cheapest broker platform. It’s good to see the increase of investment this year.
Re: table from Arnott/Research Affiliates: with this and likes of Asness/AQR, Faber/ Cambrian, Dimensional Fund Advisors et al, it’s hard to assess how much (if any) weight to give the great many multi year returns forecasts out there, e.g.:
– Research Affiliates’ Expected Return Model
– Blackrock’s Capital Market Assumptions
– State Street’s Long-Term Asset Class Forecast
– J.P. Morgan’s Long-Term Capital Market Assumptions
– BYN Mellon’s 10-Year Capital Market Assumptions
– Morgan Stanley’s Capital Market Assumptions, and
– AQR’s Capital Market Assumptions for Major Asset Classes.
That these forecasts generally have been wrong for a long while (basically from 2009 onwards) doesn’t necessarily mean that they’ll continue to be.
Indeed, the opposite might be true.
But the heralded ‘great rotation’ from US Large Cap growth to other sectors and assets sure is taking quite a while, if it indeed does now occur.
Regardless, if returns in general are likely to be lower in future then diversification remains a free lunch for the taking, even if only on a volatility dampening basis.
One puzzling thing is Vanguard predicting that “the near-zero interest rate world has passed into history. A combination of rising government debt and aging demographics will force interest rates to settle onto a permanently higher plane”.
How does this actually follow?
Fiscal repression to deal with public sector debt through policy interventions like QE and ZIRP is more likely IMO not less. The alternative is long term deep austerity, which voters likely won’t tolerate. If rates stay high it’ll also kill business investment, which is the engine of productivity growth.
As for deteriorating demographics, an aging population will spend less in decumulation reducing demand led inflation.
Granted fewer workers may mean a supply constraint led price increase cycle, but it’s not obvious (at least to me) that more OAPs relatively speaking will end up causing higher inflation and/or rates rather than lower inflation and lower rates.
And a few years ago the same pundits were saying we were going Japanese with low growth, inflation and rates in the long run.
I have huge respect for Vanguard but suspect that some unconscious recency bias has slipped into their thinking here.
Perhaps the world has changed to a new regime of inflation and rates after COVID, but the same was said (but directionally opposite) after we’d been in several years of the tepid recovery from the GFC.
The “EM has the best prospects” chart is a really interesting area.
As I understand it, what Pres Trump _actually_ did while we were mocking his antics, was to order the relocation of a vast chunk of business from China to India/Indonesia/Mexico. EM Ex. China, e.g. EXCS.L rose 10% last year while EM with China sank 4%. And if Trump gets back in he wants to do more and harder. Perhaps someone with better info/analysis can tell us whether this makes EM/China cheap, or volatile, or what?
Happy New Year.
I have a New Year request – will Monevator kindly review the new UK Treasury Bill offering by Freetrade. The pros and cons of the instrument etc.
@ SLG and Mei – cheers!
@ TLI – “That these forecasts generally have been wrong for a long while (basically from 2009 onwards) doesn’t necessarily mean that they’ll continue to be.”
I think it’s probably more instructive to read old forecasts and note how wrong they’ve been. I don’t remember any of them pencilling in a global pandemic a few years ago.
Now forecasts are an end-of-year content staple I’d guess you can pick one to suit your views.
For me, the value lies as a corrective to recency / hindsight bias. There are reasons to think we won’t continue as we are.
Re: aging population – their belief rests on the notion that the retiring demographic bulge is switching from saving to spending – the declining savings rate reducing demand for government debt. Meanwhile, a shrinking workforce and increasing need for gov spending increases equilibrium level for interest rates, in their view.
Just looking back over their argument:
“By the end of 2025, we expect policy rates to be between 2.25% and 3.75% across major developed markets.”
So low by historical standards but not 0.25% either.
Still, you’ve every right to be sceptical! The world is too complex for any model to capture. To take but one example, are breakthroughs in AI set to unleash a global productivity boom that solves the declining workforce problem? Or will millions be forced into employment? Or none of the above?
@ William – great shout! I’ll look into that.
@Time like infinity
>As for deteriorating demographics, an aging population will spend less in decumulation reducing demand led inflation.
Won’t deteriorating demographics result in a concomitant reduction in supply due to a reduction in the working age population?
@TA (#6), @xeny (#7): excellent points. No one knows the future pathways of rates and inflation – certainly not (and least of all) me!
I suppose in a very simplistic way I think it might be plausible that:
– if the proportion of pensioners to workers continues to rise there will then be ever fewer workers’ incomes to support more retirees;
– retirees may receive less by way of pensions income with which to support themselves;
– governments will be reluctant to pay high rates to borrow; and,
– voters (especially elderly?) may not take kindly to public services and benefits being cut.
In those circumstances, even though fewer workers in isolation would mean less output, overall demand led inflation could be weak, and rates could go low again because of that and/or due to Gov/Central Bank action to suppress them.
As regards the latter, ultimately:
1. The private sector (banks) create money through the use of fractional reservers to lend (the credit cycle).
2. The public sector creates money by:
a). Crediting the accounts of its private sector suppliers (e.g. invoice payment).
b). Paying its own public sector employees (salaries).
c). Paying its long term creditors (e.g, in the UK, the owners of gilts receiving interest and redemptions).
d). Paying the recipients of various social entitlements (like state pensions) amongst the general public.
e). Buying assets from the private sector, like gilts on the secondary market via QE.
Neither form of money creation relies on taxation, issuing debt (gilts) or balancing budgets.
The central bank doesn’t ever check the government has the money before allowing it to spend it. It just credits the accounts of those the government directs it to pay.
In this regard, the state is quite unlike a household or a company, which are reliant on balancing income and expenses.
In reality, taxation and issuing new government debt removes money from circulation (when the tax is paid and the gilts are paid for). It doesn’t actually raise money for the government to spend.
The state creates and is a source of money. It never wants for it.
The problem is always preventing the over or under supply of money from private banks’ fractional reserve lending and/or state spending relative to the overall production of the economy; hence the use of taxes and interest rates to suppress or stimulate demand and prices.
Obviously, we all pretend that government taxes to spend as we’d go slightly mad (and perhaps start to ask some rather probing questions about the nature of money etc) if we acted day to day upon the basis of what actually happens economically.
@TLI, nice summary of why government accounting shouldn’t be treated like household budgetting.
Nevertheless as you say a change in the money supply risks inflation, and as a first approximation if government spending = government tax receipts then the money supply is controlled, even if the mechanism is indirect. However that approximation which corresponds to household budgetting is too simplistic in important ways, first because money creation can also be done by private banks, second because the money supply shouldn’t be static but needs to change to match economic activity, and third because government “debt” (borrowing) is actually something desirable. If you think about it government borrowing means someone else depositing their money (= saving) with the government – things like government bonds, or retail deposits like premium bonds. The pensions and insurance industries, let alone the portfolios of many Monevator readers, would be in some trouble if the government ceased to borrow.
Because predicting long term pathways for rates, inflation and real asset returns is likely to be a fool’s errand (albeit one engaged in by even the brightest minds; e.g. the economist Irving Fisher on 5 Sept 1929 “Stock prices have reached what looks like a permanently high plateau…”); it’s more likely to be productive for investors to think about what will and won’t work investment wise if different rate and inflation regimes eventuate in due course so that they have a better working idea of what’s best to try to do (or avoid doing) in advance; even though they won’t (and can’t) know beforehand which scenario they will end up facing, or when it will occur, if it does.
If in the future we were to end up in a situation, for a couple of contrasting examples:
Scenario 1: of a period of high real long term market rates: then long duration assets with low risk, like ILGs, would perhaps be most attractive (as was the case, fleetingly, with the 4% p.a. real yield to maturity briefly available on 30 year linkers in the 1990s).
Scenario 2: of a(nother) period of low or negative real yields: then leveraged low volatility equities (or dynamically leveraged equities, i.e. leverage only applied when equity volatility goes low and unwound when it rises) could make sense. Also high growth, but not yet profitable, companies could soar as the discount rate on their future earnings would be very low and their costs of capital for financing expansion would be negible.
@ TLI – interesting discussion! Just to stick to the aging demographics piece:
I’d guess successive governments will mitigate the shrinking workforce problem by keeping the immigration taps open – in the absence of a serious political challenge from the far right i.e. the path followed by the Tories since Brexit.
Many pensioners will supplement their declining incomes with part-time work a la Japan.
Both trends seem like a win-win to me and mitigate the impact of austerity.
I agree that the declining public services will lead to a voter backlash – which is why I expect the Tories to lose the next election. I also suspect Labour won’t be able to do much to alleviate the pressure. I think we may well be in for a sequence of single-term governments as disillusioned voters keep punishing incumbents devoid of solutions.
But it doesn’t seem right that governments can just spend their way out of trouble if they can’t maintain confidence in the country’s finances. Trussonomics was swiftly punished by the markets. Argentina is a hyper-inflationary basket case. Perhaps the contrary example is Japan. The reasons I’ve seen given being: export-driven economy, high domestic savings rate i.e. they can pay their own way.
Just a few years ago, the prevailing commentary was how the disinflationary environment was destined to last forever, with plausible-sounding arguments. Even the central banks who have all the best data and (supposedly) expertise were blindsided. They kept singing the “transitory” mantra while inflation was running rampant.
Now the prevailing commentary seems to be that the inflationary environment is destined to last forever. I tend to buy the arguments for inflation staying higher for longer, but maybe that’s just my cultural conditioning. Govt debt/GDP is high across the West, with the exception of Germany, and needs to be dealt with. The right way would be to increase taxes on those who can afford it; cut subsidies and loopholes; manage spending carefully with an emphasis on long-term investments for growth; and tackle rent-seeking, cronyism and corruption. That’s politically difficult. The much easier way is to try and inflate the debt away, so expect political pressure on central banks to tolerate higher inflation than the official 2% target.
Anyway we can’t predict where things will go, so the portfolio needs to hold up in all scenarios. I think inflation is the much bigger risk to long-term purchasing power, and most portfolios are positioned for disinflation with stocks and conventional bonds anyway. The challenge then is to inflation-proof the portfolio. Stocks have a mixed record during high inflation. Thankfully, linkers and TIPS have become investable again and look quite attractive.
@Meany #4: that’s a super point.
The ‘conscious decoupling’ of the US and China is a bilateral process.
From the early 1980s through to 2017 there was a symbiotic relationship of US debt funding cheap Chinese imports (also importing disinflation into the US in the process), the proceeds of the sale of which then created the Chinese surpluses used to buy the same US debt, in a loop of self perpetuation and self reinforcement.
This fusion of needs for a time created ‘Chimerica’, a neologism of the British economic historian Niall Ferguson.
As the economic superpower of China rose up, both Beijing and Washington realised the vulnerability brought to both parties from their mutual dependency.
China could never fully assert itself in the South China sea and Taiwanese straits if it could be embargoed so effectively by the US and its allies, and the US could no longer allow so much of its own need for consumer goods, electronics and debt funding to be met by China.
Xi’s crackdown on too big for their boots entrepreneurs in China’s tech sector has backfired and crippled it. The wider CSI 300 has underperformed its peers, especially the Nasdaq, since the early 2010s.
And even much more richly valued national markets, like India, are attracting surging inflows from foreign investors, just as those investors flee from Chinese equities.
@TA #11: Japan is an interesting, perhaps special, case. It’s hostility to immigration is infamous, but the country is also a source of much innovation and resilience, with improving per capita output even as the working population shrinks and real GDP overall stagnates.
Sadly, the UK is uniquely hobbled, IMO, because we’ve gone and self sabotaged our trading relationships with all of our national neighbours.
Recession or inflation is not much of a choice; but in 2022, 2023 and 2024 it looks to be all we’ve had and all that we will get.
Trussenomics’ magical thinking that unfunded tax cuts for the wealthy must somehow lead to a new era of prosperity and productivity was blown up by the reaction of the very financial markets that she worshipped at the altar of.
An unwelcome collateral effect of the Truss calamity may be to make Labour rather too ‘conservative’ in spending to invest in essential upgrades to the nation’s infrastructure, especially in energy, where the green transition meets the need for more electricity generation generally.
@Sparschwein #12: All very true.
High rates or high inflation is not much of a choice, but I guess a bit of each might be more tolerable for most voters than too much of one or the other.
Peter Spiller of Capital Gearing was noting recently the nice negative correlation historically of TIPS to US stocks, which – with the global indices dominated so heavily now by the S&P 500 and Russell 1000 – may mean that they could have an especially important stabilising role going forward.