What caught my eye this week.
A friend of mine used to nag me to teach him how to invest. Every time I’d (more or less) say just have an emergency fund, mildly overpay your mortgage, and put the rest into an all-in-one passive fund.
But my friend wanted to know how to “really” invest.
In the end I agreed on one condition: they’d have to pay me every week for lessons that would go on for several months. These lessons would start from ground zero. And we wouldn’t even get to what he wanted – stock picking insights – until we’d gone through hours about cash, bonds, inflation, risk and rewards, indices, and so on.
Feeling sure the next message I’d receive would be a request for a suitable one-shot tracker, I put my feet up – only to be hear a ping moments later with a one-word reply.
“Deal.”
Now there’s a lot I could write about my subsequent experience of face-to-face teaching, but we’ll save most of that for another day. Suffice to say I didn’t charge – it was only a bluff – and I even got some Monevator materials from it. My friend generously gave me a gift voucher at the end of it all.
And about halfway through, I started looking forward to these lessons.
It’s true that if you want to understand something, it’s a great idea to try to teach it to someone. (Sometimes called the Feynman Technique, I learned this week from Monevator.) Maybe I also liked the sound of my own voice. I started wondering if I had a knack. Perhaps I could make a new side hustle out of it – should I de-cloak and provide Monevator-themed investing workshops in London?
Don’t worry, you didn’t miss the invite. About three-quarters into this experience something happened that put me right off teaching – and indeed made me wonder (again) if people can really be taught much at all.
Copa, Copa-bananas
I arrived for week 16 or 17 as usual only for my friend to bound up to me with a “hah!”
Long story short, they told me that they’d just received the latest report from their active Latin American fund, and it had returned (something like) 30%.
So there! See, I’d kept saying use passive funds, but here was an active fund they’d selected before they’d even had these lessons, and it was up 30%! So active funds could be amazing! Sure index funds were all very well, but why not find more winners like this?
A thousand sighs.
You see, we’d been through everything that shouldn’t have made this conversation possible.
I’d never said active funds couldn’t deliver good returns. I said they tended in aggregate to lag the market return.
I’d never said you couldn’t be lucky. On the contrary I said luck can happen to anyone, and that it can be very misleading when it does.
I’d stressed the need to think in terms of the whole portfolio, and over the long-term. How was his overall actively-tilted portfolio doing? Not how was one fund up some particular year.
But most of all, I’d noted again and again the need to compare any returns to a benchmark.
It was great to hear his fund was up, I said, but how did it compare to the benchmark?
My friend didn’t know. My friend hadn’t thought to check. My friend thought I was expressing sour grapes.
A thousand and one sighs.
And don’t let me teach your kids.
Benchmark pressing
US writer Sanjib Saha tackled this subject well in a post for Humble Dollar this week:
It baffles me that people often favor stock-picking over index funds – and yet they fail to measure their portfolio’s performance against a proper benchmark.
I’m not talking about those who buy a few individual stocks for entertainment or education. For them, it’s a worthwhile pastime and the stakes are low.
But there are others who ignore the evidence and arguments against active management, and devote serious money to picking stocks and timing the market in hopes they’ll earn market-beating returns. This group includes a number of people I know—folks I otherwise admire for their intelligence, critical thinking and self-awareness.
These acquaintances are do-it-yourself investors who actively manage their investment accounts, and they do so with confidence. I’ve probed a little to find out what lies behind this confidence.
My conclusion: Improper benchmarking is a common cause. In other words, many think their strategy has played out well, but—in reality—their investments have lagged behind an appropriate market benchmark.
If you’re an active investor trying to beat the market, I think you should unitize your portfolio. This will enable you to track and compare your returns exactly as professional funds do.
But will you? Who knows… 😉
Have a great weekend!
From Monevator
Asset allocation strategy rules of thumb – Monevator
What do 6,500 clicks tell us about UK FIRE? – Monevator
From the archive-ator: Seven surprising things you may not know about Warren Buffett – Monevator
News
Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!1
Investors trapped in Woodford’s £3bn fund could lose 43% in wind-up, says leaked estimate – ThisIsMoney
Number of new homes built in England hits a 28-year high – ThisIsMoney
Question mark over Chilango, which recently raised £3.7m in 8%-paying ‘Burrito’ mini-bonds – City AM
Events in Hong Kong reveal the thin veneer of civilisation [Search result] – FT
Acting on the advice of doomsters would have cost you dear [Paywall] – FT Alphaville
Products and services
Vernon Building Society the latest to offer 100% mortgages to [parent-backed] student landlords – ThisIsMoney
Ratesetter will pay you £100 [and me a cash bonus] if you invest £1,000 for a year – Ratesetter
25 years of the National Lottery… – ThisIsMoney
…but buying shares instead of lottery tickets would have returned nearly 2.5x your money – ThisIsMoney
Klarna: Beware the impact on your credit score. [Actually, just beware] – Simple Living in Somerset
Family homes for first-time buyers – Guardian
Comment and opinion
Factor farming and the value of perspective – Portfolio Charts
Bernstein says stop when you win the game – White Coat Investor
Common plots in economic history – Morgan Housel
Vanguard won the loser’s game – Morningstar
How to build a compounding machine – The Escape Artist
Compared to what? – Seth Godin
Meet the young entrepreneurs who used tech skills to make their side hustles a success – Evening Standard
The case against REITs [Nerdy] – Factor Research
Random colon special
Tim Harford: on why we fall for cons [Search result] – FT
Ceteris paribus: on generational housing inequality – Indeedably
Signal failure: on the transience of valuation metrics – Humble Dollar
N=1: on the persistent problems of low sample size – Of Dollars and Data
Naughty corner: Active antics
The price of excellence – Novel Investor
Merryn Somerset-Webb: In search of an investment to last a lifetime [Search result] – FT
Non-intuitive lessons from the man who solved the market [Also video at end] – A Wealth of Common Sense
Value has never been this cheap versus momentum – The Big Picture
Flexible friends: Investment trusts that have got your back – IT Investor
Public investors signal it’s a buyer’s market for money-losing startups – Crunchbase
Politics quarantine box
Tory majority ‘bad outcome for country’ due to Brexit implications, says [former Tory] David Gauke – BBC
Martin Wolf: Irresponsible election promises will hit brutal economic reality [Search result] – FT
Anger after The Sun photoshops out WW2 veteran from Remembrance Sunday service – Tom Pride
General Election 2019: What are the six biggest challenges for the UK economy? – BBC
Kindle book bargains
Radical Candor: How to Get What You Want by Saying What You Mean by Kim Scott – £0.99 on Kindle
The Wealthy Retirement Plan by Vicki Wusche – £0.99 on Kindle
RESET: How to Restart Your Life and Get F.U. Money by David Sawyer – £0.99 on Kindle
The Complete Guide to Property Investment by Rob Dix – £0.99 on Kindle
Off our beat
My night in a millennial hobbit home [Search result] – FT
Iceland’s big Bitcoin heist – Vanity Fair
Venice Council flooded moment after rejecting climate crisis plan – Guardian
Homocide is declining around the world because the world is getting older [Research] – Quartz
When ‘tears of joy’ emojis turn into frowning faces [Search result] – FT
I thought I could never love my large nose – but then I had my portrait painted – Guardian
If not now, when? – The Financial Bodyguard
And finally…
“It is both easy and dangerous to categorize someone who behaves differently from you as ignorant, wrong, or even thick-headed. Today’s world requires a more sophisticated understanding where you value a person for his or her strengths or weaknesses.”
– Thomas Erikson, Surrounded by Idiots
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One guy at work I introduced to investing thought he was impressing me by going into trading, I kept warning him, he wanted get rich quick, he wanted to look clever, he said I had more knowledge than him and could succeed, I keep reminding him there are many people who know a lot more than me who don’t succeed. I don’t write off the idea he can be on the better end of the fools game, if he just sticks rigidly to a slow strategy, but I tell him too that if there was a trading strategy that works then surely thered be a company doing it you’d be buying when you buy the index.
I also point out that with a bell distribution curve you will see some winners, but it doesnt make it good on average. We think in probabilities and percentages, and logic, they think in ambitions
I actually think the human element is a negative thing, I dont like relying on people, I’m actually uncomfortable with it, like trusting a human driver over a self driving car.
Also passive funds dont have to keep the same cash, and passive ones generally won’t be suspended
Ooof.. “Ceteris paribus: on generational housing inequality” doesn’t pull punches. Homeowners eventually complete their mortgages and have lifestyle options in retirement that renters can only dream of. Shades of the housing-driven societal division chat from last week.
> latest report from their active Latin American fund, and it had returned (something like) 30%.
https://www.goodreads.com/book/show/35653253-the-facts-of-life
Story in which the young man is told how to behave and when he does the opposite without suffering ill effects he’s obviously never going to listen to advice again.
Interesting chart on average tax rates to total labour costs including employer’s NI (13.8% on earnings above £162 a week I think). Here’s the report for the keen reader:
https://www.ifs.org.uk/uploads/R160-How-do-other-countries-raise-more-in-tax-than-the-UK-1.pdf
B
In a recent episode of Tom Clancy’s Jack Ryan the titular character Ryan (a former U.S. Marine and stockbroker turned CIA agent) was asked by another soldier for stock tips – Ryan replied just invest in an S&P index tracker 🙂
Can someone help me out with the average tax rate on income for U.K. mid earners ? I put it at much less than 28pc as they pay no tax on 8,500, very little between lower threshold for NI and starting rate for Income tax and then only 32pc above that…
I put it under 20pc actually.
Am I missing something?
2 years ago, a guy I work with had never invested before. It was only when I mentioned that I had made X thousands of ££ this year from my investments that ‘clicked’. But I was overly surprised to find out with how much discipline he behaved.
So he kept asking me a lot of questions like what I invest in and why should he trust the stock market after what happened in 2000 and 2008. After countless watercooler breaks, he accepted that the economy is expanding longer than it’s contracting, population growth and inflation, he wanted to pick stocks in things he knows about – in particular, technology large caps.
It took me a great amount of time to explain why a great company does not necessarily mean a great stock price. Usually, people think that nothing can go wrong with a great company regardless of whether it’s trading at 150x earnings.
Eventually, he read the ‘Random walk down the Wall st’ and picked a few index funds (plus some technology only ones because software is eating the world and all that). He hasn’t touched his investments 2 years now and always treats the gains as if they’re not real since they can be wiped out at any moment.
Really interesting to observe compared to my own behaviour which was much more immature at the beginning albeit with a much smaller starting capital. Maybe that plays a role too (?)
@BBlimp
The figures include employers NI, which is 13.8% of earnings above £162 a week.
If you find the chart in the PDF in the comment/link above it shows a breakdown of the 28% into Tax, NI, Employers NI – page 17.
Employers NI seems to be 9-10% of the 28% figure.
B
Thanks Bolt.
It seems extraordinary to me that countries with high unemployment ( Spain / France) would make employing people less attractive in this way… perhaps this goes some way to explaining why UK has higher rates of employment and less productivity ( which and I sound like a Luddite here but surely can’t be a bad thing )
@BBlimp – you can use this to work out the total % in NI and tax experienced by an individual.
https://www.moneysavingexpert.com/tax-calculator/
Thanks Vanguardfan.
I actually use the hmrc app so get a good feel about the taxes that affect the person who effects me the most… me !
I know it was in another article not today’s but just checking out the link you sent and the hmrc app I actually don’t earn 40k after tax/pension contributions at the moment. I’m ever so slightly under.
Which makes me wonder if the which article is correct and I’ll need 40k post tax in retirement ? Without a mortgage payment I’d hazard that is a great deal of money ! 😉 Infact if my mortgage was magically paid off I’d be looking to reduce my hours rather than raise my spending. Maybe a personal choice but I felt the which numbers were a little high ?
@bblimp the £42k in the Which article is for a couple, for a ‘luxurious’ retirement which includes holiday/travel spending of £12500 per year, and £4500 per year towards a new car every 5 years. I think I’d call that ‘luxurious’!
@Boltt
The IFS report comparing tax rates in the UK to other countries is fascinating and should be required reading for all would-be chancellors.
Relates to the discussion last week about how progressive the UK direct taxation system is, with low earners paying lower income and social security (NI) taxes than almost anywhere else in Europe, while high earners are already being squeezed by tax rates as punitive as elsewhere. If we want Scandinavian levels of public spending (as promised by both Tories and Labour) it would appear likely that low and middle income people will need to pay more – but of course Javid and McDonnell won’t be saying that!
Ha! That explains it ! Thanks
But are all active investors trying to beat the market ? I’m certainly not, rather just trying to steadily increase the portfolio value but avoiding huge drops during the bad times, and to achieve this I’m prepared to sacrifice a lot of the market gains to be had during the good times.
@FB – you could simply have a more bondy passive allocation, it could be said that in seeking less risk upon more equity, you’re hoping for better risk adjusted returns than the benchmark
Expecting an active manager to sell at the start of a crash risks crystalising the loss, and missing the upside, I’d say that because active managers are *expected* to act in a crash they are more risky, than simply riding it out in a passive. The one time you need a cool head the most they’re losing theirs.
And also active funds are more likely to be suspended, and like woodford when they are liquidated they have to sell off the liquid stuff first and get a terrible exploitative price for selling the illiquid
I like this:
The underlying reality is that Value outperforms Growth and Momentum because it is so painful to bear for long periods of time; that is literally the source of the Value premium. If it were comfortable and easy, then everyone could do it! Instead, it is difficult to tolerate, discomfortable as FAANG FOMO rears its head. That discomfort is why Value eventually beats Growth (key word: eventually)
from The Big Picture
Value is more “sinful”, the more ESG takes hold
“I don’t care what they do, look at that yield!”
Or “look at what great value Electric chairs inc are, I wonder why nobody buys the stock”
Interesting to see Dr Bernstein’s comments in White Coat Investor, following the ‘Asset allocation strategy – what we can learn from rules of thumb’ article and discussion last week regarding de-risking portfolios in de-accumulation if you’ve reached your target number.
— “The IFS report comparing tax rates in the UK to other countries is fascinating and should be required reading for all would-be chancellors. ” —
It isn’t as simple as that, is it? Income tax/NI is just one type of tax. Then you have Council Tax, VAT, Huge taxes (duty) on Petrol, Booze, Fags etc. Different countries have different systems and here in Italy for example, the rate of income tax for a low earner is quite ridiculous, which together with the complex bureaucracy, makes it overly expensive for a small company to take on new staff. However, I have the impression that those on low wages have quite a better quality of life than in the UK. Council tax is almost non-existent, though we pay about 250 euros per year for rubbish collections. Water is very cheap, public transport very affordable, basic food cheap, booze incredibly cheap compared to the UK. Houses are MUCH bigger than the rabbit hutch I used to live in, (UK houses smallest in Europe, I believe) rents much cheaper and plenty of houses for sale, though the buying/selling process can produce quite a few grey hairs. 🙂 The italian NHS is faster and, in my experience, far superior. Oh and more sunshine. 🙂
The Feynman Technique (always helps to name something after a great person) is a fascinating other side of the coin the the “illusion of explanatory depth”.
In general we have good confidence that we understand how something works if we are in social contact with other people who know how something works. I don’t really know how an EFT exchanges newly issued shares and buys just the right amount of underlying assets when I place a buy order that doesn’t match a market sell order. I have a vague idea, but I’m happy that Monevator knows, or perhaps Monevator knows someone who knows. I don’t really know how a toilet flush syphon works. But I know the number of a plumber.
This was recently covered by Freakonomics as a great way to change someone’s mind — being to ask them to explain how their deeply entrenched view actually works, and then (as the lack of deep working knowledge is reveal) allow them to understand that their view might not be as deeply held and so is available to influence and ultimately change.
Perhaps, TI, if you had taken the other side of this Socratic bargain and asked your friend the hard questions, he would have found the path to enlightenment instead of you… The very best coaches that I have worked with have not sought to give me their knowledge to use but rather to explore my values through questioning and then extend that helping me to see where my words or actions have been in conflict with those values and thereby driven change or improvement in performance.
@FB. You make a fair point. What is this mythical “market” that people are trying to beat and why? You have to make like-with-like comparisons. It makes no sense to compare, say, the returns on the SPX, with a return volatility of 15%, with an active fund doing some completely different, with a return volatility of 5%. It would be a meaningless comparison. To say anything useful, you’d need to compare them on a risk-adjusted basis taking into account return correlations.
Where TI is correct, however, is where you have an active fund that is explicitly trying to outperform an index, say the SPX. There you should be looking at ratio of the excess return to tracking error (the information ratio) to see if it’s adding any value. Even with passive funds, benchmarking is important. What is the point of saving 10bp on fees, if the new fund has a tracking differential 20bp worse?
One issue is defining the correct index. For major equity markets this isn’t an issue. Beyond that, however, there may be no dominant index. I’ve noticed, for example, a tendency for retail corporate and EM bond ETFs to sometimes use cheaper, narrower, “liquid” indices that systematically underperform the broader, institutional indices. This allows the ETF to replicate the broader index but state returns vs. the narrower index, reducing the tracking differential while sneaking in extra fees or costs. Not all indices are created equal and for less than ideal reasons.
Personally, I more in your camp. I don’t care if my portfolio underperforms an arbitrary index like the SPX; that’s just not the risk I’m trying to hedge. I use an absolute return benchmark: inflation+4% on a post-tax basis, with a return volatility of around 5%. This should keep me ahead of the risk I do care about: my liability curve. It also ensures that peak-to-trough drawdowns are tolerable, with a 5% down only around once per decade. Nonetheless, I still measure the performance of individual funds and investments against their stated indices (if they have them). It’s a way of keeping score and staying honest with yourself.
@ZXS48K (22)
What do you mean by ‘liability ‘curve’?
Is this the PV of future liabilities?
For those without access to FT … Tim Hartford’s article on his own site
http://timharford.com/2019/09/we-are-all-potential-victims-of-the-con-artist/
@Borderer. Yes. I tend to think in terms of hedging liabilities. So I have a series of cashflow liability streams to hedge (family’s standard of living, school/uni fees, possible care home costs for parents etc), all of which evolve at different spreads above inflation. This generates a target return. The volatility on those possible liabilities (in particular in the next 15 years when they could peak at anything from 1.3-2.5x current spending levels), compared to volatility of asset returns generates a large sequence of return risk. This puts a major constraint on portfolio volatility, since I don’t want to be exposed to a large drawdown. Hence why I’m also still working – that’s the best hedge of all.
Minimising volatility certainly makes sense with short time horizon, but if longer I consider growing quickly to way above what you need to be another way of achieving safety for what you do need, so that volatility doesn’t threaten your goals so much, and the risk of running out is less
@ZXS48K Thanks. Nicely explained.
@Matthew (26) Yes, but only if you’re in the accumulation phase. If, like me, you’re de-accumulating, you need to ‘hold fast to what you have’, without taking on any more risk or volatility over and above what is absolutely essential. The rather counter intuitive theory of a rising equity glidepath during de-accumulation is something I’m still trying to get my head around, but a severe bear market would probably see me going into cash then pound cost averaging into equities.
If, of course, I have the nerve!
@borderer – I suppose as time goes by in deacumulation, when bad stuff doesnt happen your margin of safety gradually increases as there’s less remaining time to budget for, but also I suppose less time to make back losses (if inheritance matters) but also less need for growth
So both fear and ambition should fall away; passive bonds perhaps? 🙂
@TI thanks for the Chilango heads up. I’m one of their bond-holders. Only a small amount invested but if it all goes south, it’d be my very first, shall we say, “investment lesson” to be learned.
What’s the opportunity cost though?
The whole work thing is a nightmare. If you’ve got something you’re absolutely desperate to do instead then all well and good, but if (like most I suspect) you just have a general malaise about work but no burning desire to do something else then quitting doesn’t seem to have the intended consequence of improving matters – you just end up getting bored and going back to work. Its as much a crisis of imagination as it is a matter of money. I need a big old injection of imagination before I run out entirely. If only you could buy imagination.
@The Rhino –
A high stress job with general malaise is not fun at all though.
So in that situation, could at least change to something less mentally taxing to reduce stress once reaching FI. And with the mind free to wander, one may have the energy to create that injection of imagination.