burnt out nurse and investing newbie

Prism

JohnWinder said:

Alexland said:

... Not allowing too much money get concentrated into a small number of similar companies with similar characteristics which have done well at this point in the cycle is about managing risk not attempting to outperform the market. .... it's about being comfortable with the portfolio you hold which is critical to staying the course during the bad times.

I agree with your conclusion,'staying the course' is important; and I wouldn't want to challenge your view of the world since it seems well enough informed.

One can view such a strategy as an attempt to reduce risk by reducing volatility as you say, rather than hoping it gives a higher return. That's an interesting twist on the reason to passively invest, namely 'to get the market return, and be hit over the head by its risk'; you've changed it to 'suffering less risk than the market, but accepting lower returns'.  Unfortunately, for me, that still means one is making some judgements about the market, and thus an active element comes into it akin to guessing (albeit with some analytic basis). If that approach seems not improve returns compared to the market, as per SPIVA, do we have any evidence that it reduces volatility?

SPIVA results suggests there's no reason to think the strategy you describe will get better than market returns, so we'd be looking at below market returns (or the rare chance of identical returns). So if the strategy you describe is about 'attempting to reduce risk, but accepting lower than market returns', one might as well simply hold more bonds and less stocks. I can't decide whether that or 'your' strategy is likely to give better risk adjusted returns, but yours is not so much 'set and forget' but needs some careful consideration for readjustments. Sounds tricky.

It comes down partly to if we also accept predictions of returns and the idea that different country valuations to some degree suggest those future returns. So Vanguard release their 10 year guidance on future returns every six months and are suggesting that US returns are likely to be significantly lower than the rest of the world. Should we just ignore that and assume the global market knows better and that US equities are priced exactly where they should be? Or is their enough regional bias in the world so that people don't invest globally but in fact invest in local markets even though they are higher priced than others? It does seem from other Vanguard studies that many people do invest locally to the exclusion of other options - this includes Buffett, Collins and the like all of who promote the US over anything else to their fans and followers.

Alexland

JohnWinder said:

That's an interesting twist on the reason to passively invest, namely 'to get the market return, and be hit over the head by its risk'; you've changed it to 'suffering less risk than the market, but accepting lower returns'.  Unfortunately, for me, that still means one is making some judgements about the market, and thus an active element comes into it akin to guessing (albeit with some analytic basis). If that approach seems not improve returns compared to the market, as per SPIVA, do we have any evidence that it reduces volatility?

I don't remember saying that I was resigned to lower returns? The returns will be whatever happens - it might do better who knows. I just said that I wasn't chasing performance as the motive to underweight the US right now is to improve diversification.

SPIVA is a heavily biased creation by a company with an economic incentive to suck in a load of data about expensive, lazy and poorly positioned funds (under the guise of being comprehensive) to conclude that passive is generally better than active. If you ask the right question you can force the data to demonstrate the answer you want to show. They don't attempt to limit the selection of active funds being compared to those that a reasonably diligent investor might select or consider that the investor might change funds over their lifetime.

Warren Buffet is only suggesting his wife goes passive as it's likely to be suitable for her knowledge and engagement level and he doesn't do it himself as he prefers to own robust cash generative businesses.

Eyeful

Alexland can you please tell me what your definition of "a reasonably diligent investor" is and what  active funds you believe that would lead them to select.  

Alexland

Eyeful said:

Alexland can you please tell me what your definition of "a reasonably diligent investor" is

According to the dictionary diligence would apply to those who shows care and conscientiousness in their work.

Eyeful said:

 what active funds you believe that would lead them to select.  

Ones with low costs and a fairly style balanced asset selection based on a reasonable application of valuation methods and judgement.

JohnWinder

Alexland said:

I don't remember saying that I was resigned to lower returns? The returns will be whatever happens - it might do better who knows. I just said that I wasn't chasing performance as the motive to underweight the US right now is to improve diversification.

Indeed you didn’t say you were resigned to lower returns, and I wondered if I'd gone too far in my interpretation; clearly, yes. But you did write ‘...is about managing risk not attempting to outperform the market’. So if you’re reducing risk I thought you’d have to reduce returns, on average.

If one's deliberately trying to reduce risk, then one must be acknowledging that returns will be lower UNLESS your risk reduction is coming from better diversification which is what you’re suggesting your approach does.  It seems so hard for others (than you and me) to nail down a definition of diversification widely agreed on, but my take on it is cap weighting; yours is different, though not precisely defined - simply, less of all the US tech stocks, I think you’re suggesting in this case.

The definition of diversification I fell for is Sharpe’s, of Nobel fame, which sounds like cap weighted: 'the only kind of risk that’s rewarded with higher expected long-term returns is risk you can’t get rid of by diversification. We call this market risk. A sensible proxy for this overall market is a portfolio of all the traded bonds and stocks in the world, held in proportion to their outstanding shares or bond issues.’ https://www.gsb.stanford.edu/insights/william-sharpe-how-invest-turbulent-market 

With that in mind, I concluded that moving from cap weighting reduced your diversification, and thus would reduce your expected return for the same level of risk, or if you reduced the risk then one would have to be resigned to lower returns (even though they might be higher).

tichtich

bluefukurou said:

Sun-Is-Fun said:

If you want to retire at 55, I would seriously look at buying into additional NHS pension and/or paying into a SIPP (for basic rate tax payers, every £100 you put in gets you £125 back due to tax relief up to your yearly earnings). You say you lead a simple life and are mortgage free. You could possibly live on the tax free amount (currently £12570) without paying any tax at all if you did the above and diverted some of your money into pensions.

Seconded. Folks should take advantage of anything they can to boost returns. SIPPs are great because of the 20%, in a sense, free money you get.

This seems to be a common misconception. You don't generally save 20% tax by using a SIPP (or other pension fund), because you still have to pay tax when you take the money out. If you put the money in an ISA instead, you would pay income tax on the way in but not on the way out.

The only way a basic rate tax payer would save the full 20% tax is if they would otherwise (but for this investment) fail to use their full personal tax allowance in the years that they take money out. Personally, I anticipate benefitting in this way from part of my SIPP money, but only a very small part.

Apart from this, basic rate tax-payers only save 5% tax. Thanks to the 25% tax free "lump sum", you effectively only pay 15% income tax on withdrawals from a SIPP. This is equivalent to having 6.25% added to your SIPP.

However, something that I've never seen mentioned is that this assumes that the basic tax rate will stay at 20%. That doesn't seem like a very safe assumption to me. If the basic tax rate goes up to 25%, that 6.25% gain is almost wiped out. If the basic tax rate goes up to 30%, you would actually be worse off with the SIPP. I'm old enough to remember when the basic tax rate was 33%.

There are some other considerations too. As I understand it, if you decide to buy an annuity, you would be a little (or maybe not so little?) better off buying it from a pension fund than from an ISA. And of course, higher rate tax payers are likely to do much better out of a pension fund.

Personally, even though I'm a basic rate tax-payer, I am currently planning to put most of my retirement fund into a SIPP. But I don't think it's such a no-brainer as people suggest.

DISCLAIMER: I'm not by any means an expert, and I would be quite happy to be told (with reasons) that I'm wrong!

AlanP_2

The definition of diversification I fell for is Sharpe’s, of Nobel fame, which sounds like cap weighted: 'the only kind of risk that’s rewarded with higher expected long-term returns is risk you can’t get rid of by diversification. We call this market risk. A sensible proxy for this overall market is a portfolio of all the traded bonds and stocks in the world, held in proportion to their outstanding shares or bond issues.’ https://www.gsb.stanford.edu/insights/william-sharpe-how-invest-turbulent-market 

So John is this what you do - hold the whole universe of equities and bonds in the correct proportions?

If you are doing anything else presumably you are essentially doing what Alex is doing and overweighting / underweighting something(s) relative to that theoretical portfolio put forward by Sharpe? 

PS - Nobel prizes are awarded for academic achievement / excellence not for generating investment returns. If Terry Smith (as an example) continues to generate greater returns year on year than Sharpe's method he won't get a nobel prize for it.

kuratowski

tichtich said:

The only way a basic rate tax payer would save the full 20% tax is if they would otherwise (but for this investment) fail to use their full personal tax allowance in the years that they take money out [...]  Apart from this, basic rate tax-payers only save 5% tax. Thanks to the 25% tax free "lump sum", you effectively only pay 15% income tax on withdrawals from a SIPP. This is equivalent to having 6.25% added to your SIPP.

This is right, however, if you are lucky enough to get salary sacrifice, as a basic rate taxpayer, that bumps up the return to 25%, due to the saving on NI, so in effect you have saved the 20% tax.

JohnWinder

AlanP_2 said:

 A sensible proxy for this overall market is a portfolio of all the traded bonds and stocks in the world, held in proportion to their outstanding shares or bond issues.’ https://www.gsb.stanford.edu/insights/william-sharpe-how-invest-turbulent-market 

So John is this what you do - hold the whole universe of equities and bonds in the correct proportions?

If you are doing anything else presumably you are essentially doing what Alex is doing and overweighting / underweighting something(s) relative to that theoretical portfolio put forward by Sharpe?

No. Regret, guilty as charged. Alex and I both deviate from Sharpe's preferred portfolio.

I don't think I need any bonds, so I can hold only shares - but those are going to be global all cap, cap weighted, a la Sharpe. If you're young enough with a secure enough well paying job and childless working husband, you probably don't need bonds. Or if you're old enough with some old fashioned pensions, indexed annuities and small collection of real property, you probably don't need bonds in addition to more stocks than you know what to do with. But those will be stocks a la Sharpe for my money.

Alex on the other hand thinks he can reduce his stocks risk because he has a sense that a section of the market is over-valued. I suggest that's hard to get right, and it's easier to just swap some stocks for bonds.