Good reads from around the Web.
Most of us know that investing works best when it’s a long-term project.
But too many people don’t appreciate that a long-term view doesn’t mean you’re guaranteed to do well, especially with an equity-heavy portfolio.
I’ve written before about sequence of returns risk [1], which is the danger that you’ll be unlucky and see your share portfolio plunge just before you’re set to stop contributing and to start living the high life.
What’s so hateful about this risk is that you can spend your life being the smuggest sensible investor on the block – admirably tuning out the market noise and boasting about your puny fees at parties, if you’re lucky enough to go to those sort of parties – and then wham…
…the market crashes. Overnight that annoying cousin who pumped all his money into buy-t0-let gets the All You Can Eat Deal at the retirement cafe, and you’re left hunting for bargains at Aldi.1 [2]
The incomparably consistent Morgan Housel expanded on this risk for the Motley Fool [3] US, with the following striking graph:
[4]US data from Robert Shiller and Morgan Housel (Click to enlarge)
Housel writes:
What amazes me is that these hypothetical investors would be considered some of the smartest around, investing steadily every month no matter what the market was doing, for decades on end.
Doing this is emotionally taxing, and few investors can keep it up over time.
In the real world, investors are more likely to buy after stocks have boomed, and to sell after a crash — which devastates returns.
Yet even with hypothetically perfect behavior, the difference in results between investors born in different generations can be the difference between no retirement and a lavish retirement.
And it’s mostly a factor of luck.
It is indeed striking to see the big differences in outcome, and it demonstrates exactly why different generations talk so variously about a particular asset class.
For instance, most people who invested through the 1980s and 1990s know little of the 1920s or 1930s – the UK market went up roughly sevenfold over the former period, and bonds did well too. Anyone who retired in the mid-to-late 1990s is likely to be an evangelist for long-term investing, but if you retired in 2008 you might have a different view.
Similarly, London property has been a winner for so long that people have forgotten it once fell in value. And people forgot in the 1990s that gold sometimes shines, to the extent that few people cared less when the UK government started flogging it off for a pittance.
Don’t be a loser
The only way to avoid being at the mercy of this rollercoaster ride is diversification across asset classes.
In particular, to avoid a catastrophic outcome you need to temper down any full-on enthusiasm for equities at least a couple of decades before you stop contributing money and start to make withdrawals.
That doesn’t mean abandoning equities or market timing, or anything like that. It means that a 100% equity portfolio should be at most a 50-80% equity portfolio say 20 years before your ‘date’, and you should rebalance from there as required.
I think rough bands are fine, incidentally– it’s better to be approximately right with this stuff then precisely wrong. And as far as I’m concerned the rest of the money can be in cash, given the weird situation at the moment, provided you’re prepared to chase higher rates. But of course classically it should be in bonds [5], and that’s the way to head if and when rates normalise.
Either way, you’re protecting yourself from the risk of a stock market that crashes and takes 15-20 years to get back to where it was.
If that seems fanciful, look at a graph of the FTSE 100 or Japan’s Nikkei 225.
Aim for a good result, not the best result
Sometimes diversification and rebalancing actually increases your returns, as an article from A Wealth of Common Sense [6] this week showed:
[7]
But more often you’ll do slightly worse because you diversified. That’s the price of ensuring that you don’t do really, really badly.
Rebalancing is key, as Common Sense author Ben Carlson concludes:
In almost half of all annual periods you had a loser in the group. Each of these losses created opportunities to rebalance to boost future returns. And even though there were plenty of down years for each fund, the portfolio as a whole was still positive over 70% of the time.
The biggest risks in investing are like icebergs – they’re hidden in the long-term, beneath the chop of short-term movements.
Don’t hit an iceberg!
From the blogs
Making good use of the things that we find…
Passive investing
- The “Larry Portfolio” [Small cap tracker and government bonds!] – Mint [8]
- An inside look at the financial media – Canadian Couch Potato [9]
- Do you really know your risk tolerance? – Canadian Couch Potato [10]
- Confessions of an index investor – Rick Ferri [11]
- Beware squirrely risk assessment – Think Advisers [12]
Active investing
- 6 signs of a good investing process – Clear Eyes Investing [13]
- The US oil sector: An introduction and history – Millenial Invest [14]
- A high-yield portfolio works [Yep!] – Total Return Investor [15]
- Emerging markets have room to run – Ben Carlson @ Yahoo [16]
Both/other stuff
- Tuning your mister or missus for financial freedom – Mr Money Mustache [17]
- Squeeze the cheese, reduce the fees – Under the Money Tree [18]
- Exploring changes to the UK pension system – Retirement Investing Today [19]
- A tribute to Milton Friedman – Calafia Beach Pundit [20]
Product of the week: Most lenders are hiking mortgage rates, but Yorkshire Building Society [21] has just cut its two-year fixed rates to 1.74% (with a 40% deposit) and 1.99% (25%), both with a £975 fee. ThisIsMoney [22] says that compares well to the competition.
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.2 [23]
Passive investing
- Warren Buffett’s love/hate affair with index funds – Motley Fool US [24]
- Fund fees are falling, but there’s a catch – Roth/CBS [25]
- Buy and hold is impossible [Really?] – Marketwatch [26]
Active investing
- When entertainment passes for investment advice – Bloomberg View [27]
- 5 lessons learned eating lunch with Tom Gayner – Motley Fool US [28]
- Why you stink at market timing – Consumer Reports [29]
Other stuff worth reading
- John Bogle: The future of investing [Search result] – Wall Street Journal [30]
- When competition obscures financial goals – New York Times [31]
- Beware of buying a buy-to-let in Detroit – The Guardian [32]
- Taxman returns £4m [Only £4m? I say good work HMRC ] – Telegraph [33]
- Council tax: How does your bill compare? – Telegraph [34]
- How to earn cashback from all sorts of purchases – ThisIsMoney [35]
Book of the week: I think most active investors should read less about share price moves and more about business. If that sounds boring, try the inspiring Creativity, Inc. [36]
Like these links? Subscribe [37] to get them every week!
- Okay, so I already hunt for bargains at the supermarket. But it’s fun because it’s a choice! [↩ [41]]
- Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” [↩ [42]]