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Unshakeable – Your Financial Freedom Playbook

I received my copy of “Unshakeable” at the end of February. It’s a slim, easy read of 141 pages about investment strategy / tactics, supplemented with a further 80-or-so pages about motivation and the psychology of wealth.

So, what’s the book all about & how is it different from “Money: Master the Game”?

Tony Explains right up front on page 10:

First, I want to reach as many people as possible by writing a short book that you can read in a couple of evenings or a weekend. If you want to go deeper, I hope you’ll also read Money: Master the Game, but I understand if that big monster seems intimidating.

So the good news is that if you’ve read “the big monster”, you already know all of the detailed stuff you’ll find in “Unshakeable”. Of course, “Unshakeable” is full of the same America-specific language as “Money: Master the Game” – but there’s nothing new here to surprise you in that regard.

So, is “Unshakeable” worth reading if you’ve already digested “Money: Master the Game”? I’d say yes – because its slimmer content allowed me to focus on the forest instead of the trees – and it helped me refine my thinking as a consequence.

I remember reading and re-reading “the big monster”, making notes and trying to distill the tactics that would allow me to successfully navigate the scary world of investing. In “Unshakeable”, it’s pretty-much all spelled out, check-listed and summarised – which makes it much easier to digest and avoid overwhelm.

If you were going to give someone a book about investment, it’s far more likely they’ll read and internalise “Unshakeable” than “Money: Master the Game”.

I won’t bother reiterating the points I’ve already summarised from “Money: Master the Game”. The same, low-cost, index-fund approach still forms the core of “Unshakeable”, but here are the passages I highlighted as I was reading

The greatest danger is being out of the (stock) market (p42)

From 1996 to 2015, the S&P 500 returned an average of 8.2% a year. But if you missed out on the top 10 trading days during those 20 years, your returns dwindled to just 4.5% a year. If you missed out on the top 20 trading days, your returns dropped from 8.2% a year to a paltry 2.1%. And if you missed out on the top 30 trading days? Your returns vanished into thin air, falling all the way to zero!

That blew me away – even though I’ve read a similar summary in the past – the notion that 1 month out of 120 is enough to completely scupper stock market returns makes it so clear to me that:

  1. Trying to ‘time’ buying and selling is futile
  2. Pound cost averaging – investing a little consistently over time – is the only way to always be ‘in’ the game

Go hunting for first trust deeds (p104)
Tony mentioned this in passing in “Money: Master the Game”.  The idea is to lend money against a real-estate asset where the return is high and the risk is low, because you can sell the asset to recover the debt if need be.

After reading “the big monster” I had no idea how to take action on this – so I didn’t do anything. Recently, however, the rise of property crowdfunding & P2P services have made this type of investment  quite accessible.

I wouldn’t call this a key part of my strategy (see “Core & Explore later) – but there are potentially high returns (10-12% pa) and relatively low risk opportunities here.

There’s a great P2P comparison web site called 4th Way. They recently ranked their top picks and rated PropLend as their #2 and FundingSecure as their #3.  (I’m not a fan of their #1 choice of LandBay because of the relatively low returns).

Bonus: If you haven’t already sorted out what to do with your 2016 ISA allowance, you can hold some of these property assets inside a new IFISA – meaning your profits are tax-free. Perhaps worth a look – particularly as the 2017 ISA allowance rises from £15K to £20K per person.

Diversify in 4 ways (p110)
On page 112, Ray Dalio summarises the benefits of diversification:

By owning 15 uncorrelated investments, you can reduce your overall risk by about 80% and you’ll increase the return-to-risk ratio by a factor of five. So your return is five-times greater by reducing that risk.

“Unshakeable” reiterates how to diversify in these four ways:

  1. Across asset classes – stocks, bonds, real estate
  2. Within asset classes – multiple stocks, bonds, properties
  3. Across markets, countries & currencies – don’t over-invest in your ‘home’ market
  4. Across time – pound cost averaging – investing a little and often

Using bonds as ‘dry powder’ (p130)
During the last financial crisis, savvy investors sold bonds to snap up stocks at bargain prices. This is an interesting idea – but it does require a bit of an ‘active’ approach and may be best left to your trusted IFA – if you can find one.

Alternative investments (p131)
“Unshakeable” suggests publicly traded REIT’s as a way of diversifying within the real-estate category. I know almost nothing about this – so it’s on my list of things to research, starting here.

From my point of view, the biggest problems of owning ‘real’ real-estate assets are:

  • Illiquidity – if you need to sell, it’s only worth what someone is willing to pay at the time
  • No diversification – a big lump of cash all tied up in one building
  • Surprise costs – major things can and do go wrong with buildings
  • Relatively low returns – it varies a lot by property type and location
  • Maintenance and letting fees – can reduce net income substantially
  • UK tax changes – makes buy to let less and less attractive currently

Core and explore (p135)
Given that asset allocation (diversification) drives returns, what should the core of any portfolio look like?

  1. Use index funds for the core of your portfolio – I’m more than happy with my choice of the SWDA index fund – low, cost, good performance, well diversified.
  2. Have a cushion of income-producing liquid assets (REIT’s, bonds) which can be sold to buy stocks (index funds) at bargain prices
  3. Ideally have 7 years of income-producing liquid assets set aside to meet short-term cash needs (and avoid selling stocks when they are low).
  4. Explore – having sorted out the core, have a bit of fun with high-risk, high-return investments
  5. Rebalance – benefit from tax loss harvesting and buy assets when they’re cheaper

Life planning (p201)

This section was a good reminder to me to get this stuff sorted sooner rather than later.  What’s the point of accumulating wealth if we lose control of how it will be deployed and / or passed on to those we care most about?

Finally – My financial plan

got-a-planIt’s taken me a while  – almost a year to the day since I ordered and first read ‘Money Master the Game’ from Amazon.

I’ve met a whole bunch of IFAs, read a whole load of books, followed tons of blogs (see further reading).

I’ve been really hesitant to pull the pin and actually take action on my plan – because it seemed like a big, irreversible decision.

But, this morning, I’ve sent off the paperwork to Alliance Trust to start making payments into my pension (SIPP) account.

The long and short of it is that I decided to invest in 100% equities via a global equities index fund.  Now, this will seem pretty crazy to you, no doubt – but here’s my rationale ..

I’m assuming that you’re already convinced about index funds compared to active investing.  If so, the question is ‘which index fund to choose?’  Tim Hale’s book ‘Smarter Investing’ lays down some useful guidelines:

  • Tracking error should be below 2%
  • Full replication, not synthetic or derivative based
  • Total Expense Ratio below  0.4% for global equities
  • Size of the fund should be in excess of £100M
  • Fund should have been around longer than 5 years
  • Fund turnover should be below 5% per annum

In each of these cases, the Fidelity Index World scores well:

  • Tracking error is around 2% (it varies)
  • Physical / full replication
  • Total Expense Ratio is 0.12%
  • Size of the fund is £875M
  • Has been running for over 5 years
  • Fund turnover is almost zero

I plumped for a global index fund to benefit from diversification across all of the developed world’s stock markets.  There’s a line of argument that says that this exposes me to currency risk – which is true – but it seems to me there’s even greater risk of limiting myself to a UK tracker – just 10% of the world’s stocks.

So why 100% equities?  Why no bonds in there at all? It’s because I own a (mortgage free) property which generates a rental income – and as an asset class, that’s a lot like bonds.

So, the property and its rental income fall directly in my security bucket and I’ve squirrelled away some of that income in a deposit account so I can use the cash in an emergency.

I’m also contributing to a S&S ISA – buying the same index fund.  Both the ISA and the pension are using the Alliance Trust platform – because it’s cheap and it (mostly) works online OK.

I met a lot of IFAs, but none convinced me they could add significant value to this process.  Sure, they could help me design a more diversified portfolio, they could help me back-test their recommendations against my plan and see which one would win, but they have exactly the same knowledge about the future as I do – none.

There’s no way of telling if my plan will out-perform theirs in the future – or vice versa.  We can make assumptions based on past performance, but that didn’t help most of us see the whole 2007/2008 fandango on the horizon.

Any IFA will have more knowledge and experience than me – but their crystal ball is as useless as  mine.  None of them said my plan was crazy – just maybe a little unrefined.

On the upside, it’s a plan I understand, one I can stick to and manage myself.  It’s not a perfect plan – but it’s mine. And, more importantly, as of today, it’s the best kind of plan – one that I’ve put in to action.

Because my investments are 100% equities, I need to be fairly certain that I’ve got a long enough timeline to smooth out the volatility that will undoubtedly happen.  I’m not planning on touching the ISA or SIPP for at least 10 years – hopefully more like 20.

But, if this plan all goes wonky, here’s my plan B.

Leave the pension and ISA alone for as long as humanly possible and use my cash buffer as slowly as possible.

It’s not rocket science – but the biggest threat to the future value of my pension pot isn’t making poor investment choices or the volatility of the stock market – it’s having to sell shares when they’re low because I need the cash.

Hence the importance of having a cash buffer.  Hell, if push comes to shove, I’ll work in my local supermarket to eek out the cash a bit longer – hopefully long enough for equities to bounce back and for my pension pot to regain some value.

Clearly I can’t know what the future will bring, can’t know how pension rules will change, can’t tell what the state of my health will be, how long I’ll live, what will happen to property, bonds, equities, etc etc etc.

But doing nothing would also be a mistake.

Making basic choices now which afford me some flexibility in the future is about as good a it gets.  So, when I get to 70, 80 or 90 years old I’ll be able to say “I did what I could do” rather than “If only I had ..”.

7 simple steps: Your checklist for success

chequered flagChapter Overview
A summary of the main points and my personal action list

You made it to the finishing line – yay!

Now that I’ve read through the book twice, I realise that I was unnecessarily bamboozled by a plethora of jargon I didn’t understand.

  • What’s a 401K?
  • What’s a Roth IRA?
  • How does the S&P 500 compare to the FTSE?
  • Etc, etc ..

It turns out that, although I now know the answers to these questions and many more, they are all largely irrelevant to my investment planning.  However, this fear of the unknown is precisely what feeds the financial industry.

What I’ve arrived at are the following conclusions which are pretty self-explanatory and simple.  There’s no great mystery about investing – but there’s a massive industry that gets paid when you delegate your decision making to them.

Nobody (apart from independent bloggers and other altruistic souls) has an interest in simplifying this stuff – because there’s just too much money to be made from alluding to subtleties and complexities which you clearly do not understand.

Don’t be fooled.  Anybody who can read and write can understand this stuff, it’s not rocket science – but some of it is counter-intuitive.

While there are many up-and-coming online services available in the US to smooth the financial planning process, in most cases we don’t have access to like-for-like services here in the UK (yet).

However, don’t think that consulting a high-cost IFA is your only alternative.  With a little bit of reading and research, you can figure this stuff out for yourself.

Step 1: Save

You actually need some spare cash to invest. Every pound you don’t spend is one you can invest instead.  That’s a double win! What’s more, if you get used to spending less, your retirement pot also can shrink – which means you can reach financial independence that much quicker.

There are some great blogs I now follow on this very subject, often  referring to FIRE (Financial Independence Retire Early). I’d highly recommend adding these personal finance sites to your reading list.  I continue to learn a lot from them.

Step 2: Know the Rules

The main takeaway in this section is that passive investing via low-cost index trackers is the best option for 99% of us.  Most of the people cannot hope to win most of the time by cherry-picking stocks and timing the market.  Statistically, there have to be winners and losers and your chances of winning consistently doing this are close to zero. If there’s one thing you should remember from the book, it’s this:

Fees and taxes matter more than the nuts and bolts of your portfolio.

The most tax-efficient vehicles for saving are pensions and ISAs.  There’s a £40K pa limit on pension contributions (currently) and a £15K pa limit on ISAs.  Saving more than £55K pa tax efficiently is tricky.

If the aim is to keep total fees below 1% pa, this pretty much precludes using an IFA who will charge between 0.5% and 1% pa.

Using the lowest cost funds and a low cost platform, you can keep fees below 0.5%pa – but adding an IFA fee to this is enough to make your otherwise sound investment strategy a bad one.

Step3: Make the game winnable

How much do you actually need to retire?  Taking a safe withdrawal rate (SWR) of 3% pa you need savings of £400K to yield a gross income of £1,000 per month – which will turn into £800 after income tax.

That’s a lot of capital to accumulate for a relatively small income – but that pretty much ‘guarantees’ that level of income forever.

Compare that to an annuity you purchase for £400K, and the income will likely be in the region of £500 per month.  Annuities are definitely worth considering carefully because there’s no getting out of them once you press the ‘buy’ button.

If you’re young and time is on your side, you can benefit from compound interest to grow your savings faster as time passes.  If you’re older and have fewer years to accumulate your nest egg, you need to save more aggressively.  There’s no magic wand here.

Step 4: Make the most important investment decision

Diversifying your investment is crucial.  Investing 100% in equities might give you the greatest return – but it also exposes you to the most risk.  Investing 100% in bonds is safer – but it’s unlikely you’ll meet your growth requirements this way.

Most people plump for a mix between equities and bonds as a way of smoothing the highs and lows of the stock market with the slow and steady ride promised by bonds.

Depending on your appetite for risk and the number of years you have until you need to access your retirement fund, the mix might range from 20% equities/80% bonds (low risk, lower return) to 80% equities / 20% bonds (higher risk, higher return).

By making regular investments every month, you’ll benefit from pound cost averaging because you’ll buy when equities are expensive AND cheap.  Over time, this will average out the price you pay for equities and is safer than investing lump sums.

As equities change in price, your target balance between equities and bonds can get out of whack – so it’s important to rebalance once a year or so to maintain your risk exposure.  Some funds automatically rebalance for you.

Step 5: Create a lifetime income plan

Not much for us in the UK to do here, except to set up a living trust so that your heirs and dependents can access and manage your estate if you are unable to do so or once you die.

Step 6: Invest like the 0.001%

  1. Pick a diversified low cost index fund.  The Vanguard LifeStrategy 40% Accumulation fund fits the bill for me.
  2. Pick a low-cost platform to enable you to buy and sell. I chose Alliance Trust.
  3. Place your investments in tax-efficient pension (SIPP for me) and/or ISA wrappers.
  4. Make regular monthly payments for as much as you are able or until you max out your £40K pa pension limit and your £15K pa ISA limit.
  5. Rinse and repeat for as long as you can.
  6. Consult a tax advisor BEFORE withdrawing any money from your pension account.

There it is.  That’s everything I learned from re-reading and researching Tony Robbins’ Money Master the Game.

In the course of figuring some of this stuff out, I’ve come across other books which might have been a better fit for me to read,  however ..

I read this book BECAUSE it had Tony Robbins’ name on it.  It’s highly unlikely that I would ever have read a pure finance book- because I was too intimidated by the entire subject.

So, while I’ve read a lot of criticism of the book, I think the main point is that it’s given personal-finance-phobic people like me a way in to the subject and demystified it enough for me to just get on with it. And for that I’m grateful 🙂

I’ll add the odd post now and then to the blog as my further reading dictates, but that’s pretty much all for now here.

6.0 Meet the masters

meet the mastersChapter Overview
How the uber-talented and wealthy actually invest ..

Now if you’re like me, you kind of endured the previous 450 pages of the book to get to this point.

So it might surprise / disappoint you to hear that I’m not going to deal with this entire section in any detail at all. Why not? WTF!?

Here’s the short answer – it really doesn’t matter what your asset allocation looks like.  Much like dieting – a good plan that you stick to will totally out-perform the perfect plan you can’t abide.

Here’s another startling fact. Fees makes more of an impact on your investment pot than the diversification of assets.

But don’t take my word for it.  In researching for this blog, I did a lot of reading (books and blogs) and have come to the following conclusions.

Fees & Taxes Trump Allocation
I read a great book entitled Global Asset Allocation –  which essentially summarises the whole of Chapter 6 in just a few pages. It’s £2 to buy, easy to read and I highly recommend it.  Read a summary of the book.

These are the key takeaways:

All the most famous guru-style strategies had vastly different exposures: some 25 percent in gold, some zero and they ended up being very similar. The spread between these 15 portfolios was less than 1 percent a year.

People spend 90 percent of the time thinking about allocation, when they should be spending 90 percent of the time on minimizing fees and taxes.

The exact percentage allocations don’t matter that much. Make sure to implement the portfolio with a focus on fees and taxes.

So, that expensive mix of investments you paid your IFA for?  Turns out that, by virtue of his (or her) fees, that portfolio is statistically unlikely to perform as well as something you self-selected (without a fee).

We took the best performing strategy and compared it to the worst. If you add worst-case fees to the best, it has the effect of transforming it into the worst-performing.  Fees are more important than your asset allocation decision.

So, what’s an average UK investor to do?  My decision has been to reject going down the IFA route completely, find a low cost platform, and buy a bundled diversified single fund.  Here’s why ..

Reject the IFA route
This sounds kind of harsh, but I’ve got pretty vanilla requirements and paying an IFA a retainer of 0.5 – 1% pa of my total invested wealth is enough to make that pot of money not keep up with inflation.

It seems crazy but it’s true and, judging by the shift in investments from active to passive, paying an IFA an ongoing fee is absolute madness.  If you believe that a passive, index-tracking approach is the way to go, layering a hefty IFA fee on top of that approach without the hope or promise of ‘above market returns’ is just insane.

active v passive
Why plump for index trackers rather than ETFs? The short answer is that ETFs are designed to be actively traded – and that’s the last thing I want to do.


I’ve met some IFA’s I really liked (and some I didn’t), but that doesn’t change the maths.  The book says to keep fees below 1% – and that’s virtually impossible to do when the minimum an IFA will charge you is 0.5% pa.

An IFA will argue that their fee is more than paid for by the increased return from the investments they cherry-pick for you.  While that may be true for some people some of the time, it’s statistically impossible for most people to gain above-average returns most of the time.  There have to be winners and losers in this active investment game. My limited experience of active fund management bears that out – my investment didn’t even keep pace with inflation.

If there’s one thing I’m absolutely convinced about through reading this book and my other research, it’s that passive investing via a low cost index fund is the only rational choice I can make.  Having made that choice, it precludes me from paying an IFA an annual fee – because that’s enough of a hit to sabotage the returns from the index tracker.

Find a low cost platform
Currently my modest pension pot of £83K is using the Old Mutual Wealth platform.  I contacted them recently to find out what I’m being charged for doing absolutely nothing at all – and it turns out that it’s more than it should be.  Their charge basis 3 says that I’m paying 0.5% on the first £25K and 0.35% on the rest.  So ..

0.5% x £25K = £125 pa
0.35% x (£83K-£25K) = £203
Total annual fees = £328
Average fees = 0.40% AUM

So what’s the big whoop-de-do?  By comparison, the Alliance Trust SIPP I’ve set up charges a flat fee of £186 pa. That’s 0.22% compared to Old Mutual’s 0.4%.  Oh, and as my pension pot grows (hopefully), that % will shrink – compared to the tiered % fees of Old Mutual Wealth.

Should I care about such trifling sums? Yes.  Because as I build up my pension pot, the difference of 0.18% makes all the difference when compounded over multiple years.

Buy a single diversified fund
If you mooch through the different strategies detailed in chapter 6, what we’re looking at is different allocations between equities, bonds, commodities and cash.

If you accept that the actual percentages of asset allocation don’t much matter (but costs do), then finding the most diversified, lowest cost fund becomes the smartest thing to do.  That’s pretty much what I’ve come down to.

Vanguard is a company mentioned multiple times in the book – and they are the clear benchmark for low-cost index-trackers. While not a pure index tracker, they have a range of low-cost funds which combine equities and bonds into a single fund – called LifeStrategy.

You choose your risk tolerance from 100% equities to 20% equities, and you choose whether you want the investments to produce an income or whether you’ll automatically reinvest the income.  Two decisions, and you’re done.

Personally, I’ve chosen the LifeStrategy 40% accumulation fund, I can buy them via the Alliance Trust platform and I can hold them inside an ISA or SIPP wrapper.

Vanguard 40 percent LSThe LifeStrategy funds carry an annual fee of 0.24% pa and, when added to the platform fees of Alliance trust of approximately 0.2%, it means that I can keep my actual fees below 0.5% pa – pretty cool huh?  So I’ve definitely minimised fees and because I can hold the LifeStrategy fund inside a SIPP and an ISA, I’ve minimised taxes too.

Is this likely to be the best possible investment strategy? Probably not.  But it’s one I can stick to, invest in over time as my income allows and not have to think about.

As Carl Richards points out in The Behavior Gap ..

The goal isn’t to make the ‘perfect’ decision about money every time, but to do the best we can and move forward. . . . Most of the time that’s enough.

(His follow-up book, The One Page Financial Plan is also well worth a read.)

What’s important is to pick a financial strategy, implement it – and forget about it.  The real risk isn’t another financial collapse or the ‘markets’ turning against us. The risk is our fickle human nature to sell when we panic and buy when we feel we’re missing out – the worst possible times to buy and sell.

Buying and holding a simple index tracker for the long term  is the best way to remove the main source of risk from the whole financial conundrum.  Remove yourself.

  1. Choose it.
  2. Buy it.
  3. Forget it.
  4. Take a look at age 70.

So, that’s what I intend to do ..  Well, almost.

Remember that ‘ethical’ problem I hinted at in Chapter 2.6, it’s still an issue for me.  What I’ve decided to do is buy and hold the Vanguard LifeStrategy funds for now – until a more ethical alternative comes along.

I’m really excited that I’m not just hoping and waiting for that.  I’m making it happen. But it’ll take a while to become reality.  In the meantime, I’ll do the LifeStrategy thing.

5.5 Secrets of the ultrawealthy

secretsChapter Overview
If you’ve maxed out your pension and ISA contributions, how else can you invest tax efficiently?

Private Placement Life Insurance

PPLI sounds like a dream come true because of its tax advantages.  I wonder if the same kind of product is available in the UK?

It seems not.  From the lack of information available and the previous link indicating that things are looking up for the UK and European Private Placement Market, I don’t think you or I can go out and buy one of these things today.  However, this Wikipedia article mentions offshore PPLI solutions being widely used in Europe.

My guess is that PPLI is possible in the UK – but you need enough cash to make it worthwhile investigating the whole offshore malarkey.  It appears that the situation is similar in the US where only high net-worth individuals can access these kinds of policies directly.

That’s a shame, but it’s important to remember that this is a potential solution only if you’ve maxed out your annual pension contributions (£40K) and your ISA contributions (£15K).  These should be your first tax-efficient investment choices.

The Teachers Insurance and Annuity Association of America offers PPLI-like policies to individuals who otherwise wouldn’t have access to them.  Do we have an equivalent in the UK?  Again, it seems not.

I’ve asked Teachers Assurance if they know of anything similar – and I’ll update this post when and if I hear back from them.

Living Trust
Unlike a will, a living trust may come into effect in one’s lifetime. A living trust can also avoid the time and cost associated with the probate period of a will, meaning that assets can be transferred relatively quickly and easily after one’s death.

For a DIY approach in the UK, Law on the Web is a good place to start.  The Get Your Shit Together site quoted in the book also looks good. For a more hand-held approach, Your Wealth has some good information.

Whatever route you take, thinking about estate planning sooner rather than later makes sense to me.

5.4 Income = outcome

Witty hill of beans reference

Chapter Overview
Outliving your income stream isn’t funny. It’s time to talk about annuities again

Immediate Annuity
This is the regular type we discussed earlier. I played around with the numbers a bit more and the older you are when setting up the annuity, the more attractive the income you get.  It also helps if you’re in poor health and are likely to die young for whatever reason.  I guess that this kind of thing might have a place at some point in the far, far distant future for us.

Deferred Annuity
There’s a good explanation of deferred annuities here and it seems that they are available in the UK.

One thing I really like about the SharingPensions web site is their easy analysis of the costs associate with various annuity options.

annuity costs

So, you want a joint annuity where your surviving partner continues to receive the same annuity payment?  That increases the annuity cost by 1% – and decreases the annuity payment by the same amount.

You want the annuity payment to be linked to the retail price index (index linked) – that’ll cost you an extra 2.57% ..

Clearly, annuities need to be very carefully evaluated because there’s no changing them (currently) once you sign on the dotted line.

Longevity Insurance
Judging by this December 2014 article, this isn’t available as a product yet in the UK.  I guess as our population of retirees grows and we live longer, this will be an inevitable addition to the stuff we’ll need to evaluate and make sense of with our old and addled brains ..

Fixed Indexed Annuities
I couldn’t find any UK mention of this kind of product, so I guess we’re lagging the US a bit.  While the book waxes lyrical about the pros of this kind of an insurance policy, this WSJ article seems to offer a more balanced perspective, as does this one.

AdvisorsExcel &
I couldn’t find any UK equivalent of this online purveyor of the above kind of annuity.

The web site is pretty simple and US-specific. It just gives a ballpark annuity quote and an invitation to be contacted by their equivalent of an IFA.

4.4 Timing is Everything

timingChapter Overview
Nobody can reliably and consistently time the market.

Given that we can’t predict which assets will do well in the future, what can we do to minimise the potential for losses?

Dollar cost averaging
Unsurprisingly, we call this pound cost averaging and it’s simply the process of making regular small investments rather than one big lump-sum investment and guessing the right time.  On average, drip-feed investing works better.

Portfolio rebalancing
Morningstar has a good article on what exactly this entails.  The idea is that once you decide what your ideal asset mix should be, you check every now and then to see if it is still in line with that objective.

There are two reasons for this: First, you might be entertaining greater risk or lower returns than you’re aiming for, and second, you might have an opportunity to offset some capital losses against your capital gains.

While you can keep a track of your portfolio for free on Morningstar, their X-ray tool is a paid add-on which analyses your asset allocation.  I haven’t played with it because I’ve pretty much decided to buy an all-in-one diversified index fund which is automatically rebalanced.  More on this later ..

Tax Loss Harvesting
This is the practice of selling equities which have made a loss to reduce the capital gains made by selling equities which have increased in value.  This practice is bundled with rebalancing because that’s the time when you’re most likely to be buying and selling as part of that rebalancing act.

However, as this great Monevator article points out, everyone in the UK has an £11,000 capital gains tax allowance each year.  Also, capital gains realised within a tax free wrapper (pension or ISA) do not count at all.

As an individual, you currently have a £40K pa maximum pension contribution to use up and a £20K ISA pa max before even considering investing outside those tax-efficient wrappers – and therefore your exposure to capital gains or losses.  If you get to that point, go and read the Monevator article!

4.1 The Ultimate Bucket List

securityChapter Overview
Which investments are ‘safe’?

Starting with chapter 4, the book starts to get into the meat of the business of investing.  Enough with the financial foreplay!

These are the terms I needed to research for what kinds of investments should go into the security bucket of our asset allocation.

Cash & cash equivalents
Cash and cash equivalents are short-term tactical investments. Unlike equities, they are unlikely to decrease in value – but equally, they might not keep pace with inflation. The money in your current account is a cash equivalent, so too is the money in your cash ISA or savings account, as are short-term government bonds (gilts). Think low-risk, low-return. You can readily convert cash equivalents into actual cash.

Bonds are loans or IOUs where you are the bank. You lend your money to a company, a local council, the government – and they promise to pay you back in full, with interest. Typically, bonds are seen as safer and more stable than equities, because insolvency-wise, bond-holders outrank share-holders when the organisation is liquidated and the cash is divvied up.

TIPS (Treasury Inflation-Protected Securities)
In the UK we call them index linked gilts and they’re issued by the government and do pretty much what they say. You get your money back + interest + an adjustment for inflation. In terms of security, this is about as good as it gets.

When the UK government issues a bond, it’s called a gilt. This quaint and confusing terminology comes from the original (paper) bonds being gilt-edged.

US Treasury Bonds
For the UK, see above. Gilts (bonds) issued by the UK government may, or may not be, index-linked.

The following description makes me thing the UK debt office doesn’t want me to understand what T-bills are:

Treasury bills are zero-coupon eligible debt securities and can be held in CREST and Euroclear.

Oh, really? So, T-bills, or Treasury Bills are like gilts but much shorter-term. They pay no interest, but, they are sold below face value. So, you might get a 21-day T-bill with a face value of £100, but you actually pay £98 for it. In 21 days’ time, the government pays you back £100 and you’ve made £2 – yay! That’s all fine and dandy, but UK T-bills currently yield approximately nothing.

In the US, a T-note is an intermediate-term interest-bearing bond issued by the US Treasury. In the UK, it was a currency note, last issued by the Treasury in 1914, and valid until 1928. It seems we no longer need to worry ourselves with T-notes here in Blighty ..

A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level. As far as I can tell, there is no UK equivalent.

Corporate bonds
A corporate bond is similar to a government bond (gilt) but issued by a company. They are usually issued as a way for a company to raise cash, and are essentially certificates of debt. When you buy corporate bonds you are lending money to a company in exchange for an IOU. The IOU is returned in full at the end of the term and interest is paid annually or bi-annually (also known as the coupon).

Corporate bonds are seen as slightly higher risk than gilts because it’s less likely that the government will go broke.

For example, Hargreaves Lansdown list corporate and non-gilt (non-government) bonds.  Some of the terms and coupons seem quite attractive: A 21-month bond issued by BT paying 8.75%.

Municipal bonds
You guessed it, your local council can also issue bonds to raise cash. Depending on the council, this might be seen as more or less risky than a corporate bond. This recent FT article says that this will likely become increasingly available as an investment option.

Real Estate
Aside from actually purchasing residential or commercial property and gaining an income via rent or realising a capital gain by selling it, there are a couple of investment vehicles that allow you to invest in real estate without directly purchasing it. As an asset class, real estate is in this security bucket because it is a tangible asset – it will probably always have some value above zero.

First Trust Deeds
A first trust deed is a mortgage that has priority over all other mortgages or trust deeds. If the lender of a first trust deed forecloses, all other mortgages, liens and trust deeds are negated. Clearly, if you want to lend money to finance a property, you want to be first in line if things go wonky.

This is probably of only hypothetical interest in the UK because I couldn’t find any mention of trust deeds as an investment option, just as part of a legal mechanism to record debt.

REITs (Real Estate Investment Trusts)
On the other hand, REITs are getting bigger in the UK. You can see a list of current REITs here.

When you buy a REIT, you are essentially buying shares in a company whose primary activity is investing in property. In this sense, a REIT is a hybrid investment in equities and property. Your direct investment is essentially in the equity of the REIT company – and their investment is directly in property.

The advantages are that you can own a share of multiple properties – commercial and residential – without actually purchasing the properties. The investment is more easily tradeable than the actual properties, so there are advantages of improved liquidity and reduced transaction costs. There’s also the ability to diversify between real estate markets as a REIT doesn’t have to be dedicated to UK property. REITs can also be very tax efficient, as the property company pays no corporation or capital gains on the profits made from property investment.

The disadvantages, as far as I can see, are that your investment is only as good as the company issuing the REIT – so it definitily involves some of the risk of making a direct equity investment. There’s also the risk of some disassociation between the value of the underlying assets (the actual property portfolio) and the value of the REIT. Imagine the scenario of a stellar property portfolio being managed by a sub-par company with excessive overheads: That would negatively impact the value of your REIT investment.

I’m interested enough in REITs to investigate further, and because there is an asset base with a fundamental value above zero, REITs could belong in my security bucket.

However, think back to 2008 when all the toxic mortgage-backed investments came to light. Some of them were rolled-up into REITs – and some investors lost out in a big way.

3.5 Reduce fees and taxes

fees matter
Click to read the FT article about fees

Chapter Overview
Tax-efficient investing is rule #1

Thoughts on fund and IFA fees
The book consistently makes the case for low-cost index trackers beating actively managed funds 95% of the time.  In Europe, that figure is closer to 90% according to independent research – but, even so – a definite no-brainer.

I’ve spent the last couple of weeks speaking with IFAs to figure out what kind of an investing approach I should take.  Guess what? Some think index trackers are a good idea as part of an actively managed allocation of assets.  Many replayed a version of ‘paying fees means bigger returns’ so index tracker savings are irrelevant.

After speaking with the fourth or fifth IFA, it occurred to me that they were ALWAYS going to suggest a way of investing which meant me paying fees – to them.

This worked out to be between £2-5K up front and between 0.4-0.7% of assets under management (AUM) to operate the scheme.

Even forgetting about the initial payment, losing 0.5% in fees each year is enough to make any investment outperform or underperform inflation.

Remember, 90% of actively managed funds will not outperform the index.  So what pay 1% extra in underlying fees + 0.5% to an IFA to end up with a substandard investment?

After speaking to the third or fourth IFA, I realised I was doing the equivalent of asking a butcher whether I should have meat for dinner.  Of course, his answer is utterly predictable, just as an IFA will never suggest an investment plan that doesn’t involve the involvement (and fees) of an IFA.

How about using an IFA to set up a sensible asset allocation via index trackers?  Unfortunately, this is the worst of all scenarios.

Using an IFA to set up an actively managed portfolio means that at least you have a slim (10%) chance of recovering the IFA and fund fees by out-performing the market.  Index trackers cannot, by definition, out-perform the average – and paying an IFA to set up a portfolio using them means there’s no way to break-even on the deal.

I’ve yet to figure out my own asset allocation via index trackers, but I’m pretty sure that it doesn’t make much sense to incur ongoing fees in this regard.  Maybe the initial fee might be worth it – but I’m reserving judgement.

In the UK we have two main vehicles for making tax-efficient investments: Pensions and ISAs.

ISAs are pretty straightforward. You put a maximum of £20K per year of your tax-paid money into an ISA – and all of its growth is tax-free.  So if your £20K ISA grows to £30K over a period of time, you can spend all of that £30K whenever you cash it in without handing over a chunk of it to the tax man.

The downside is that you’ve already paid tax on the income which you then invested into the ISA.  The upside is that you know exactly how much you’ll have to spend in the future (barring fluctuations in the value of the investment).

An ISA is just a tax free wrapper for many kinds of investments.  You can have an equities-based ISA (stocks and shares) or a cash-based one – but in reality it can hold a wide range of stuff you want to invest in.

For example, the Alliance Trust platform (truly dreadful and I’m looking for an alternative) allows you to fill your ISA with stocks and shares, bonds, index trackers etc.

Let’s say you’re married and you have 20 years to go to retire and you can afford the maximum ISA contribution of £20K each per annum.

Over the course of 20 years, assuming an average return of 5%, your joint investment pot would grow to be in excess of £1.3M according to this compound interest rate calculator.  At a SWR of 3% pa, that’s enough to give you an income of £39K pa or £3,250pm.

Is that enough or not?  Only you can decide – and remember to take inflation into account because assuming 2% inflation for the next 20 years, that £3,250 pm will actually have the buying power of £2,000 in today’s money.

So, ISAs can be a useful way to save for the future, but what about pensions?

No thanks at all go to our accountants for explaining this clearly to me! There are various different kinds of pension with weird sounding names but they’re all governed by a few simple rules.

There’s an annual limit of how much you can contribute to a pension in a tax-efficient way.  In 2015 that’s £40K pa, previously, it was £50K.  This is a total limit, so if both you and your employer are making contributions, you cannot exceed the £40K max in total.

In reality, you can exceed this maximum – but all the tax benefits are lost because the ‘extra’ is taxed at 55% – and pensions are only interesting because of the tax breaks.

On the plus side, the £40K you put into a pension is not taxed at source, so all of your contributions are made before deducting tax. The downsides are that when you are eventually able to draw on your pension (after age 55), you pay tax on the income at whatever the current rate is at the time.

As of April 2015, there’s greater flexibility in how you can use your pension – but who knows what the laws will be by the time you can eventually access it?

There’s a (current) lifetime limit of £1.25M per person across all pension funds.  So, hurrah, if you have that problem.

There’s also a thing called carry forward whereby if you didn’t use all of your pension allowance for the previous year, you have three years to catch up and make those payments.

Again, ‘pension’ is just a tax-efficient wrapper for many kinds of investment – similar to the ISA wrapper.  Again, via a platform such as Alliance Trust, you can decide what actual underlying investments will go in to your pension pot.

What happens after ISAs and Pensions?
So, you’re lucky enough to have more that £60K a year to save (£20K ISA + £40K pension) – what else is available in the way of tax-efficient savings?

As far as I can tell – nothing.

Schemes such as EIS or VCT do exist but they tend to be a much riskier way of tax-efficient investing.  The advice I’ve been given and read online is to only invest money you can afford to lose completely.

Don’t let the tax-efficient tail wag the investing dog.

Take your tax-paid spare cash and, after maxing out your ISA and pension allowances, invest more into the same underlying investments that you already hold in your ISA and pension wrappers.

2.8 Huge risks / big rewards

Shackleton knew about risk and reward
Shackleton knew about risk and reward

Chapter Overview
Risk = Reward

Another self-explanatory chapter but with a couple of references which are worthy of investigation.

Structured Notes

Wikipedia defines it as: “A hybrid security that includes several financial products, typically a stock or bond plus a derivative. A simple example would be a five-year bond tied together with an option contract. The addition of the option contract changes the security’s risk/return profile to make it more tailored to an investor’s comfort zone. This makes it possible to invest in an asset class that would otherwise be considered too risky.

The book says the benefits of structured notes are pretty much that – participating in some of the upside of an investment while limiting the risk or downside.

It certainly looks like they’re out there too.  This page lists a handful of deals.  I know the book circles back later to deal with this again, so I’ll investigate in detail then!

Market-Linked CD’s and FDIC insurance

The book says that Market-linked Certificates of Deposit are similar to structured notes except that they are insurance-backed by the Federal Deposit Insurance Corporation (FDIC).

The UK equivalent is The Financial Services Compensation Scheme (FSCS) which provides capital protection of £85K  for sole accounts, or £170K for joint ones.

Looking at that previous link about structured notes, all of them have FSCS protection – which seems like an essential component of protecting the risk of loss of capital – the entire point of this kind of an investment.

As with all FSCS protection, it applies to the institution, not the investment.  So, for example, if you had a number of different investments with (let’s say) Barclays totalling over £85K and Barclays went bust, you’d only get £85K back from the FSCS.

It’s worth bearing in mind that for full FSCS protection above £85K, the investments need to be with different institutions.  You can check which institution the FSCS guarantee applies to before making the investment – and it’s not always obvious.

For example, I know that Santander Bank now own Cater Allen Bank – but the FSCS generally applies to all Santander brands, not to Cater Allen.

Here’s a useful, Who owns whom? article.

Fixed Indexed Annuities

Not to be confused with Indexed or Index-linked Annuities. A google search mostly delivers results about the latter type – which are plain old vanilla annuities but index-linked to increase with inflation.

Fixed Indexed Annuities are linked to a stock market index and are also known as equity-indexed annuities and hybrid annuity. Here’s a good article explaining their pros and cons.

Basically, a fixed indexed annuity looks similar to a structured note except that some growth is also protected – compared to the structured note where only the capital is protected.

On the flip-side, the actual amount of growth is capped compared to a structured note.  So while you may be able to lock-in some of the growth AND protect the capital with a fixed indexed annuity – that growth (all other things being equal) is likely to be lower than with an equivalent structured note.

All this is probably academic because I couldn’t find any UK providers of these kind of annuities.