Picking a world tracking ETF

masonic

https://forums.moneysavingexpert.com/discussion/comment/82064180#Comment_82064180

It's great that you've reached a point where you are able to earmark excess wealth for the benefit of charity. I think that highlights exactly why our approaches differ. While I have recently hit my own "number", I’m not yet at the "surplus capital" stage where liability matching is trivial. For me, there is a small risk of shortfall if a major market stress event occurs. My portfolio is structured to ensure that if a 2000-style event happens tomorrow, I don’t have to make life-changing decisions. I also don't see cash as a viable answer here. While it handles short-term volatility, it offers no protection against the purchasing-power risk of a lost decade.

So, I think we are both applying rational financial principles. We’ve just tailored them to different chapters of our lives. You have the luxury to optimise for a long-term charitable legacy, while I am currently optimising to protect assets I will come to rely on later in retirement.

GeoffTF

https://forums.moneysavingexpert.com/discussion/comment/82064193#Comment_82064193

My portfolio is structured to ensure that if a 2000-style event happens tomorrow, I don’t have to make life-changing decisions. I also don't see cash as a viable answer here.

The relevance of cash here is that holding cash is a mathematically simple way of reducing risk at the expense of expected return whist keeping the risk adjusted return constant. Most investors use bonds rather than cash to reduce risk. Bonds usually give a higher return than cash, but introduce risks of their own. That makes it more complicated, but the principle remains the same. You want the highest risk adjusted return you can get from the equity part of your portfolio, and can adjust your risk level with less volatile investments (or use leverage if you are really gung ho).

masonic

https://forums.moneysavingexpert.com/discussion/comment/82064226#Comment_82064226

We are definitely looking at this through two entirely different frameworks. You are viewing the equity portion as a single, fixed block whose risk is dialled up or down from the outside using cash or bonds. My focus is on the structural risk inside that equity block.

Over the long term, equities are key to providing real returns, so simply diluting them with cash or bonds to lower volatility actually increases long-term shortfall risk. But within that equity allocation, history shows that major market stress events do not hit all sectors equally over the long term.

Because neither we nor the market can know in advance which regions or sectors will bear the brunt of a secular unwinding, the rational choice for my risk tolerance isn't to hold a heavily concentrated, cap-weighted basket and dilute it with cash. The rational choice is to ensure the equity eggs themselves are simply spread more evenly across different baskets from the outset.

GeoffTF

You have said that you maintain your US equity exposure at 50% to reduce the risk that the big techs crash. VWRL currently has 62% invested in the US, so you have diluted that by 12%. My UK equity allocation is currently 17% versus 3% for VWRL. My US equity allocation currently works out at 53%. That is not much different from your 50%. A home bias reduces withholding tax, and also reduces volatility because a proportion of earnings are in GBP. I have a large unsheltered holding of Vanguard Developed World ex UK, so I need a UK fund anyway. 17% compares with 20% for the Vanguard packaged funds and 26% to 30% for the AJ Bell packaged funds.

Opinions differ on the best equity percentage for drawdown portfolios. I have not followed the research, because it is not relevant to me. My defined benefit pensions more than cover my living costs. Supplementing my taxable income to cover the cost of residential care would not be a problem. My house would cover the additional costs, or I could sell some gilts.

aroominyork

This has been an interesting conversation. GeoffTF seems to be arguing that the market is optimally priced for risk-adjusted return; that people only diverge from a cap weighted portfolio when they think they can beat the market; and the volatility of equities cannot be reduced by tweaking your equity holdings.

That thesis needs all investors to have the same objective of maximising risk-adjusted return, otherwise the market will not operate efficiently. But that is not the case, just as masonic and GeoffTF have demonstrated in their differing objectives of, respectively, ensuring a comfortable retirement and maximising their legacy to charity. To put it crudely, if forced to choose one group of companies masonic might prefer UK equity income while GeoffTF prefered the Mag7. masonic is happy to target a sub-optimal risk-adjusted return, which raises the prices of ‘sub-optimal’ companies.

GeoffTF’s thesis also requires rational behaviour. The plethora of psychology graduates employed by the City suggests that does not mirror reality.

masonic

https://forums.moneysavingexpert.com/discussion/comment/82064289#Comment_82064289

Then it turns out we are doing very similar things in practice. Your deliberate home bias, driven by currency considerations and tax efficiency, is a great example of what I've been arguing all along. You've tailored your asset allocation to your specific circumstances, rather than following a pure cap-weighted global index.

On my side, I should be more precise that my US allocation is at 45% right now. However, I use a 50% threshold as a trigger for rebalancing. I am using Index Linked Gilts as a substitute for the security of a guaranteed income floor. At some stage I may exchange my ILG for an annuity.

In my case, if the US continues to outperform the ROW, then its percentage of the global index will drift even higher than its current 62%, but my allocation will not. To the extent it grows to 70%, 80%… of the FTSE All world index, that will be money I've left on the table for the next person, and I'm ok with that. Likewise for the extent that the Mag7 grow beyond their current 20% of the All-world index.

It seems we have both built portfolios that deviate from market-cap weights to manage real-world risks and considerations, even if our considerations are somewhat different.

GeoffTF

https://forums.moneysavingexpert.com/discussion/comment/82064384#Comment_82064384

This has been an interesting conversation. GeoffTF seems to be
arguing that the market is optimally priced for risk-adjusted return;

That is a mathematical consequence with the simplifying assumptions of CAPM. The market is not optimally priced in practice, but that it does not appear to be possible to exploit that, except by chance. There is plenty of evidence for that.

that people only diverge from a cap weighted portfolio when they think
they can beat the market;

If they are behaving rationally.

and the volatility of equities cannot be
reduced by tweaking your equity holdings.

Yes, it can. There are plenty of low volatility funds. They outperformed until they became popular. What you cannot do reliably is increase your risk adjusted return by tweaking your equity holdings.

GeoffTF’s thesis also requires rational
behaviour.

Not at all. The market can be as irrational as it wants. The market capitalised index will still be the average performance. It is a mathematical certainty that investing in the index with very low costs will beat most investors in the long run, irrespective of whether the market is rational.

GeoffTF

https://forums.moneysavingexpert.com/discussion/comment/82064444#Comment_82064444

You've tailored your asset allocation to your specific circumstances, rather than following a pure cap-weighted global index.

It is also a matter of history. It used to be expensive, one way or another, to invest internationally. There were no cheap index funds. I had to invest directly in UK assets. That has changed. My UK equity percentage has gradually declined. I like to make changes in baby steps to avoid making mistakes. My equity percentage gradually increased as my capacity to absorb risk increased.

masonic

https://forums.moneysavingexpert.com/discussion/comment/82064504#Comment_82064504

I'll not butt in on this exchange other than to make the following observation.

If the following two premises are true:

1. that people (if they are behaving rationally) only diverge from a cap weighted portfolio when they think they can beat the market
2. the volatility of equities can be reduced by tweaking your equity holdings

Then the logical conclusion of 1+2 is that if someone deliberately tweaks their holdings to reduce best and worst case outcomes within their equities, they are behaving irrationally, regardless of their motivation or personal circumstances.

Do you really believe this?

GeoffTF

https://forums.moneysavingexpert.com/discussion/comment/82064667#Comment_82064667

I am not sure what your point is here. Of course people can reduce volatility by tweaking their equity holdings. Buying all the least volatile stocks would do it. If the market is efficient, that will correspondingly reduce their expected return to keep their risk adjusted return constant. (As I have said, problems occur if that becomes popular. The expected return of low volatility stocks would fall as a result. You will find a more detailed discussion if you search for "volatility factor".)

Is it irrational to make changes to your portfolio that have no effect on your risk adjusted return, and will reduce it if too many others follow your example? Perhaps. An important point here if that the market portfolio does not suffer from the same problem. More people climbing aboard should not distort the relative prices. If everyone bought market weighted trackers, that would cause problems, but that will never happen.