Good reads from around the Web.

I don’t easily back down in what I’ll pompously call ‘intellectual debates’ (which I have all the time with everyone, to everyone’s annoyance).

But I will change my mind, if persuaded.

For example I was far more left-wing at University – having been “to the right of Genghis Khan” as a schoolboy, as my dad once quipped.

Today I’m pretty centrist (though libertarian if not an outright anarchist on personal freedoms and so on).

Traveling from Left to Right with age is not an unusual journey, but I do think it demonstrates the flexibility to change my mind.

Being wrong the right way

This is relevant to our discussions here, because if I was to pick one thing that’s most changed my active investing after more than a decade at the coal face, it’s probably that I’ve cultivated an ability to more quickly decide I’m wrong.

And then to sell, sell, sell.

This is not as easy as it sounds.

As the on-point Morgan Housel recently noted in a Motley Fool article:

One of the hardest parts of investing is finding the balance between:

• Riding out periods temporarily unfavorable to your views.

• Realizing your views are wrong and moving on.

It’s the difference between patience and stubbornness, and can separate the ruined from the rich.

Sell your lagging value shares too readily, and you’ll cultivate a Buy High, Sell Low strategy that’s bound to end in tears.

Or on the growth investing angle, be to quick to dump winners because you now see they’re possibly overvalued, and you’ll probably never enjoy big gains from the handful of hot shares that generate most returns in bull markets.

Obvious corollary alert: This challenge is exactly why most people will be best off not trying to pick stocks or to time markets, and to invest passively instead.

(Maybe me too! Time will tell.)

One career ruining call

For instance, Barry Ritholz reminded us this week at Bloomberg about the fall of the once-famed market timer Joseph Granville.

Granville moved markets. He made millions of dollars a year from his newsletter business, and when he urged his subscribers to sell everything on 7 January 1981 he apparently sent the US Dow index down 2.4%, on then-record volume.

What power!

Sadly, though, he was wrong. In fact America was just on the cusp of its greatest ever bull market.

Worse was his inflexibility. Ritholz notes that:

Granville, who died in 2013, never managed to admit his error or reverse himself; he ended up being consigned to the dustbin of history, his track record in tatters.

Mark Hulbert, who tracks the performance of investment newsletters, noted in 2005 that Granville’s letter was at the bottom of the “rankings for performance over the past 25 years – having produced average losses of more than 20% per year on an annualized basis.”

To be an active investor, you need to take a different view from the market. It demands a certain arrogance to take a contrary view to the world’s best guess.

But to believe the world is wrong and you are right for three decades! That’s hubris on a par with the great Greek myths.

Certainly, admitting you are wrong can get harder with time. But it’s doable.

It took me about a decade to finally concede I was wrong not to buy a London flat in 2004, for instance. (And who knows, perhaps in 2025 I’ll see I am wrong not to buy one now…)

Staying humble and reminding yourself daily of your limits is I think essential – whether you’re an active investor, or a sensible passive investor whose strategy is built from day one on understanding the difficulties of all this decision making.

Foxy forecasting

We might ask why we find it so hard to intelligently prevaricate?

I suspect it’s to do with incentives.

In investing – and in much of the rest of life – people prefer you to be bold and wrong than to be undecided.

As a result, you’ll hear an active fund manager say “I don’t know” about as often as you’ll hear them say: “Yes, let’s see what we can do about the fees on that.”

As John Kay wrote this week:

In Expert Political Judgment, Philip Tetlock demonstrated to little surprise that forecasters were not very good.

More surprising was his identification of the characteristics of good and bad forecasters.

Tetlock employs a distinction, credited to the Greek poet, Archilochus, but popularised by the philosopher, Isaiah Berlin, between hedgehogs and foxes.

Hedgehogs know one big thing; they have an all-encompassing world view and discover facts that confirm what they already know to be true. Foxes know many little things; they are eclectic in their sources of information and nuanced in their judgments.

Hedgehogs command more public attention but foxes make better forecasters.

Harry Truman, the former US president, (perhaps apocryphally) sought a one-handed economist who would not say “on the one hand” and “on the other”.

The two-handed approach corresponds to the reality of most complex issues. Yet modern business people, politicians and media seek the Truman type and find it in hedgehogs.

To grab attention and build a reputation, it is more important to be unequivocal than to be right.

[continue reading…]

This is a bit of a meandering and personal rant. Feel free to skip it!

A new year, a wobbly stock market, and naturally a young not-so-young investor’s thoughts turn towards topping up his SIPP.

And as I pondered how big a lump sum to shock and awe the boys down at Hargreaves Lansdown with, two factors came to mind:

• From April, dividends will be taxed more heavily.

• Pensions are going to be revised again in the March Budget, too, and it’s unlikely that Monevator readers’ many sensible suggestions will be in the driving seat.

I’ve been self-employed for most of my working life, but I’ve only been set up as a Limited Company for about a third of it.

And to be honest, my earnings have only really been big enough to make much difference how I paid myself for the last four or five years.

(Before then I was mostly on borderline artist-in-a-garret rates, at least compared to my conventional London friends).

Now if I do nothing from April, the new dividend tax rates mean my tax bill will be around £2,000 higher than it would have been under the old system – thanks to a 6% rise in my effective tax rate.

We debated whether this was fair when the change came in, so let’s put that to one side.

What interests me now is how I find myself responding.

Fund-a-mentally

I’ll say right away that I’m not a very money motivated person.

That might strike you as an insane comment to make, given that I run a personal finance website and spend half my days clucking over my ever-growing nest egg.

But it’s sort of true.

I’ve never followed any line of work for the pay check, really (as my employers from my 20s would no doubt gleefully confirm).

And I don’t spend much money, either.

In fact I probably look like a bit of disaster to some of my peers.

What matters to me is freedom to do what I like – or more accurately to avoid doing what I don’t like.

That’s why I am self-employed, and why I far prefer to work from home.

It’s also my motivation for investing: I find everything about conventional work suffocating.

I don’t want a freedom fund or even a f***-you fund.

It’s more like a survival fund for me.

You’re having a half!

Given my ambivalence towards slaving away for mere money, taxation is a vexing issue.

Without wanting to get political (my post-Thatcher reflections were a better place for that, or even – contrarily – my lament about income inequality) I’m happy paying roughly 20% or so in income taxes.

And I guess I can live with 25-30%.

Any more tax than that and I strongly suspect I’m just supporting other people’s lifestyle choices, rather than the essentials of State and a worthwhile safety net.

Unfortunately, add together corporation tax and the new dividend tax and I will be paying an effective 46% tax rate ¹ on any income over £43,000 or so – and in reality I’ll be paying it well before then, given my portfolio still has unsheltered savings, bonds, and equities outside of my ISAs and SIPP, where any cash returned will register as income.

Now £43,000 might strike some of you as a lot of income, depending on how and where you live.

But trust me it’s very mediocre among my peers in London.

Yet striving to boost my income – only to hand over almost half of the extra to the Government?

I find the thought pretty demotivating.

Confused future pensioner

One obvious solution is to direct all the would-be higher-rated income into my SIPP instead.

As I say, I’m not in the mega-earner category or anything like it. So this could effectively shelter (or at least postpone) a good swathe of my income from the new dividend tax meat cleaver.

But sadly, that’s where those upcoming pension changes start to worry me.

Could George Osborne bring in new restrictions, or even retrospective measures?

It wouldn’t surprise me at all.

Friday’s off – tax-free

I have plenty of other thoughts swirling around about all this.

For example, it makes clear yet again how much better it would be to own my own home from a tax perspective.

While I desperately try to grow my investment portfolio as tax-efficiently as I can and to keep manageable the tax take on my income that after all has to pay the rent, my friends who own their own places see their (lottery winning) tax-free capital gains roll up year after year after year.

Of course they’re not paying tax on the imputed rent element of their home equity, either.

And then they bewilderingly declare that their £750,000-£1 million property is not a financial asset, just to further annoy me.

Home ownership in this country really is the killer tax break that keeps giving.

But with London prices having moved from extreme to insane to “oh, so this is what my grandmother meant when she said flinched at 50p for a bag of chips that used to cost a ha’penny”, that’s for another day. ²

No, I’m thinking I should simply forget about earning more money.

Instead I could keep my lifestyle costs low and pay myself with free time.

Yes it will delay financial independence by a few years.

But given the upcoming tax whack and the unsheltered assets I’m already struggling to tuck away into ISAs each year, not by so much as it might.

And best of all?

They don’t tax free time.

(Yet.)

Note: Thoughtful responses about how you personally address these conundrums very welcome, but ad hominem attacks declaring that since I earn more than you or your cousin Nigel I should be happy I don’t pay 80% tax rates will probably be deleted.

1. Note: 46%, NOT 52.5%. The combined corporation tax and income tax rate for a higher rate tax payer is 20% corporation tax plus (80% of 32.5%) on the dividend, which equals 46%.[↩]
2. Or another country. Or another part of the country. Either would help deal with the income issue, too, in that I’d almost certainly have to earn less.[↩]

Remarkably, our Slow & Steady passive portfolio now has five candles on its birthday cake. And while its growth rate won’t make anyone’s wishes come true overnight, the portfolio is piling on the pounds at a textbook rate that’s comfortably in line with expectations.

We’ve made an annualised gain of 6.8% over the five years, which amounts to a real return of just over 4% a year once you knock off inflation.

That puts the Slow & Steady ahead of the FTSE All-Share, which grew a nominal 6% annualised over the last half decade. Exciting.

Our portfolio has been buoyed by a large slug of US equities, which put on 13% per year over the five-year period. There’s one in the eye for the many over the years who advised trimming the US because it’s overvalued. Those naughty market-timers!

The US does look frothy by the light of the tools we have available but those measures only explain about 40% of the variation in returns.

In other words, trying to outfox the market is quite likely to leave you out of pocket.

Meanwhile, emerging markets – supposedly the only economic bright spot on the horizon when we first started the Slow & Steady project – are the one asset class that’s really dragged us down, losing an annualised 3.88% over five years.

So much for the moribund West and the Asian Century, eh? At least as far as our cache of capitalism is concerned to-date.

Agreeably average

Despite the inherent unpredictability of the markets, our 4% annualised gain sails very close to the 3.8% return we’d have expected from a 70:30 portfolio based on the UK’s historical growth rates for equities and gilts ¹.

Really, this is a statistical quirk. We can’t expect portfolios that are riding on market turbulence to habitually deliver the historical average, especially over a relatively short five-year run.

But it does go towards showing that a passive portfolio can be expected to deliver reasonable returns over time using little more than a consistent, diversified, low-cost strategy and a steady dripfeed of cash.

Micromanagement as a response to the worries of the world is just guessing – and markets will always fluctuate. For example, despite losing nearly 8% in six months earlier this year, we’ve ended up just over 1% on the past twelve.

Here’s our regular spreadsheet snapshot:

In raw cash, we’re up 21.23% since we started. That’s a £3,862 gain on total contributions of £18,130.

The Slow & Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £880 is invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts here.

New Year, same plan

While others attempt to rebalance their lives and maybe lose a few kilos – New Year, New You style – we prefer to rebalance our portfolio and trim our equities.

Each year we shift 2% from our equity allocation over to UK government bonds.

This is known as lifestyling and it’s designed to lower the risk level of your portfolio as you run out of years left to recover from the large stock market crash that lurks around the corner. (We just don’t know which corner.)

When it happens (not if) we’ll be relying on our boring bonds to be our portfolio counterweight – limiting the depth of our plummet by pulling in the opposite direction. (We hope).

• In our first five years we’ve moved from a highly aggressive 80:20 equity:bond split to a still fairly fearsome 70:30.

• In another five years, we’ll have moved to a borderline bellicose 60:40.

As of now, we have 15 years left on the portfolio’s investing clock, and I’m comfortable with the level of risk this far out.

The 2% equities cutback is going to come from our UK fund. We’ll add 1% to the conventional UK government bond fund and 1% to our inflation-protected UK government bond fund.

Currently the portfolio is a little slanted towards UK equities in comparison to the wisdom we’re receiving from the world’s investment crowd.

The UK makes up about 7% of global stock market capitalisation right now. That means we should give it around a 5% slice of our total portfolio, once you take into account that we’re 70% in equities.

Originally the Slow & Steady portfolio was more heavily biased towards home but subsequent research has led me to conclude this is just a comfort blanket.

I’m weening myself off it over time.

All a question of rebalance

Next we’re going to rebalance the portfolio back to its target asset allocations.

Ordinarily, we only rebalance if an asset veers wildly off course – more than 25% above or below its target allocation (or after a 5% change if the asset represents more than 20% of portfolio).

This annual move, like the shift to bonds, is a risk management exercise. Our aim is to try to ensure the portfolio doesn’t get overloaded with riskier assets.

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 Emerging Markets – risky but seemingly cheap at the mo’.

In the case of emerging markets we’re also hoping for a rebalancing bonus – buying an asset when it’s relatively inexpensive and capitalising when (if) it bounces back in the years ahead.

But again, it’s important to stress we’re not making a judgement call here – rather we’re just staying in line with the asset allocation we previously set.

Finally, we need to adjust for inflation. We invested £870 per quarter in 2015 but RPI has gone up by about 1.1% over the year. So from now on we’ll need to top-up our quarterly contribution by a tenner to £880 to account for cash’s loss of value.

Incoming!

Q4 is income bonanza time for our funds. They paid out £313.23 in dividends and interest, which we’ve promptly fed back into the growth machine courtesy of our automated accumulation funds.

Here’s how our income massed up:

• UK equities: £80.31
• Developed world equities: £159.37
• Global small cap equities: £4.82
• Emerging markets equities: £36.15
• Global property: £18.86
• UK Government bond index: £13.72

Total dividends: £313.23

New transactions

We’re lobbing another £880 into the market’s maw while rebalancing each fund back to its target asset allocation. That means:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.08%

Fund identifier: GB00B3X7QG63

Rebalancing sale: £369.97

Sell 2.391 units @ £154.77

Target allocation: 8%

Dividends last quarter: £80.31

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%

Fund identifier: GB00B59G4Q73

New purchase: £50

Buy 0.221 units @ £226.27

Target allocation: 38%

Dividends last quarter: £159.37

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.38%

Fund identifier: IE00B3X1NT05

No trade

Target allocation: 7%

Dividends last quarter: £4.82

Emerging market equities

BlackRock Emerging Markets Equity Tracker Fund D – OCF 0.24%

Fund identifier: GB00B84DY642

New purchase: £396.03

Buy 400.432 units @ £0.99

Target allocation: 10%

Dividends last quarter: £36.15

Global property

BlackRock Global Property Securities Equity Tracker Fund D – OCF 0.23%

Fund identifier: GB00B5BFJG71

No trade

Target allocation: 7%

Dividends last quarter: £18.86

UK gilts

Vanguard UK Government Bond Index – OCF 0.15%

Fund identifier: IE00B1S75374

New purchase: £382.55

Buy 2.66 units @ £143.80

Target allocation: 15%

Dividends last quarter: £13.72

UK index-linked gilts

Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%

Fund identifier: GB00B45Q9038

New purchase: £421.39

Buy 2.853 units @ £147.71

Target allocation: 15%

Total dividends = £313.23

New investment = £880

Trading cost = £0

Platform fee = 0.25% per annum.

This model portfolio is notionally held with Charles Stanley Direct. 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 for other good platform options. Look at flat fee brokers if your portfolio is worth substantially more than £20,000.

Average portfolio OCF = 0.17%

If all this seems too much like hard work then you could instead buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.

Take it steady,
The Accumulator

1. Historical growth rates from the Barclays Equity Gilt Study 2015 minus 0.1% fund costs. Fund costs already subtracted from the Slow & Steady portfolio results.[↩]