https://www.lemonfool.co.uk/viewtopic.php?f=56&t=11241
... and so another tax year must have drawn to a close.
Life is life
I am still:
- - married with several children who are all one year older than they were last year
- in my forties and also one year older (soon I will have to truthfully say 'mid' rather than 'early')
- semi-retired
- living mostly off investment and trading income
- earning some money university lecturing
- earning a little more from book royalties
In current news I didn't do much consulting this year, but I have done some online journalism which isn't as well paid but fits well with my interests (I already write stuff on my blog for free, so why not). My third book is currently with the publisher and should come out later this year. There were no inheritances this year!
Performance and income sustainability
Overall our household balance sheet is up 2.1% since last year. Broadly speaking that is the net result of:
- Dividend income (net of tax): 3.4%
Other income (net of tax): 1.1%
Household spending: -3.2%
Mark to market: 0.9%
(Household spending includes mortgage interest, but not repayment since the latter has no net effect on overall wealth). No increase in house value is included in net worth; I still value my house at acquisition cost plus cash improvements.
Excluding net housing equity and the cash float I keep to smooth our income out, the headline total return (XIRR) of my investment portfolio was 4.4%, of which 4.2% was in dividends with a small contribution of 0.2% from mark to market (this differs from the 0.9% above which was calculated on a simple rather than XIRR basis).
Now for the all important margin of safety. You can already see from the figures above that household spending was covered by dividends, if we ignore mortgage repayments. Here is my preferred way of presenting this, the 'waterfall'. From top to bottom spending goes from 'permanent' costs to costs that will eventually vanish; and on the income side from 'guaranteed' dividend income down to other passive income (royalties), then finally various kinds of employment income.
If 100 is income from all sources then:
Household expenditure excluding mortgages: 62.6
........ with mortgage interest: 74.2
........ with mortgage interest & repayment: 84.4
Income from dividends outside of tax shelters, net of tax: 47.4
Income from all dividends: 75.3
Income from all dividends, plus book royalties (net of tax) - eg passive income: 86.0
Income from all dividends, royalties, self and part time employment (net of tax): 100.0
Broadly speaking then all dividends together (75.3) covers both household expenditure and mortgage interest (74.2). If we were to stop working entirely then passive income (86) would also cover our mortgage repayments (84.4), but I would need to sell down some assets outside of tax shelters to keep tax sheltered dividends safely in their shelters. Effectively the employment income means I don't have to do this, and also generates some free cash flow for ISA contributions. It also means I can contribute more to my SIPP (which of course has a contribution limit based on 'income' that doesn't include dividends).
Household expenditure was in fact higher than normal, as we acquired a second car (plus a couple of boats, and various other bits and pieces). To be conservative I treat this as a repeating expense rather than doing a proper capital amortisation. Dividends were up about 1.5% from the previous year, with 50% higher royalties (due to having two books out) and an 8% increase in employment income (more lecturing, but less consultancy).
Going forward I expect our expenditure to reduce a little in the years to come once our children are through formal education, and this does not account for state and DB pensions which are currently forecasted to pay out another 10% of our current total income (we are still contributing to DB pensions and are not at maximum NI contributions so these should increase a little). Book royalties will probably dwindle over time. Although I do hope to write that elusive blockbuster best seller, but sadly books on trading and finance are not as popular as cruddy self help and cookery books. And at some point it would be nice to go from semi to fully retired.
Incidentally we paid an effective tax and NI rate of around 7.2% on our total income. That seems... low. Some of it is from using legitimate tax planning (nothing fancy, just maximum ISA and SIPP contributions), but it mostly reflects the tax advantages that dividend income has compared to employment income.
Portfolio overview
My investment portfolio can be deconstructed in various ways. For this post I will use the following categories; the figures shown are the contribution of each category to my total investment performance (on an XIRR basis):
a) UK equities -0.45%
b) ETFs +4.35%
c) Long only investments (consisting of a plus b) +3.9%
d) Systematic futures trading +1.0%
e) Equity hedge -0.2%
An explanation of d and e; my futures trading account is funded with a lump of equity (both buy and hold, and ETF) and some cash. To avoid equity returns “polluting” that account I hold a hedge against the equity exposure (also in futures). This makes the returns of that account a combination of two hedge fund strategies - “managed futures” and “equity neutral”. However I think the categories above are easier to understand.
UK equities
This is effectively a 'trading' portfolio, using a mechanical system described here https://www.lemonfool.co.uk/viewtopic.php?f=7&t=684&p=6221#p6221. Since I published that post I have added a new twist in that I enforce sector diversification; so you can think of this as the bastard robot child of HYP and PYAD value if you like. Or not.
Mostly it's held inside SIPP and ISAs, to avoid paying CGT. There are also a couple of legacy stocks with larger positions, which are held outside tax shelters. I have been gradually reducing their position tactically over time.
Start of the year:
ICP 18.8% (legacy)
STOB 17.1% (legacy)
BKG 10.4%
VSVS 9.5%
RMG 8.9%
LGEN 7.6%
GOOG 7.5%
HSBA 7.4%
IBST 6.9%
BP 6.0%
I sold some STOB to crystallise a CGT loss, and all the other trades were mechanical:
Bought and sold Babcock, for a 26% loss.
Sold RMG for a 31% loss
Sold IBST for a 20% loss
Bought CEY
Bought PTEC
So now the portfolio looks like this:
ICP 20.98%
VSVS 10.79%
BKG 10.59%
CEY 8.91%
STOB 8.76%
GOOG 8.69%
PTEC 8.66%
LGEN 8.47%
HSBA 7.21%
BP 6.94%
Although the yield was 4.4% the total return was negative; an XIRR of -2.3% to be precise. This compares badly with the FTSE 100 tracker I use as my benchmark coming in at 7.6%. Looking back over the years since I started doing being this anal about my performance, this is the first year I've underperformed. Apart from the losers I sold Stobart also underperformed (though it's still up 100% from my original purchase price), and both CEY and PTEC have lost money since I bought them. On the upside BP and GOOG (which is Go-ahead, not Google in case you didn't know) both earned around 20% over the year.
I have been a net seller of UK equities for many years now, but my allocation is now about right. I reinvested the dividends earned from all UK stocks back into the UK, but they are still a smaller proportion of my portfolio due to the relatively poor performance. I'll return to questions of portfolio allocation later.
ETFs and funds
All my non UK and non equity exposure is in ETFs, with a smattering of investment trusts. As usual trading was done for tax optimisation, to generate funds for SIPP and ISA Investment, and to get the right risk exposure (discussed later). I don't look at the performance of my ETF portfolio seperately, only in conjuction with UK shares.
Long only
Performance here was better, but still not fantastic. Dividends on the whole piece were identical to the UK share, with a yield on starting value of 4.4%. The aggregate XIRR was 4% exactly, hence a small capital loss was made. Again this under performed a benchmark Vanguard 60:40 fund, which came in at 7.2%.
Systematic futures trading and equity hedge
Better news here. I made a loss on my hedge, although if netted with the equities it hedged I actually made a small profit (not included here, as that would be double counting because the equity gains already appear in the 'long only' section above). On futures trading I made 5.2% using the notional capital at risk in the portfolio; although modest this is higher than industry benchmarks (up 0.7% for the year, with the best performing funds making around 10.3% on an equal risk basis).
Total investment return
My total return on all my investments, including cash held for futures margin, came in at an XIRR of 4.4%. Once again Vanguard 60:40 seems an appropriate benchmark (since if I wasn't trading futures I could throw all my cash into that fund), at 7.2%. All in all then a slightly disappointing year, although unlike the last two years my futures trading added to rather than detracted from my performance.
Risk
My investment portfolio asset allocation at the end of the year stood at 22.7% in bonds, 65.1% in equities, 9.5% in cash and 2.7% in other (Gold and commercial property).
This is more cash than I normally have. About 2.6% (of the 9.5%) was transferred to ISAs and will be invested shortly. I am toying with the idea of starting another little portfolio which will invest in investment trusts using some simple filters around discount and yield. I also have a little more than usual in my current account, and in my trading account. In practical terms this just means I have more of a cushion against the rather lumpy arrival of income in the form of dividends and royalties.
My allocation in my preferred risk weighted terms looks like this:
|Asset |Strategic|Start of year|Current|
|Bonds | 22% | 13.1% | 12.0% |
|Equity | 50% | 59.4% | 60.7% |
|Futures | 25% | 24.5% | 24.7% |
|Other | 3% | 2.9% | 2.5% |
As usual the lower allocation to bonds reflects a mechanical trading rule that uses the last 12 months of relative risk adjusted performance; bonds are down around -0.5% and equities up 5.5%.
Regional exposures, should you care (each row adds up to 100%):
| | Asia | EM | Euro | UK | US |
|Bonds | 0% | 22% | 19% | 18% | 41% |
|Equity| 26% | 27% | 17% | 27% | 3% |
The 0% weight in Asia reflects a lack of decent bond ETFs, whilst the 3% in US equities is because they are frightfully expensive (again there are mechanical rules lurking behind these numbers, this time based on relative valuation metrics: dividend yield and PE ratios).
Summary
These once a year exercises are important; I don't really look at investment value at all during the year, with the exception so it's nice to do it just once. Plus there are various other reasons I do need to look things over: to optimise CGT, to get the information required for tax returns, and to make sure my portfolio allocation is still as desired. Still, we shouldn't get too hung up on this process. There is almost no statistical evidence of under or over performance here, even over the last few years together since I've started doing this on such a rigorous basis. The most important check is to make sure the Micawber principal is being met:
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Or in plain English, is there a margin of safety present, and is it expected to continue? Since the answer to both questions is yes, we can relax for another year.