The Simplicity Portfolio : 1 year on

the aggregation of marginal gainsJust 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:

  1. how simple investing can be;
  2. that you don’t need a financial adviser:
  3. the benefits of diversification; and
  4. 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!

You can follow The Escape Artist on Twitter here

18 comments

  1. 100% VWRL is the ultimate in simplicity. It is slightly higher cost 0.25% but I guess this is offset by never having to rebalance and do fewer trades when adding new money.

  2. The Big Monkey · · Reply

    A timely article TEA.

    I constructed the simplicity portfolio but without the bond components. As you say, the portfolio bumbled along nicely with little or no input / effort.

    We (myself and the good lady) are still in the accumulation phase. We are about 18 months away from ER. At what point would you convert a percentage of the portfolio to bonds, just after ER (by selling equities) or in the months leading up to ER (by converting your monthly input into bonds so that you don’t need to sell equities)?

    Also if you don’t buy bonds / gilts directly, would you consider Vanguard UK Government Bond Index and Vanguard UK Inflation Link Gilt Index Funds to be a reasonable choice for a passive investor?

    TBM

  3. The Big Monkey

    If you are following the simplicity portfolio, then I think you would want either cash or short term gilts instead of the two Vanguard funds you mention.

    The two Vanguard funds you mention are reasonable choices, but have a longer duration and are more interest rate sensitive. So not a good choice if interest rates go up.

    If you are as close as 18 months to ER, what would happen if the market fell 20% or 30% or more in the next 18 months? Would you still be able to retire? If not then perhaps you want to decrease your equity exposure now to be able to withstand a market drop and still retire.

    And congratulations.

    1. Andy – Thank you – great responses to The Big Monkey’s questions.

      If you ever want an unpaid job helping me answer emails from readers, just let me know. The pay sucks and the hours are awful. But its fun 😉

    2. The Big Monkey · · Reply

      Hi Andy,

      Thanks for the reply and your thoughts.

      In reality I think that I am overwhelmed by too much information / too many choices and obsessing about the small details.

      Looks like you also need a blog of your own.

    3. dawnmartyne · · Reply

      hi andy
      what investment vehical would you use then for short term gov gilts?

  4. dawnmartyne · · Reply

    great article. i love the simplicity.
    Id love the VWRL but its that high US exposure that worries me, but this has proved not to be a problem in the last 12 months .
    IF the US market was to crash id sell all and buy that one fund.

    1. Hi Dawn,
      Have a look at Vanguard’s homepage for VWRL (https://www.vanguard.co.uk/uk/portal/detail/etf/overview?portId=9505&assetCode=EQUITY##overview) and look at the About the benchmark section. It states there that:
      “…
      – The index measures the market performance of large- and mid-capitalisation stocks of companies located around the world.
      – Includes approximately 2,900 holdings in nearly 47 countries, including both developed and emerging markets.
      – Covers more than 90% of the global investable market capitalisation. ”

      Based on this I think it fair to expect that USA is a (very) large chunk of this ETF as it is in the index this ETF is tracking as well.

      If you are still looking for an All World ETF how about this one as an alternative?

      FTSE All-World High Dividend Yield UCITS ETF (VHYL) (https://www.institutional.vanguard.co.uk/portal/site/institutional/uk/en/detail/etf/overview?portId=9506&assetCode=EQUITY##overview)

      Objective
      … seeks to track the performance of the index, … , excluding real estate trusts, in developed and emerging markets that pay dividends that are generally higher than average.

      Top country exposure, As at date 30 June 2016 (from the homepage)
      Countries (Fund, Compare to VWRL)
      United States (41.80%, -11.30%)
      United Kingdom (10.50%, +3.90%)
      Switzerland (5.70%, +2.60%)
      Japan (5.30%, -2.90%)
      Australia (4.10%, +4.10%)

      As for the “…IF the US market was to crash id sell all and buy that one fund.” approach – how about keeping your portfolio as it is right now and just putting some new money into either VWRL or VHYL? If that’s an option, that is.

      Regards, Pinch

      1. dawnmartyne · ·

        hi pinch
        ive got VHYL and
        thats exactly what im doing!
        thanks.

  5. Ahainsworth@fsmail.net · · Reply

    Hello, I’ve been reading your blog for some time now and am super interested in investing in passive funds on a monthly basis but am completely baffled as to the cheapest way to do this. Although we hold a Halifax share dealing account and have some bank shares, These are just from share save /employment schemes and that is the full extent of our foray into stocks! The funds would be used to eventually pay our very low rate interest only tracker mortgage which we currently save for in just a regular savings account and a crappy rate ISA. My hubby is in banking so needs clearance to buy individual stocks / shares but I believe this is not the case when buying funds? Just need a bit of general advice as to what to do next and how to make the leap from reading aout it and knowing this is our next move, to actually understanding completely the most efficient way to get started. Feel free to direct me to another website that’s more ” passive investing for total and utter dummies!” Yours, Clueless of Cleckheaton

  6. Hoping to pull the trigger in two years to escape the rat race.
    Regarding the high bond allocation, do you think the bond bubble that we are in may be about to pop?
    If interest rates are increased by the FED, we could be in for much lower bond yields. If they stay the same, still some trouble with much poorer yields than we have seen over last 20 years.
    The blog by EarlyRetirementNow has a super post on this topic recently.

    1. Yes, you’re right that interest rates could go up. In the Simplicity Portfolio, I talked about holding up to 25% in cash or short term gilts (govt bonds)…whose value is relatively insensitive to interest rates.

    2. mikemelissinos · · Reply

      If the trend in bonds turn down, you may consider eliminating your bond exposure altogether. You carry less price risk if you hold short-duration bonds, but the income you generate from them still may not cover your loss of principal if prices move significantly.

      Maintaining a fixed allocation in any market no matter what doesn’t make much sense to me. You may find value in implementing a stop loss on a long-term horizon so if your investments do turn lower, you limit your losses.

      In the portfolio allocation model mentioned in the article, all but one market (cash/short term gilts) have high correlation to one another. In uptrends, it pays off better to essentially go “all in” on equities, but with that comes periods of serious pain especially if you do not use stop losses.

      Investors nearing retirement crave the income from bonds and dividend-paying stocks. During uptrends, they get a win-win. In downtrends, they may still receive their income but it likely will not cover the loss of principal – which I value a lot more than loss of income (when you get and stay out of the bond market and dividend-paying stocks).

  7. Love your blog homie!! I agree with your words. I follow a somewhat similar path. Best of luck in the FI journey

  8. bellabeck · · Reply

    Hi, I cannot open the file ‘The Simplicity Portfolio’ can you check the links for me please? Thanks

    1. Should be working now!

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