I’ll start by saying this article is informed and inspired by Benjamin Graham’s The Intelligent Investor. You may be unfamiliar with that name, but to quickly add authority you may be more likely to know Warren Buffett, who has cemented a record as the most successful investor in the world. Warren Buffett was a student and later employee of Benjamin Graham.
Buffett called this book “by far the best book about investing ever written.”
The Intelligent Investor was first published in 1949, and subsequently revised several times until 1973. Graham passed away in 1976, and the 1973 edition was re-published in 2003 with up-to-date, comprehensive and relevant notes at the end of every chapter. These notes are still pretty useful as anyone born before the 90s will be more or less familiar with the examples given.
In any case, it’s a large book and took me quite some time to read and digest, hence I hope in this article to at least begin to summarise what I discovered.
As the final part to this long-winded introduction I should mention another book I read several years ago which servers as a far more digestible introduction to the world of investing. The Motley Fool UK Investment Guide (3rd Edition) taught me the basics which i’m about to jump into. I’ll start with a brief history of my activity and then jump into why.
Where I Began
According to my Amazon order history page, some time in March 2012 I ordered the above Motley Fool book. I remember distinctly I was told to acquire the 3rd edition specifically. I forget why or by whom but I did, and obviously had a nice time reading it.
The outcome of this book was certainty that I would start a regular savings plan with a S&S ISA provider where I could buy into index trackers that would mirror the performance of several global market indexes, such as the FTSE100.
After starting a new job at the beginning of 2014 I put the plan into action, opened a S&S ISA with Fidelity, and set up a monthly regular contribution to a number of index trackers which I’ll describe in the table below. The weighting has and will change slightly over the years as I variously get bored or over-think. More usefully, if one or more of them over perform, then the weighting of my portfolio might change, and so need re-balancing.
For example if the American Index Fund were to grow quicker than the other funds, I might end up with 50% of my portfolio there instead of 35%, and so I could either sell and re-buy to re-balance, or change contributions to achieve the same over a longer period.
To skip forward 6 years, the annualised return (the average return per year on each pound ever invested) at the beginning of the year 2020 was around 13% per year. As of the beginning of June 2020 (middle of the Covid-19 pandemic) this had reduced to just over 9% per year. During March it had gone down to negative whilst most of the world’s markets were tumbling.
As i’m sure i’ll mention again later, that negative annualised return for a few weeks in March, whilst showing a value (if I sold everything that day) of less than the total amount I had contributed over 6 years, was irrelevant as I didn’t need to and had no intention of selling then. To paraphrase someone clever:
Time spent in the market is more important than time spent trying to time the market.
Before I get carried away I’ll try to justify why I picked and stayed with the above fund choices.
What Why and Where
Anybody who has actually taken paid for investment advice, or is more eager than me to make money will be familiar with at least the first of the two forms of investments I want to discuss, and that is actively managed funds. The second form, and the approach I have chosen above is passively managed funds.
In essence, an actively managed fund pays clever people to try to beat the market, or the sector that it works within. This means frequent trading (each trade costs money), highly paid researchers, and highly paid fund managers. There are thousands of these funds, and each one is aiming to use insight or math or brains to beat the market.
A passive fund is a rather simpler affair, it takes an underlying index and simply holds shares in each constituent of such an index in order to mirror its performance.
For example, the above HSBC American Index Fund attempts to track the S&P 500 index (an American version of the FTSE100, if you like, containing the ‘largest’ 500 US companies).
As you might imagine, this approach avoids the necessity for frequent trades, they are without the need for researchers as the contents of the S&P 500 is public knowledge, and a fund manager doesn’t need to be able to predict the future, or know which of those 500 firms will go boom or bust.
Morningstar, a very useful global financial services company that has a huge amount of research and data, pretty well sums up the longer term viability of using actively managed funds. They say:
…the likelihood of picking an under-performing manager, and the potential penalty for doing so, tends to be greater than the likelihood of finding a stronger performer and being able to earn those potential rewards.
When picking an actively managed fund, you are looking at past performance to predict future returns. You’ll have seen a statement about how viable an approach that is with almost any investment product you look at, i.e. it’s not a great plan. On the other hand, with a passive fund you are avoiding making any predictions and are simply saying “i’ll go with the markets.”
Whilst what Magic Geoff the investment fund manager earned over the last 5 years has little relevance on his future ability to grow his fund now he’s had his gallbladder removed, the past performance of the global markets stretches back over 100 years, and is a somewhat better predictor for the future.
The S&P 500 index began in 1926, its current form of 500 companies began in 1957. Its annualised performance from 1957 to 2018 is about 8%.
It’s important though to remember we are saying here that the overall return over that period is around 8%. This period of 61 years has included many boom years and many recessions, and everything between. A recent example being 2018, where the S&P 500 shrank by over 4%. That would have been a bad year to cash out. Not as bad as Q1 2020 though!
To sum up, fund managers can’t predict the future and most often get it wrong, passive funds represent a more predictable route to growth. When it comes to selling and getting money out, it is slightly more important to be able to time when you do this, so as to capitalise on growth and avoid any dips.
Market volatility during the Covid-19 pandemic has been huge, so if you absolutely had to retire and cash out your entire S&S ISA in mid-March 2020, you’d be in trouble. If you could delay your retirement by 6 months, or a year, you would very likely be back into a good position.
Before moving on I should reference the ‘weighting’ column of my table.
There are many approaches to building a passive fund portfolio. One could argue the most neutral approach would be a single global tracker that represents the whole planet. There are funds to track the FTSE-All World that may accomplish this, alternatively there are funds to track the FTSE Developed index, which excludes the UK. The UK only make up about 5% of the world ‘markets’ and so you could achieve a balance by tracking the FTSE Developed and the FTSE100.
I ultimately decided I wanted a bit more control, and so bought into individual region trackers. In the below table I’ve thrown in the index that each tracks. Below this I will talk a bit about my decision processes.
The main points of interest here are that I’ve gone with the FTSE 250 tracker instead of the FTSE 100, and I’ve weighted the UK at 20% of my portfolio as opposed to the globally-balanced nearer 5% figure mentioned above.
My reason for the FTSE 250 preference is that I see many of the FTSE 100 companies are global, large cap companies. The FTSE 250 on the other hand represents the next 250 largest companies, which are generally more UK focused due to their sizes. This means that my 20% UK focus is more UK focused than were I to have that 20% in the FTSE 100. In my opinion anyway!
As to why it’s 20% instead of 5%, that’s just me having some belief in the future of the UK over the long term. The last 6 years have shown America (via the S&P 500) to have far exceeded the growth of the FTSE 250, however it’s a long race and we don’t want all our eggs in one basket.
This leads us nicely to the next important aspect of my approach, pound cost averaging.
Pound Cost Averaging
Let’s say you have £10,000 burning a hole in your mobile phone banking app. You invest it all in a FTSE 250 tracker today. That’s pretty good, in twenty years it’ll have easily doubled in value. However tomorrow the virus starts infecting cats and the FTSE 250 tanks by 10%. You’ll be kicking yourself for overpaying for that tracker by 10%. If you’d split your money in half and paid half today and half tomorrow, you’ll have reduced the damage. The more we split these purchases up the more we de-risk ourselves accidentally spending more than we should.
By investing the same amount every month, year after year, you’re basically extending on the above to always get the best deal possible. If you buy £1,000 of tracker A in January and it costs £500 a share, you’ll have 2 shares. By September that tracker has halved in value for £250 a share, and so you’ll now get 4 shares for that £1,000. By December it’s rebounded and is now £1,000 a share, and so you only buy 1 share and don’t spend any more. In the context of almost certain long-term growth, this smooths out the highs and lows, hence the name, pound cost averaging.
Equities and Bonds
I’ll mention bonds. Basically bonds — for the last couple of decades at least — grow at a slower rate than equities, however in recessions they are more stable. For quite a while company pensions used an approach they called ‘lifestyling’ to gradually move more of your equity holdings into bonds as you got closer to retirement. This would reduce volatility and provide stable and predictable value when you came to draw down.
The pension provider approach was very naive though. It assumed everybody retiring would have a date set and come what may they would cash in on that date. They assumed everyone set to retire on March 2020 would both have to retire on that exact date, and that they would all have exactly the same circumstances as regards wealth, assets, and needs.
For example, Flash Gordon and Geoff Capes both work at Flaming Budgerigars Ltd. Flash is set to retire at 55, he’s got his company pension, he’s also got a 5 million pound house and a couple of race horses. Geoff Capes on the other hand also wants to retire at 55, has his company pension and 36 budgerigars in his garden aviary. He’s got a mortgage that should be just paid off.
Flash has no real need to be moving his equity into bonds as he has many options to work around any market fluctuations, such as selling one of his horses, or possibly down-sizing his house. In this case he’d stand to lose much more than he could gain by remaining in equities.
Geoff has no real savings to speak of and will be relying on his pension from day one. In this case it’s more important for him to be able to predict what he’ll have, and have it on a set date. Moving into bonds over the 5–6 years leading up to retirement is probably a good idea for him.
That’s all for this time. Please do let me know in the comments section if you have any thoughts or ideas or I’ve missed something silly.
I should add that in the above I’ve yet to mention the decisions required around the approach to accessing your ‘money’ post-retirement. Namely the choice of cashing everything out to buy an annuity (guaranteed income for a set or infinite period) versus drawdown (attempting to simply cash out as much as you need each month without going bust before you clog pop). If you’re lucky that’ll be in my next bunch of words.