For people that want to keep things simple, here’s an example portfolio based on low cost Exchange Traded Funds (ETFs) from Vanguard. This has been designed with people investing for the long term (eg financial independence) in mind.
Why Vanguard? Because it is owned by its customers. Vanguard are the only fund management group I know who have no incentive to over-charge you.
If you’ve been reading this blog and paying attention you will know that alignment of interests is one of the fundamental Principles of Lifehacking. Never entrust your money to someone who has the incentive and the opportunity to screw you.
Why ETFs? Because they are simple and offer the lowest ongoing fees. The ETFs are traded on the London Stock Exchange* and can be bought as easily as a regular share. The ETFs used are:
VHYL = Vanguard All-World High Dividend Yield ETF
VEUR = Vanguard FTSE Developed Europe ETF (includes UK)
VUSA = Vanguard S&P 500 ETF
VFEM = Vanguard FTSE Emerging Markets ETF
One issue with index investing is that if the index is over-priced at the time of purchase, then the long term investor is doomed to poor performance. The challenge is trying to figure out whether an index is underpriced or overpriced when you come to invest. This is not easy, but fortunately all you really need do is avoid buying extreme cases of overpricing, which are relatively rare.
Sometimes it’s obvious that a market is in bubble territory. In response, we can reduce its weighting or avoid altogether.
So for example in 1989 I was a student and I knew almost nothing. But I knew at a price : earnings multiple of over 80x, the Japanese equity market looked insanely overpriced against the USA or UK. And when the US market peaked in 2000 at a CAPE of 44x amidst the dot-com boom and millennial celebrations, it was not difficult to realise that buying the index at that point might be dangerous.
I claim no ability to predict the future. When it comes to market timing, there are 2 types of people: those that don’t know how to do it and those that don’t know that they don’t know how to do it. So this is not an argument for market timing, it is simply an argument for having regard to valuations when investing. An over-priced market can keep going up in the short term, of course, but eventually a straw breaks the camel’s back and the process goes into reverse.
Looking for value is fundamental to all rational investing, even passive investing. The Simplicity Portfolio addresses this by seeking to overweight better value indexes and underweight over-priced indexes. This differs from the approach advocated by many passive purists who recommend market cap weightings.
Here are the allocations in The Simplicity Portfolio:
The Simplicity Portfolio currently underweights the USA on the basis that the CAPE on the S&P 500 is currently approximately 26x, against a long run average of about 16x. So only 10% is allocated to the USA instead of a purely passive weighting based on market capitalisations of over 50%.
For the same reason (valuation), there is no allocation to small cap equities because small cap valuations don’t appear to offer additional value at this time.
With US valuations relatively high, particularly for many companies without long operating histories and track records of dividend payment (think Twitter, Facebook etc), I think its appropriate to tilt towards value as well as getting global exposure via VHYL which excludes non-dividend paying stocks. I also think its appropriate to have allocations to Europe (including the UK) and Emerging Markets, both of which trade on lower CAPEs than the US market.
The 75% equity exposure equates to the highest level recommended by Ben Graham in The Intelligent Investor which Warren Buffett describes as the best book on investing ever written. With interest rates at historic lows, bond yields are very low and the opportunity cost of holding bonds or cash is high. So The Simplicity Portfolio currently maximises equity exposure subject to the 75% constraint proposed by Graham.
Yes there are lots of scared people out there who will tell you that 75% equity is too high given that the markets look toppy and are just about to crash etc etc. But I don’t think it’s helpful to encourage the irrational fear that many people have of equity volatility. As Warren Buffett reminds us, the long term investor has more to fear from inflation than from equity volatility.
Unless we go down the property landlord route, most of us are going to have to accept equity-style volatility if we want to get to financial independence. Remember that price volatility is not the same thing as real risk. The best thing that investors can do is learn to understand and master their fear of volatility.
Equally, many people will say having 25% in cash / short term gilts represents an unacceptable drag on performance with yields so low. I have some sympathy with this but its no bad thing to have some “dry powder” to invest into equities after a crash. It would of course be possible to re-allocate some of this 25% towards other fixed income alternatives such as REITs, infrastructure funds etc. If you are in the wealth-building phase and can ignore equity volatility, then feel free to take your equity allocation up towards 100%.
The portfolio is based on the principle of keeping things simple and costs low. Note the expense ratio of just 0.15% per year.
This compares to typical total fees of 2.0% – 2.5% per year typical for customers of a financial adviser / wealth manager with active funds. These people are giving away most of their portfolio income to their advisers and fund managers for nothing. Personally, I don’t see the point in having money if you are going to allow the income it generates to be taken from you and your children by economic parasites.
The reason that you rarely see simple solutions in investing advice is that 1) the customers are naive and 2) the financial services industry doesn’t make as much money from simple solutions. Its easier to steal candy from the kids when there is lots of noise and lots of toys in the sandpit.
As I showed here, minimising fees is incredibly important due to the effects of compounding. Many people can easily save a million pounds over the course of a lifetime by reducing fund management fees. If you have an easier way to make or save an extra million pounds, then I’m all ears.
The income from the portfolio will obviously fluctuate based on the underlying economic performance of the assets and currency movements. I dont believe in trying to suppress volatility. Reaching for yield and paying up for “certainty” are 2 of the most dangerous and expensive things that you can do when investing. Remember The Turkey Distribution. Better to build flexibility and resilience into your spending.
The Simplicity Portfolio excludes gold and other commodities which can provide a store of value because, for those seeking financial independence its important to focus on wealth generating assets that pay an income and compound in value over the long term.
In the complex world in which we live, asset allocation and portfolio construction decisions are as much art as science. There is no point in aiming for perfection: it is better to be roughly right rather than precisely wrong. What do I mean by roughly right? I mean that there is not a higher return (for equivalent risk) guaranteed elsewhere nor materially lower costs.
This is a low turnover, passive portfolio but all portfolios may need some change from year to year to rebalance and reallocate away from overpriced markets and towards better value alternatives. Low churn is good but complete neglect may not be. So its worth reassessing your asset allocation at least once a year and rebalancing if appropriate.
This is provided for information and is not regulated investment advice. This is a model portfolio and has not been tailored for any individual, including me. My portfolio is different, not least because it contains a large slice of actively selected quality equities. So think about your risk tolerance and asset allocation preferences when constructing your own portfolio.
But let me leave you with this thought. I’ve seen a lot of investors portfolios over the years (including many with the “benefit” of a wealth manager or financial adviser) and most of them are a mess. Most are full of historical baggage, pointless complexity and incur ridiculous fees for no good reason. The Simplicity Portfolio is simpler, lower cost and easier to run (without sacrificing expected returns) than 99% of what’s out there.
Welcome to the 1%.
*and the SIX Swiss Exchange and NYSE Euronext Amsterdam
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