Just over a year ago, I wrote The Simplicity Portfolio.
As has been said before, a year is the time it takes for the Earth to revolve around the Sun and not necessarily the appropriate period over which to judge investment performance.
But The Escape Artist has observed that the world would benefit from some financial education. So let’s take a look at the performance of The Simplicity Portfolio since then.
In its first year, the portfolio delivered a total return of +12.5% for the version that included 25% cash and +16.3% for the all-equities version. Which is not too shabby. So let’s take a closer look at what’s driven this result.
To re-cap, the aims of The Simplicity Portfolio were to show:
- how simple investing can be;
- that you don’t need a financial adviser:
- the benefits of diversification; and
- how to “tilt” towards value using index trackers.
Let’s start with a reminder of what was in the portfolio:
The equities element was made up of 4 Vanguard ETFs. These are funds listed on the London Stock Exchange that hold shares in thousands of real companies based all around the world selling real things that real people want to buy. Contrary to popular belief, they are not gambling chips in a casino nor devious instruments used to cruelly oppress the proletariat (if you are Jeremy Corbyn and need me to explain this to you in more detail, just drop me an email: TEA@theescapeartist.me).
For these purposes, I’ve assumed that the fixed income element of the portfolio was held in cash earning an interest rate of 1%.
As I explain in coaching, The Simplicity Portfolio was designed to pass what I call The Meteorite Test. The Meteorite Test is where a boulder falls from the sky and can land anywhere on the world’s surface. Let’s be optimistic and assume it doesn’t land on our head. A sensible diversified portfolio should be unaffected wherever the rock falls because the underlying assets of the portfolio are spread all over the world. Even if the meteorite lands on Vanguard’s head office, the Simplicity Portfolio shouldn’t be affected. We’ll be sympathetic to the grieving families of the Vanguard employees but, for the rest of us, life will go on.
As well as passing the Meteorite Test, the other beauty of a diversified equity portfolio (rather than say a buy to let property portfolio) is that it is easy to put together with very low cost and almost no hassle, DIY or paperwork. So those of us that practice strategic laziness are probably better off with equities.
As for costs, the annual management charges of The Simplicity Portfolio are just 0.15% per year. If you are the customer of a financial adviser, you’re probably paying all-in costs somewhere between 10x and 20x this amount without even realising. Now if only there was something you could do about that…
Did we just get lucky? A one year return of 16.3% for the equity component of the portfolio is pretty sweet. But of course, it could have turned out very differently.
We only ever get to see one version of history. Nassim Taleb writes about the idea of alternative histories: the unseen paths that events could have taken, but didn’t. If you want to visualise this, try reading Fatherland by Robert Harris or The Man in the High Castle which portray the world after a Second World War which went the other way. Coulda happened.
It’s sensible to assume that an equity portfolio could deliver returns of anything between, say, +60% to -50% in any single year. The average real (i.e. adjusted for inflation) return on global equities has been 5% per year measured over the past 116 years (source: Credit Suisse Global Investment Returns Yearbook 2016). If we assume average inflation of say 3%, that’s equivalent to about 8% per year nominal return. On this basis, the 16.3% return of the equity component of the Simplicity Portfolio is perhaps double what we might reasonably expect over the long term?
So perhaps we got lucky this year. But investing is all about doing the right thing and then trusting that the universe will be kind to us. And, as the golfer Gary Player says, the more he practices, the luckier he gets.
The portfolio seems to have survived the Brexit vote, which had the effect of reducing the desire of international investors to hold assets in £ sterling. So the £ has fallen against other currencies including the US$ and the €. This has undoubtedly given a boost to the £ value of the Simplicity Portfolio. Which is good news for those of us that do our spending in £ but hold our assets in a mix of currencies.
Brexit may or may not turn out to be the equivalent of a meteorite landing on the UK. It is what economists call a “shock” to the economy. But shocks can be positive or negative in terms of their long run effects.
In the short term, the drop in the value of the £ will make UK exports more competitive and imports more expensive, all other things being equal. And it will probably cause some investment projects to be delayed. But the longer term effects are effectively impossible to predict with any accuracy. The good news is that we don’t need any predictions. Because, with the Simplicity Portfolio, we are diversified and the UK represents only about 7% of global stock market value.
In the original article, I suggested that people could choose between:
- 75% equities : 25% cash or short term bonds; or
- up to 100% equities for those in the wealth accumulation phase
Jim Collins, the elder statesman of US financial independence bloggers, offers a neat rule of thumb to choose an asset allocation. Jim suggests that people working towards FI have 100% of their portfolio in shares (plus an emergency fund of cash). Later, once you’ve quit working, you include a 25% bond allocation to act as a portfolio stabiliser.
100% in equities may sound like an aggressive asset allocation but remember this is for people that are still working and saving. So, if the stockmarket crashes, they should be pleased (not scared) because they will be benefiting from £ / $ cost averaging and getting more units for their money each month.
For people who have retired, a 25% cash / bond allocation should hopefully ensure they are never a forced seller of shares during a bear market. And if the stock market does crash, the retiree should benefit from rebalancing: buying more equities when they are cheap funded by the sale of some (relatively expensive) bonds.
The irony is that The Simplicity Portfolio underperformed an even simpler portfolio: just owning the Vanguard All World ETF (VWRL). By my calculations, a portfolio with a single holding of VWRL delivered a total £ return of about 19.7% over the same period. So perhaps the message is that you can make your investing even simpler than The Simplicity Portfolio?!
The Simplicity Portfolio was tilted towards value. In other words, I selected indexes that looked like they offered value based on metrics like the Shiller PE, price: book value and dividend yield. But the relative performance of The Simplicity Portfolio is a reminder that valuation is not a reliable predictor of short term returns. In other words, shares or indexes that start expensive can, at least over the period of just one year, get more expensive. And cheap assets can get cheaper. But, over the long term, value investing should provide a performance advantage.
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 shares. So think about your risk tolerance and asset allocation preferences when constructing your own portfolio.
To sum up, it’s simple to put together a diversified, low cost portfolio to build wealth passively over the long term. I think of my equity portfolio as a compounding machine that generates money while I sleep, like a rocket can generate propulsive force even when the astronauts are asleep. So if you haven’t yet built your own compounding machine, what’s stopping you?
Once you have your low cost compounding machine up and running, best to focus on what you can control. And for most people that means increasing your earnings and reducing your spending.
Remember to enjoy the journey!
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