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Some musings on portfolio construction based in the UK

A helpful place to also put any annual reports etc, of your own portfolios
Newroad
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Some musings on portfolio construction based in the UK

#431736

Postby Newroad » July 31st, 2021, 6:14 pm

Evening All.

Just a few observations, which may be of interest to some.

It seems to me that most forum members tend to report on (and in many case, perhaps construct/manage too) their portfolios in absolute terms, i.e. percentage increases over one or more timeframes - the most common two being since inception or the previous year. There is a variation on this of people who are concerned with their income (as opposed to capital or total return measurements), but for practical purposes, it is still an absolute measurement - just a different kind of one. I suppose this is all somewhat understandable, maybe for three main reasons

    It satisfies that natural competitive instincts of many
    It's fairly easy to do
    How to do something else, e.g. considering it in risk adjusted terms, is not so clear, especially for non-US residents

I get drawn into these conversations as well from time to time, though I'm not sure how helpful that is, either for me or the person I'm replying to :(

There are a subset of forum members who are different to this: 1nvest is an obvious one, but there are others as well. The exact form this difference of lens takes varies - for some it is capital preservation, for some it is optimising drawdown within safety parameters (of being wiped out) etc. At some level, I am in this subset - which has led me over the past 12-15 months, to morph my three groups of family portfolios (ISA*2, SIPP*2, JISA*2) from 100% Global Investment Trusts (WTAN, ATST & FRCL respectively) into different, arguably more "risk balanced" holdings. Notwithstanding having worked in the City back in the day, my experience there was more narrow - not really about portfolio management or similar. So, I had working knowledge or better about how most instruments worked, but not necessarily how to use them well together. You might argue I still don't! :)

So, I had to learn about passive vs active, which products were now on the market to suit each (which led me in part into VWRL and VAGP for the passive component), unitisation etc. But it still wasn't enough, or more accurately, I still couldn't be sure whether what I was doing was at least reasonable. This led me further on the journey - what I really wanted to get was a risk-adjusted feel of my portfolios - without paying too much to get it. To describe my thinking over time in detail would take too long, but five main things I tried were ...

1: Buying "Portfolio Construction", by Russ Koesterlich, on a cheap deal from Harriman House
2: Using PortfolioVisualiser.com to backtest
3: Using PortfolioCharts.com to backtest
4: Using the free version, then taking out a month's free trial with StockCharts.com
5: Getting a MorningStar free account, and trying out its free services

Item (1) proved a decent read, and I would advise most people to consider it or something similar. Were I closer to drawdown, I might instead have purchased McClung's "Living of Your Money" and I probably will do in the future, but I'll wait until I'm closer to retirement and hope for an updated edition with updated data.

Items (2) is good for asset class backtesting, but (understandably) is a bit US centric. That makes its specific instrument backtesting less useful for UK residents.

Item (3) is more useful for UK centric backtesting, as it lets you select your location, but it has less granularity with respect to asset classes, e.g. how to try and get the effect of holding HDIV or BIPS

Item (4) was certainly useful tactically (e.g. it's RRG graphs appeared to help me time some switches that I already wanted to do well) but it didn't have all the UK instruments I needed, or at least their historic detail wasn't available. It has a voting system for new instruments to cover, but this is neither quick nor certain.

Item (5) was of little use, but maybe the paid for version would be, with more on this below.

I then almost decided it was all too hard for a retail UK punter, but have recently come across two things new to me

A: II (Interactive Investor) has some functionality I came across by accident, free with an account, which is almost hidden in the X-Ray (underpinned by MorningStar) capability. There is a little PDF icon in the top right corner of the X-Ray section, strangely unlabelled, which when pressed gives you a much more detailed report - including, like magic, a Correlation Matrix! Suddenly, I can now make use of some of the theory I learned in Portfolio Construction. It will be even more useful when VAGP starts being factored in June 2022 - it requires three years of information for an instrument and it only began in June 2019. One limitation is that you appear not to be able to put in "What If" scenarios - but if anyone else knows how, please let me know?

B: Trustnet's free functionality has a Portfolio section, where, once you've entered in the details, has an "Analysis" tab, which further in has an "Analyse Risk Exposure" tab along with some other useful ones. It considers risk, using FE Fundinfo data (I'm not sure how this compares to Morningstar data) against holding the FTSE100, with cash being 0 and a measurement of 100 equalling the FTSE 100 (for what its worth, my three portfolios measure 64, 73 and 76 respectively). One key thing is that it is UK centric, at least in the version we see - hurrah! As second key thing is that you can specify the period for measurements (which means I can get VAGP data considered if desired).

Of course, this is not the end of the journey, it's likely there isn't one - but with (A) and (B) above and, as I said, even better from June 2022, I now have some tools that are genuinely useful for me. I hope they may be of use to some others.

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#431785

Postby JohnW » August 1st, 2021, 12:59 am

Thanks. Interesting. If I can take up a few points.
I didn't think '% increases' was an 'absolute' measure; I thought it was a relative measure, so not sure what you're distinguishing this type of measure from. Did you mean 'in relative terms'?
"Portfolio Construction", by Russ Koesterlich, is a new one on me; it's only three years old so I can be forgiven. The blurb offers the 'come-on': that the old approach won't achieve what it did in the past, because of low interest rates, so 'read this book'. Can you tell us what he says should be done differently now from the old stocks/bonds mix approach. I'm a bit skeptical.
For what it's worth, the goodreads website rates the book 3.3 based on 9 reviews. Ferri's book on the same topic gets 4.2 on 1000 reviews, as does Bernstein's on 1600 reviews.
Newroad wrote: including, like magic, a Correlation Matrix! Suddenly, I can now make use of some of the theory I learned in Portfolio Construction.

I always wonder how much use we can make of old, ie not future, correlation coefficients, since it's not a static property of asset types. Can we be confident enough about what some correlation coefficients will be in future to substantially alter an asset allocation based on the other information we'd otherwise rely on?
Newroad wrote: with cash being 0 and a measurement of 100 equalling the FTSE 100 (for what its worth, my three portfolios measure 64, 73 and 76 respectively)

This looks to me like another measurement which can be done, but how much does it help? Firstly, do they describe the formula or algorithm they use to get '64' instead of '73'. Secondly, has the formula been validated to show that a '64' sipp is less volatile than a '73' sipp? Thirdly, can different people apply the formula to the same asset mix and all get the same '64', or do some get '73'? Fourthly, is there any false precision in suggesting that '64' is different from '66'? And lastly, hearing my sipp is '64' for the first time, would be like being told ice is zero degrees, boiling water is 100 degrees, the air temperature tomorrow will be 20 degrees but I've never experienced this temperature scale before so I have no idea what 20 degrees feels like.
Still, it might turn out to be an eye-opener for investors; let's hope.

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Re: Some musings on portfolio construction based in the UK

#431813

Postby Newroad » August 1st, 2021, 10:39 am

Hi JohnW.

Percentage increases whether of share price, dividend yield, or whatever, is an absolute measure. To distil it to its simplest form, one might have gone all in on SMT (LSE) or GME (NYSE) over some time period and got a stellar capital return, but at what risk? If in drawdown, what chance that one got wiped out completely doing so (or having future drawdowns heavily impacted). So, unless you're Warren Buffet's spouse, go 90% S&P500, 10% Treasuries - and you can afforf the S&P to halve - you need to factor in risk, not just reward, IMO.

I got Koesterlich's book because it hit the target of what I wanted and was inexpensive. Like I said in the original post, get it or something similar - I'm not advocating that specific book. I can't comment about the blurb you've observed, but it doesn't seem like that sort of book to me. Rather than offer a solution, it gives you a checklist and a set of steps/approaches that you need to figure out for yourself according to your own circumstances - and seems thoughtfully written. Further, I think the guy had already made his money at time of publication (see his background) so had less interest in selling snake oil than most. Maybe some of the reviewers wanted a magic solution - which I'm sure we can both agree there isn't.

I think where Correlation Coefficients can be useful is so we don't delude ourselves as to risk, in particular about our ability to reduce it. I think we're short of good consumer tools to do more than that at present, in particular for the UK market, but maybe that will come in time. When it does, we'll be able to model the what if scenarios better (including picking periods of history which we judge match more closely the period we currently face - which would get around the historic nature of the data a bit). Indeed, Portfolio Visualiser enables that already somewhat - but, as I said, is more US Centric.

On the FE Fundinfo risk ratings, they are in essence volatility vs the FTSE 100 as I understand it. This is arbitrary, of course, but makes some sense given the intended UK audience. I take your point about what does a volatility of 64 (or 73 or 76) feel like - but, for example, if one has a choice of portfolios in mind without another means to "split the tie" then risk/volatility reduction would seem a reasonable approach to adopt.

Anyway, if the two tools (II X-Ray and Trustnet Portfolio) I mention at the end are no use (or not available) to someone, fair enough - but if they are of use to anyone, great :) Bigger picture, I was trying to encourage not reporting portfolios in absolute terms only, e.g. imagine if people also gave a FE Fundinfo Risk rating for their portfolio at point of reporting - it might give some additional insight.

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#431819

Postby JohnW » August 1st, 2021, 11:20 am

Thanks. That's cleared it up.
Reporting risk-adjusted returns, rather than just (absolute in terms of the original investment) returns, wouldn't that be a nice refinement we could all get something from. I hope you've started something.
I read the blurb on that book from the publisher's website: 'Interest rates are close to historic lows, equity valuations and bond prices appear stretched, and global economic growth has slowed. Investors need a new asset allocation solution.' Sounds like the book might be saying nothing new.

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Re: Some musings on portfolio construction based in the UK

#431833

Postby Newroad » August 1st, 2021, 12:08 pm

Hi JohnW.

On the book, it's chapters give some insight as to approach

    1: Money for Nothing: The Challenges of a Low Rate World
    2: Investment Therapy: Setting Objectives, Removing Constraints
    3: The Cost of a Good Night's Sleep: Considering Risk
    4: Not Dead Yet: Why Diversification Still Matters
    5: A New Lens: How Factors Drive Performance
    6: Math and Magic: How to Forecast Returns
    7: Some Assembly Required: How to Build Portfolios

after which comes the Conclusion. It starts ...

"At this point I expect some readers may be disappointed. Nowhere has the book provided guidance on making a killing in the stock market, or how to trade commodities. On the other hand, hopefully it is clear by now that was never the intent"

Instead, it's teaching you to fish rather than giving you fish, to use the old adage.

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#431858

Postby scrumpyjack » August 1st, 2021, 2:24 pm

JohnW wrote:Thanks. That's cleared it up.
Reporting risk-adjusted returns, rather than just (absolute in terms of the original investment) returns, wouldn't that be a nice refinement we could all get something from. I hope you've started something.
I read the blurb on that book from the publisher's website: 'Interest rates are close to historic lows, equity valuations and bond prices appear stretched, and global economic growth has slowed. Investors need a new asset allocation solution.' Sounds like the book might be saying nothing new.


‘risk adjusted'. Well it would be good if it were possible to have a sensible definition of what ‘risk’ is. The usual measures (Sharpe, Traynor, Volatility etc, etc) really don’t cut it for me. Given that to me ‘return’ means after inflation, the so called ‘risk free’ rate of return (from government bonds) is now almost certainly negative. Given that we don’t know what the future rates of inflation will be we cannot know what the ‘risk free’ return is. The return on ‘risk free’ assets can itself be viewed as very risky.

IMO it is a delusion to think that one can measure risk. Like beauty, looking forward at any rate, risk is in the eye of the beholder.

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Re: Some musings on portfolio construction based in the UK

#431872

Postby Dod101 » August 1st, 2021, 3:24 pm

Thanks for that scrumpyjack. I am puzzled by the discussion so far and frankly have managed to invest more or less successfully for the last 30 years without understanding Sharpe, Traynor, Volatility and for that matter alpha and beta except as the first two letters of the Greek alphabet. Oh I also have an idea about volatility but not Volatility.

I am only concerned that I have enough income (more than enough if possible) from my dividends and that the portfolio hopefully increases in value by a little more than inflation if possible.

The chapter headings of the book look interesting but there is not much new under the sun.

Dod

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Re: Some musings on portfolio construction based in the UK

#431879

Postby Newroad » August 1st, 2021, 4:10 pm

Hi Dod (and ScrumpyJack)

There is a reasonable argument, in my view, that anyone with an even remotely sensible strategy could have "invested successfully" over the last thirty years. Please note, this applies to me, over a slightly shorter timeframe just as much as you, e.g. putting everything into FCIT either side of 2008 for the kids JISA's has done just fine*. But in our cases and the many like them, what portion luck versus judgement?

There is a similarly reasonable argument, in my view, that the next thirty or so years are going to be nowhere near as easy to successfully invest in - heightening the need for Portfolio Construction and implicit in that, giving risk commensurate consideration as well as reward. Part of this goes to ScrumpyJack's point, although he made it for a different reason - risk free assets (the usual proxy being US Treasuries) are typically returning just above zero.

If one judges risk is either irrelevant or non-measurable, fair enough - especially if the outcome of such a judgement has little effect - e.g. you're not likely to run out of money in any case and/or you have no dependents or you don't mind how much passes to them in due course. Alas, I both suspect risk is relevant and do have dependents, so I concern myself with the matter.

How much this enables me to help both me and them only the future will tell.

Regards, Newroad

* just over 350% rise since once child's date of birth, just under 300% for the other, as it happens
Last edited by Newroad on August 1st, 2021, 4:24 pm, edited 1 time in total.

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Re: Some musings on portfolio construction based in the UK

#431882

Postby scrumpyjack » August 1st, 2021, 4:24 pm

I started investing in about 1969, though I was fortunate to have been given shares in 1954 when I was 5, although I didn’t know this until I was about 18. I then lived through the hyperinflation of the 1970’s (and hypertaxation) which nearly bankrupted large segments of British industry. The FT100 lost 2/3rds of its value in a few months in 1974 and was then ‘rescued’ by the Insurance companies doing some concerted buying. I had seen elderly relations who put their money in government stocks before and after the war. After all, for the previous century that had been a pretty stable investment. They were wiped out by inflation. Gilts were an awful investment then as interest rates soared. For the last few decades, as inflation was brought under control and interest rates fell back, gilts did very well. But IMO that unwinding cannot go on long term (how far below zero can rates go?!) and is a ‘zero sum’ game.

My take on all this is that one must spread one’s investments globally, and must go for businesses making real profits with a good track record. Investing in currency denominated assets is very risky – currencies can lose their value. It is sad that the easiest way to make money in this country has been to borrow sterling and buy real assets, then sit back and watch sterling lose value and your net worth go up. Not very productive for the country, but that is how most people in my generation got rich.

So all these pseudo ‘measures’ of ‘risk’ do not convince me at all. Anything can happen, and probably will!

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Re: Some musings on portfolio construction based in the UK

#431883

Postby Newroad » August 1st, 2021, 4:30 pm

Hi ScumpyJack.

Many, though not all, of our observations and instinctive conclusions appears similar - most notably, to invest globally. This is in large part what the "Removing Constraints" part of the book's Chapter 2 is about - e.g. removing home country bias.

What you call pseudo measures of risk I see as (best easily available) proxy measures of risk. You may think that is a distinction without a difference, fair enough if so. We and our dependents, if any, metaphorically live and die by that same (proxy) sword.

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#431892

Postby scrumpyjack » August 1st, 2021, 5:33 pm

Newroad wrote:Hi ScumpyJack.

Many, though not all, of our observations and instinctive conclusions appears similar - most notably, to invest globally. This is in large part what the "Removing Constraints" part of the book's Chapter 2 is about - e.g. removing home country bias.

What you call pseudo measures of risk I see as (best easily available) proxy measures of risk. You may think that is a distinction without a difference, fair enough if so. We and our dependents, if any, metaphorically live and die by that same (proxy) sword.

Regards, Newroad

.
Hi Newroad,

Yes I think it is too easy to draw false comfort from these backward looking measures of 'risk'. Rather like the guy who jumped off the Empire State building and as he passed the 35th floor thought to himself 'so far so good!'. Common sense is a better measure of future risk (which is the only one that matters) than some clever mathematical formulae based on the past.

Regards

SJ

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Re: Some musings on portfolio construction based in the UK

#431914

Postby mickeypops » August 1st, 2021, 9:34 pm

I’m with Dod101, and others, on this. I don’t think it needs to be this complicated. Otherwise we’d all have to employ professionals and incur the costs and hope that we’ve found a good one.

I’m happy to be an income focussed investor in Investment Trusts which have a decent record, trusting the managers therein to deliver the goods. Has worked for me, so far.

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Re: Some musings on portfolio construction based in the UK

#431953

Postby Newroad » August 2nd, 2021, 8:34 am

Hi MickeyPops.

I think it's fairly clear from the above that I'm advocating self-help in this regard, rather than employing professionals (though, if your pot were big enough, the latter may be worth doing at some level).

You mention complication and the desire to avoid it - what then underpinned your selection of 20 or so Investment trusts and their relative ratios? That would seem to me a relatively complicated and perhaps complex task?

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#431974

Postby mickeypops » August 2nd, 2021, 10:17 am

Newroad wrote:Hi MickeyPops.

I think it's fairly clear from the above that I'm advocating self-help in this regard, rather than employing professionals (though, if your pot were big enough, the latter may be worth doing at some level).

You mention complication and the desire to avoid it - what then underpinned your selection of 20 or so Investment trusts and their relative ratios? That would seem to me a relatively complicated and perhaps complex task?

Regards, Newroad


I take your point. It takes experience and certain analytical and research skills I think to have the confidence to construct a portfolio to meet one’s requirements, there’s no denying that. I do think though that the financial services industry likes to bamboozle the public with some of the statistical analysis you refer to: Sharpe ratios, volatility index etc. It’s in their interest to do so.

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Re: Some musings on portfolio construction based in the UK

#432042

Postby Newroad » August 2nd, 2021, 2:57 pm

Hi MickeyPops.

Based on the information you've kindly provided in your own portfolio update, I've done my best to approximate your portfolio in TrustNet, rebased using broad brush measures to £100K starting. This might help inform you, me and also others as to the kind of functionality which is freely available, by way of a practical example - my apology in advance for any errors in interpretation.

Image

Image

Image

Image

I thought it best to compare it to Global Equity Income IT's, rather than the FTSE100 - you may be able to find a better proxy in TrustNet were you to bother. As you can see from the figures, despite it being broadly comparable with that sector's performance, it hides considerable volatility beneath the waves!

I also wondered if, in your analysis and research that led to your portfolio construction, you considered putting it all in VYHL (or similar) - and what you concluded with respect to that type of idea?

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#432059

Postby scrumpyjack » August 2nd, 2021, 3:49 pm

mickeypops wrote:I’m with Dod101, and others, on this. I don’t think it needs to be this complicated. Otherwise we’d all have to employ professionals and incur the costs and hope that we’ve found a good one.

I’m happy to be an income focussed investor in Investment Trusts which have a decent record, trusting the managers therein to deliver the goods. Has worked for me, so far.


I think provided you are of at least average intelligence and are prepared to make some effort to understand investing and economics, the only 'professionals' you need are the ones you are already employing, like Baillee Gifford, Nick Train, Terry Smith etc. There is no point, IMO, in employing financial advisers, or wealth managers or whatever they like to call themselves. They generally do not add value but just another layer of cost. I cannot see any point in paying 0.6% to 5% every year for this extra layer of 'advice' where more often than not the skills of the adviser are selling and marketing rather than Warren Buffets skills! Another poster described them as 'eat what you kill' advisers which sums it up rather well in my view. To cap it all their fees are not tax deductible whereas the costs of the investment trust manager are at least CGT allowable and to some extent deducted from income before they pay out divis.

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Re: Some musings on portfolio construction based in the UK

#432060

Postby Newroad » August 2nd, 2021, 3:55 pm

Hi ScumpyJack.

For what it's worth, I don't think anyone in this chain is suggesting paying for additional professional advice (except, perhaps, my purchase of a book for a few pounds).

This is about self-education to the level desired, either from interest or usefulness.

Regards, Newroad

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Re: Some musings on portfolio construction based in the UK

#432073

Postby mickeypops » August 2nd, 2021, 4:33 pm

Newroad wrote:Hi MickeyPops.

Based on the information you've kindly provided in your own portfolio update, I've done my best to approximate your portfolio in TrustNet, rebased using broad brush measures to £100K starting. This might help inform you, me and also others as to the kind of functionality which is freely available, by way of a practical example - my apology in advance for any errors in interpretation.

I also wondered if, in your analysis and research that led to your portfolio construction, you considered putting it all in VYHL (or similar) - and what you concluded with respect to that type of idea?

Regards, Newroad


Thanks for the analysis Newroad. I track my IT portfolio against Vanguards Lifestrategy 60, which would have been my choice were I to have taken a different investment approach to funding our retirement. The Total return performance is very similar, with the caveat that I haven’t modelled the impact of selling off Vanguard units monthly or quarterly to release the income required.

I’m a firm believer in the idea that people are suited to different investment approaches depending on their personalities. I like the steady flow of dividends arriving into our Sipp accounts, without being overly concerned about the capital value of the portfolio. But each to his own of course.

Thanks again

MP

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Re: Some musings on portfolio construction based in the UK

#432140

Postby 1nvest » August 3rd, 2021, 2:04 am

Thanks for those pointers and details.

Must admit that for me Sharpe volatility based risk measures are casual. So much so I use a simplified approximation of dividing the annualised total real gain by the standard deviation in yearly real returns, where when comparing two portfolios the one with the higher value might be considered as being the better. HOWEVER for me risk of loss is my primary 'risk' focus. Which can lead to totally different choices. For instance gold and T-Bills broadly might be assumed to yield 0% real whilst T-Bills does so with low volatility and gold has high volatility. So under a Sharpe type risk measure suggests T-Bills has the better 'risk-adjusted reward' compared to gold. However loss wise, stocks/gold had lower risk than Stocks/T-Bills, the worst case SWR was higher.

I've also used methods that treat a asset allocation as both a drawdown bucket and a growth/accumulation bucket where the 'better' case was where SWR was the highest/longest and where accumulation grew the most. On that measure for instance 100% stock didn't yield the highest/best risk adjusted rewards, for instance 4% SWR is bolstered to 5%.

Yet another risk factor often overlooked is taxation/costs risks. Whilst on paper gold and T-Bills might 0% real, when you factor in such times as the 1970's high interest rates/high taxation, 15% nominal gains from T-Bills along with 15% inflation and 40% taxation = -6% relative net difference. Inflation is just another taxation, that the Bank of England are under remit to target a 2% rate.

http://warrenbuffettoninvestment.com/ho ... -investor/

The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5% passbook account whether she pays 100% income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5% inflation. Either way, she is “taxed” in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120% income tax, but doesn’t seem to notice that 6% inflation is the economic equivalent.

Jack Bogle used to use 8% gross nominal, 6% net, 50 year average total investment lifetime as the figures to suggest that many investors took on 100% of the risk for 40% of the reward as a consequence of often quite opaque costs/taxes. Often made worse still by investors bad behaviour, a tendency to buy-high/sell-low, one of the greater investment risk sits between the keyboard and back of chair. William Bernstein suggests treating investing like soap, the less handled the more there is. Historic figures also often omit much higher past costs/fees and absence of tax exempt/efficient accounts.

But that is all rear-view mirror based, hoping that forward time might rhyme and fall within past boundaries. Harry Markowitz, the Nobel Prize-winning creator of Modern Portfolio Theory once said ...

I should have computed the historical co-variances of the asset classes and drawn an efficient frontier, but I visualised my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.

i.e. he (at least originally when he made that comment way back) saw 'regret' as risk.

On a risk-adjusted basis with risk of loss the focus, 50/50 stock/reserves with stocks split 50/50 UK/US and reserves split 50/50 bonds/gold also has 50/50 £/foreign (gold is a form of global currency). For the bonds split them 50/50 short and long dated (such as via IGLS/IGLT). Half right, half wrong is better than being fully wrong. Covid etc. has for instance seen flight to safety, US$ (and hence US stocks) and gold both up. When fear fades and greed returns so US$ and gold might drop back/relatively lag when investors flight from safety into 'better value'. Not being fully in, or fully out of US$/gold, along with being broadly diversified - and both regret and loss risks might be relatively lower.

Volatility as risk ... well all assets at times have endured high volatility. Even T-Bills have dropped near 50% in real terms at times (MaxDD between the mid 1930's and early 1950's IIRC). As can stocks and gold halve or more. When you average in (save over time) and average out (drawdown over time) interim volatility isn't really a risk other than if if totally scares you out of the market after large downside volatility moves, in which case on-paper volatility is realised to become actual loss/risk.

Itsallaguess
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Re: Some musings on portfolio construction based in the UK

#432143

Postby Itsallaguess » August 3rd, 2021, 6:08 am

1nvest wrote:
Harry Markowitz, the Nobel Prize-winning creator of Modern Portfolio Theory once said ...


I should have computed the historical co-variances of the asset classes and drawn an efficient frontier, but I visualised my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.


i.e. he (at least originally when he made that comment way back) saw 'regret' as risk.


Which just goes to help prove mickeypops earlier point, when he's said that aligning risk-strategies with our own personalities often seems to be much more important than diving down statistical rabbit-holes and trying to mathematically 'prove' something to the nth-degree...

As a largely income-based investor, I want to make sure my base-line 'required income' is unlikely to run out within the investment timescales required of it. Capital value, whilst clearly important, is less so than the ongoing delivered income....

So if I have records to show that over a long enough pot-building period, whilst working and growing my investments, a delivered income of £x has never dropped below the 'required income' line, even after markets have had to cope with a number of fairly nasty tests, then that gives me some personal confidence. It's important to me that such a 'required income' line is some level *above* what I might see as a 'minimum-spend survival' line, as I don't particularly want to feel like I'd be living through another long period of lockdown if such a low-level of spending might ever be required, but also for another important reason that will be highlighted later on...

That confidence can be boosted by the fact that the delivered income is actually more than the 'required income' in a given year, and so the first 'safety buffer' exists that can help provide that confidence, and any excess can be re-invested to help maintain inflation-proofing spending power and also build that excess income even further.

On top of that, a cash or near-cash buffer can be used as a confidence-boosting back-stop, in case that first 'excess income' safety-layer ever gets breached. A level of cash equal to around three-years spending feels, to me at least, a good second layer of confidence, especially given that we might confidently expect at least some level of investment-income to be maintained during such a three-year period, so in fact there's very likely to be more than three-years worth of 'survival funds' available using this 'second safety-layer' approach...

And then we can perhaps look at those two safety-layers and compare it to our long-term records, and perhaps see that even during a number of earlier market routs, none of them might actually have been needed, and we can gain some good confidence in that, but in addition to that double-layer of confidence is the knowledge that *even if* either of those two important and financially strong safety-layers were ever actually needed, then the 'required income' line has been drawn initially to be some level above what I might see as a 'minimum-spend survival' line, and as such, if things started to look bleak on the market front then I imagine there will be an automatic cut-back in spending anyway, which as many of us have experienced over the last 18 months, can be surprisingly low when push really comes to shove...

So there we've got three levels of risk-countering safety, aligned with my investment strategy, designed to deliver my personal long-term investment requirements, and which also very importantly suit my investment personality, without even standing by the oft-seen overly-statistical rabbit-hole, never mind diving down it and spending a lifetime getting lost in it....

It sounds like Harry Markowitz came back up from the rabbit-hole and said 'You know what? Forget all that and just do what suits you best', and I think that's an important lesson that we all need to keep in mind when reading these boards at times....

Cheers,

Itsallaguess


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