Which Index funds to invest in?

LHW99

Linton said:

GeoffTF said:

masonic said:

"I agree with you that there are many ways to sensibly set up a portfolio to meet one's needs...However where I would disagree is that a sensible reason for doing so is to beat the market...what one can do is to influence the volatility which may not matter much when in the accumulation phase but could be important if your investments are funding your day to day expenses"

"Unlike a professional money manager I don't need to be concerned about my "results" in the short term as long as I achieve my objective which is to protect the assets we have built up against inflation and allow us to spend it down in our retirement."

"I'm not necessarily interested in better returns, I'm more interested in lower risk investments that offer some amount of control and produce a reasonable return. When markets sink and a tracker goes down, you have two choices, sell or take the ride to the bottom and hope it recovers  within acceptable timescales. I would much rather have a less volatile fund that achieves say 50% of the upside but only looses a smaller amount on the way down. Trackers may be fine for the younger set but for the over 70's, they are less good."

(1)These are all quotes from people who believe that under-weighting the US reduces volatility. Where is the evidence for that? Volatility could be reduced by holding more cash or bonds, if that is what they want.

masonic said:

My own view aligns with much of this. I mentioned a few posts ago I have had a small tilt away from the US for a long time, and I've always acknowledged it would likely be a drag on my returns. The primary reason for me is the sector concentration at a high valuation, which increases loss potential. It's precisely because I don't believe I know what will happen that I don't want too many eggs in one basket.

You seem to be saying that you do not like stocks on high valuations, because you believe that they have a higher loss making potential than the market. Where is the evidence for that? In theory, a market weighted portfolio is the most diversified portfolio. The US market has many more companies and higher earnings than any other market. It also has just about every type of business represented. Many of the big tech companies are near monopolies. Would you be happier if the Magnificent 7 were spread around the world?

masonic said:

Another reasonable justification for underweighting the US (which hasn't been mentioned here but have elsewhere) is a desire to live off natural yield, since dividends are disfavoured in the US for tax reasons, and are subject to WHT for us foreigners.

(2) Restricting your self to high yielding stocks, entails missing out entire sectors and markets, reduces diversification and lowers the risk adjusted return.

1) Risk to an academic seems to be linked to standard deviation typically measured over 3 or 5 years.  Higher standard deviation implies higher risk.  Personally I do not care about the normal levels of movement one can associate with Gaussian noise generated by the internal operation of the market.  It is the one-off systemic events that worry me.

The .com crash is a perfect example.  Another was the 2008 financial crash.  The chances of events of such a magnitude particularly affecting individual market sectors, happening within a few years as a pure chance random noise event must be for all practical purposes zero. They are a different type of event than that covered by academic "risk"  and Gaussian noise and must be managed in a different way.

The obvious way of handling them is to ensure that one's portfolio is not particularly concentrated in any factor that could be affected by a catastrophic event thus minimising the effect on the overall portfolio.  

2) Reduced diversification is a risk with income investing.  However if one is aware of this it is not too difficult to provide broad global diversification using both equity and Fixed Interest of various types. Why should "Lowering risk adjusted return" be a concern given income is much more stable than capital value and one's objective is not to maximise total return but rather to safely extract sufficient ongoing income from limited assets?

Wrt 2) it is not always necessary to focus on high yielding stocks, for a natural yield strategy. However that would depend on what proportion of retirement income is to be supported by it.

Assuming full SP, and either annuity of small DB income alongside, no reason not to use an income strategy for the extras, as natural income is less affected by downturns than capital values. It avoids the necessity of selling units during a prolonged crash, which would reduce capacity for recovery.

I began planning for this part of our retirement income around 15 years before SPA, and have kept an approximately 25% US exposure since then (from around 2000). I can now generate the additional income needed at a rate of around 2.5%, and have achieved an average total pa return over the past 10 years of around 6.5%.

Linton

LHW99 said:

Linton said:

GeoffTF said:

masonic said:

"I agree with you that there are many ways to sensibly set up a portfolio to meet one's needs...However where I would disagree is that a sensible reason for doing so is to beat the market...what one can do is to influence the volatility which may not matter much when in the accumulation phase but could be important if your investments are funding your day to day expenses"

"Unlike a professional money manager I don't need to be concerned about my "results" in the short term as long as I achieve my objective which is to protect the assets we have built up against inflation and allow us to spend it down in our retirement."

"I'm not necessarily interested in better returns, I'm more interested in lower risk investments that offer some amount of control and produce a reasonable return. When markets sink and a tracker goes down, you have two choices, sell or take the ride to the bottom and hope it recovers  within acceptable timescales. I would much rather have a less volatile fund that achieves say 50% of the upside but only looses a smaller amount on the way down. Trackers may be fine for the younger set but for the over 70's, they are less good."

(1)These are all quotes from people who believe that under-weighting the US reduces volatility. Where is the evidence for that? Volatility could be reduced by holding more cash or bonds, if that is what they want.

masonic said:

My own view aligns with much of this. I mentioned a few posts ago I have had a small tilt away from the US for a long time, and I've always acknowledged it would likely be a drag on my returns. The primary reason for me is the sector concentration at a high valuation, which increases loss potential. It's precisely because I don't believe I know what will happen that I don't want too many eggs in one basket.

You seem to be saying that you do not like stocks on high valuations, because you believe that they have a higher loss making potential than the market. Where is the evidence for that? In theory, a market weighted portfolio is the most diversified portfolio. The US market has many more companies and higher earnings than any other market. It also has just about every type of business represented. Many of the big tech companies are near monopolies. Would you be happier if the Magnificent 7 were spread around the world?

masonic said:

Another reasonable justification for underweighting the US (which hasn't been mentioned here but have elsewhere) is a desire to live off natural yield, since dividends are disfavoured in the US for tax reasons, and are subject to WHT for us foreigners.

(2) Restricting your self to high yielding stocks, entails missing out entire sectors and markets, reduces diversification and lowers the risk adjusted return.

1) Risk to an academic seems to be linked to standard deviation typically measured over 3 or 5 years.  Higher standard deviation implies higher risk.  Personally I do not care about the normal levels of movement one can associate with Gaussian noise generated by the internal operation of the market.  It is the one-off systemic events that worry me.

The .com crash is a perfect example.  Another was the 2008 financial crash.  The chances of events of such a magnitude particularly affecting individual market sectors, happening within a few years as a pure chance random noise event must be for all practical purposes zero. They are a different type of event than that covered by academic "risk"  and Gaussian noise and must be managed in a different way.

The obvious way of handling them is to ensure that one's portfolio is not particularly concentrated in any factor that could be affected by a catastrophic event thus minimising the effect on the overall portfolio.  

2) Reduced diversification is a risk with income investing.  However if one is aware of this it is not too difficult to provide broad global diversification using both equity and Fixed Interest of various types. Why should "Lowering risk adjusted return" be a concern given income is much more stable than capital value and one's objective is not to maximise total return but rather to safely extract sufficient ongoing income from limited assets?

Wrt 2) it is not always necessary to focus on high yielding stocks, for a natural yield strategy. However that would depend on what proportion of retirement income is to be supported by it.

Assuming full SP, and either annuity of small DB income alongside, no reason not to use an income strategy for the extras, as natural income is less affected by downturns than capital values. It avoids the necessity of selling units during a prolonged crash, which would reduce capacity for recovery.

I began planning for this part of our retirement income around 15 years before SPA, and have kept an approximately 25% US exposure since then (from around 2000). I can now generate the additional income needed at a rate of around 2.5%, and have achieved an average total pa return over the past 10 years of around 6.5%.

Yes, where you get the income from is rather more tactics than strategy.

In my case there are 4 reasons for going for high yield stocks rather than just taking natural income from a broad portfolio...

1) I prefer to keep objectives very simple - the growth portfolio is solely focussed on diversified equity growth with the dangers of one-off failures taken into account.  The income portfolio focuses on sufficient diversified income from minimum assets regardless of any other factors.  The composition of the two portfolios is therefore very different.

2)  There is a balance needed between the portfolios.  The more efficient the income portfolio the more can be invested in pure growth or held as cash for one-off expenditures.

3) An important benefit from generating income from the minimum sized portfolio possible is that my guaranteed income (SP, annuities) is getting uncomfortably close to the top of the basic rate tax band.  Taking investment income tax free  from ISAs avoids paying higher rate tax.

4) Having the two separate portfolios means that it is easy to switch between income and growth simply by moving money from one portfolio to the other.  This is needed if, for example, one has fixed rate annuities and so may need more income later in life. Conversely one's income needs may decrease over time.

Bigbobby

For me my investments are made up of 80% Vanguard FTSE Global All Cap index fund and 20% Global Bond index fund.  I am still rather young hence majority are in stocks.  Some might say that over time stocks outperform bond however I am a believer in having different assets rather than just 100% equities.  Both have a role to play in a portfolio, equities tend to provide growth and bonds provide stability.  Also people often underestimate their risk tolerance when the market tanks.  I also go global rather than just our pals across then pond.  The US might do great in the future it might do terrible who knows which is why I like to spread myself around the world.

london21

Vanguard FTSE Global All Cap Index VRXXA and Vanguard S&P 500 VUAG

chiang_mai

Bigbobby said:

For me my investments are made up of 80% Vanguard FTSE Global All Cap index fund and 20% Global Bond index fund.  I am still rather young hence majority are in stocks.  Some might say that over time stocks outperform bond however I am a believer in having different assets rather than just 100% equities.  Both have a role to play in a portfolio, equities tend to provide growth and bonds provide stability.  Also people often underestimate their risk tolerance when the market tanks.  I also go global rather than just our pals across then pond.  The US might do great in the future it might do terrible who knows which is why I like to spread myself around the world.

It depends which bonds you buy and for what reason. I buy bonds as an alternate asset and as an alternative to a Money Market account. But I don't have an expectation that they will perform inversly to equities, if that's what I want I would need to be far more careful in my choices and hope that the markets would continue to operate in the way I hoped. And then there are those bonds that carry risk that is approaching that of equities, bond fund selection requires just as much care as equities, if not more so.

InvesterJones

michael1234 said:

I'm probably talking rubbish as usual but presumably whilst money market funds are more stable than government bonds, if interest rates go down the return on mmf goes down but bond yields will go up because the coupon remains what it was.

Close. If interest rates go down, bond yields also go down (at least on the short end, in theory). But if you've already bought your gilt then you don't care - you've locked in your yield.

As for stability.. that's more a function of duration again - MMF often invest in short term government bonds or reverse repos anyway.

chiang_mai

michael1234 said:

I'm probably talking rubbish as usual but presumably whilst money market funds are more stable than government bonds, if interest rates go down the return on mmf goes down but bond yields will go up because the coupon remains what it was.

I await a suitably pompous reply from someone telling me I'm wrong (which is fine as at least I'll know )

Money market rates tend to be short term and not stable over time, they vary according to the BOE overnight rate (SONIA) which is a function of the base rate and the state of the eocnonmy at the time. On the other hand, Government Bond yields (or coupon rate), or Gilts as they are typically known, are fixed rate, from the moment they are purchased but their value will vary based on whether rates are falling or rising....a bond yield moves inversly to the bonds value. 

michael1234

chiang_mai said:

michael1234 said:

I'm probably talking rubbish as usual but presumably whilst money market funds are more stable than government bonds, if interest rates go down the return on mmf goes down but bond yields will go up because the coupon remains what it was.

I await a suitably pompous reply from someone telling me I'm wrong (which is fine as at least I'll know )

Money market rates tend to be short term and not stable over time, they vary according to the BOE overnight rate (SONIA) which is a function of the base rate and the state of the eocnonmy at the time. On the other hand, Government Bond yields (or coupon rate), or Gilts as they are typically known, are fixed rate, from the moment they are purchased but their value will vary based on whether rates are falling or rising....a bond yield moves inversly to the bonds value. 

By "stable" I guess I meant the fact that in the UK at least, they have to remain identical for at least one month but often for many months or years. Bond price change daily based on confidence of the market in the government to repay.

InvesterJones

michael1234 said:

chiang_mai said:

michael1234 said:

I'm probably talking rubbish as usual but presumably whilst money market funds are more stable than government bonds, if interest rates go down the return on mmf goes down but bond yields will go up because the coupon remains what it was.

I await a suitably pompous reply from someone telling me I'm wrong (which is fine as at least I'll know )

Money market rates tend to be short term and not stable over time, they vary according to the BOE overnight rate (SONIA) which is a function of the base rate and the state of the eocnonmy at the time. On the other hand, Government Bond yields (or coupon rate), or Gilts as they are typically known, are fixed rate, from the moment they are purchased but their value will vary based on whether rates are falling or rising....a bond yield moves inversly to the bonds value. 

By "stable" I guess I meant the fact that in the UK at least, they have to remain identical for at least one month but often for many months or years. Bond price change daily based on confidence of the market in the government to repay.

Then I think you're misunderstanding. Money market funds do not remain identical - they invest in short term instruments that reflect changes in the underlying lending rate within days. A bond on the other hand is fixed at the moment you buy it for the life of the bond (as long as you hold it that long).

michael1234

InvesterJones said:

michael1234 said:

chiang_mai said:

michael1234 said:

I'm probably talking rubbish as usual but presumably whilst money market funds are more stable than government bonds, if interest rates go down the return on mmf goes down but bond yields will go up because the coupon remains what it was.

I await a suitably pompous reply from someone telling me I'm wrong (which is fine as at least I'll know )

Money market rates tend to be short term and not stable over time, they vary according to the BOE overnight rate (SONIA) which is a function of the base rate and the state of the eocnonmy at the time. On the other hand, Government Bond yields (or coupon rate), or Gilts as they are typically known, are fixed rate, from the moment they are purchased but their value will vary based on whether rates are falling or rising....a bond yield moves inversly to the bonds value. 

By "stable" I guess I meant the fact that in the UK at least, they have to remain identical for at least one month but often for many months or years. Bond price change daily based on confidence of the market in the government to repay.

Then I think you're misunderstanding. Money market funds do not remain identical - they invest in short term instruments that reflect changes in the underlying lending rate within days. A bond on the other hand is fixed at the moment you buy it for the life of the bond (as long as you hold it that long).

Example MMF: (almost a straight line)
https://www.hl.co.uk/funds/fund-discounts,-prices--and--factsheets/search-results/r/royal-london-short-term-money-market-class-y-accumulation/charts

Example government bond: (not almost a straight line)
https://www.hl.co.uk/shares/shares-search-results/t/treasury-0.25-31072031-gilt