Investing mechanically with index trackers is boring

My retirement investment strategy has been relatively unchanged since I started this blog in 2009.  When you boil it all down around 90% of it is nothing more than a diversified portfolio of assets that do nothing more than track indices through the use of low cost ETF’s and funds.  Each month I add to this portfolio with new money and all I do is buy whichever asset class has been performing the worst (ie whichever class is most underweight).  Should an asset class ever deviate from its target holding by 25% then I would either buy or sell back to nominal holding.  This however seems to happen very infrequently because of my continual new money entering the portfolio

Let me demonstrate just how boring this all is.  It is the morning of the 3rd of October 2014 and already all of my mechanical index tracking investing decisions for the month have been completed.  This is what has occurred:

• Last weekend, as I do every weekend, saw my Excel spreadsheet that shows my financial position and compares it to my long ago mechanically set target allocation updated.  Boring and absolutely no brain power required.  Total time spent 10 minutes.
• My employer paid me on the last day of the month, Tuesday.  Total time spent to ensure money had cleared in my account was 5 minutes.
• I’m a big believer in the Pay Yourself First mantra and I’m ruthless at it.  This means before I pay any bills, before I buy any food, before I do anything I Save Hard.  So with money in the bank and one eye on my Excel spreadsheet I knew I needed to allocate to cash and so 100% of my savings were moved over to RateSetter.  Total time to move my money and set-up an auto investment in their 3 year market at 5.0% was 5 minutes.  Again, boring and absolutely no brain power required.  
• Over the next few days my employer will get around to salary sacrificing a big chunk of my salary into my employer selected defined contribution pension fund.  I know that my current set-up will have 20% of this invested into an Emerging Markets Index Tracker and 80% will go to an Index Linked Gilt Tracker.  Next weekend I’ll login to make sure that my employer has completed the transfer and the investment is correct.  Total time will be 5 minutes and again it will boring plus require absolutely no brain power.

By next weekend I will have spent 25 minutes managing what is now a very large amount of wealth.  I am also done until next month.  However while it’s incredibly boring and requires no brain power boy is it effective.  Having been at it for a few years I now honestly believe that this strategy is all that somebody needs to build wealth successfully.

How difficult is it to segregate our assets

In the modern, in my opinion overly complex, financial world there must by now be nearly as many investment risks as there are grains of sand on that now long forgotten Spanish beach where you spent your summer holiday.  One of these is that your broker/wrapper/online provider goes belly up and takes your wealth with it because they failed to segregate your assets from their own through fraud, negligence or even good old fashioned incompetence.  Here I am currently most exposed through my SIPP provider Youinvest, my ISA provider TD Direct, my trading account provider Hargreaves Lansdown and the large insurance company (the name of which I won’t mention as I could never recommend any element of their offering) who ‘looks after’ my defined contribution pension offered through my employer.

The same problem exists if the same fate befalls your fund manager.  Here I'm personally seeing significant exposure through Vanguard, State Street Global Advisors (SSgA) and BlackRock (think iShares).

It’s a risk I've known about for some time but on a scale of risks that I’m conscious of I had it ranked fairly low, thus wasn't doing too much about, as I thought that:

1. The process of segregating your customers assets from your own really isn't very difficult so it should occur through negligence or incompetence very infrequently;
2. Given its simplicity non-segregation would be easily and quickly identified by the firms accountants, compliance officers, auditors and/or regulator should it occur; and
3. Non-segregated amounts, should they occur, would be relatively small in relation to total assets under management so result in only a relatively small loss given a large sum would be like an elephant standing in the room for those same accountants, compliance officers, auditors and/or regulators.

News this week tells me that my assumptions were naive and just plain wrong with Barclays investment arm having owned up to having “£16.5bn of clients' assets "at risk" between November 2007 and January 2012”.  This is neither a small amount of money nor a short period of time.  It also happened to occur during the period when Barclays was in severe financial difficulties and had to be ‘bailed out’ by the state investment funds and royal families of Qatar and Abu Dhabi to the tune of £7.3 billion.  It’s also not the only time with them having been penalised back in 2011 for “failing to ring-fence client money in one of its accounts for more than eight years”.  Of course Barclays say that ‘it did not profit from the issue and no customers lost out’ but they would say that wouldn't they and given the timing it could have easily been a very different story.

2 Years to Go

Only three weeks ago I was writing about my 75% of the wealth required to retire milestone and now as I sit writing this post, drinking a tasty homemade coffee which is helping me save hard ( ), it’s time to write about yet another.

Today my top level asset allocation looks like this:

 Click to enlarge

The detail behind this is still very much in line with my strategy that I first published in 2009.  Between the 04 January and 02 August 2014 (funny dates as I record my financial position weekly) this investing wisely portfolio returned 3.9%.  Move forward to today and that year to date return has morphed into 7.0% in around a month.  Should long run history repeat to average this portfolio should return about 4% per annum in real inflation adjusted terms over the long term (it’s returned exactly that since I started this journey in 2007) going forwards.

On top of that I continue to work on methods to save hard:

Click to enlarge

Every little 0.01% helps

Today’s post title will possibly make High Yield Portfolio (HYP) advocates think I'm about to talk about Tesco’s (Ticker: TSCO) Friday action which included a 75% cut in the half-year dividend to 1.16p and a share price fall of 6.6%.  I'm not though because my own HYP contains alternate Sainsbury’s so I'm not (yet) affected plus there is already plenty of good blog coverage on the topic.

Instead I want to cover an important announcement that could with time save passive index investors a lot of money but which for some reason gained no MSM press inches that I'm aware of.  I don’t know why but the cynic in me thinks it could possibly be because the company that made the announcement doesn't advertise heavily and that is what much of the news is today – thinly veiled advertisements.  It was however picked up by the very astute non vested interest Monevator team.  Some Vanguard UK and Irish Domiciled Index Mutual Fund’s, ETF’s and LifeStrategy Fund’s have had their investment charges lowered.

Personally this affects me in the following ways:

• I hold a lot of the Vanguard FTSE UK Equity Index Fund in my Youinvest SIPP.  Ongoing Charges on that fund from Monday reduce from 0.15% to 0.08%.
• I hold the Vanguard S&P 500 UCITS ETF in my TD Direct NISA.  Ongoing Charges on that ETF will reduce from 0.09% to 0.07%.
• I also hold the Vanguard FTSE Developed Europe UCITS ETF in my TD Direct NISA.  Ongoing Charges on that ETF will reduce from 0.15% to 0.12%.

The Two Phases of Wealth Building

Every week I religiously capture the value of each of my investments which I then sum to give me an instantaneous net worth.  This week saw my net worth increase by more than £5,000 without contributing any new money.  For me that is a very large amount of money, and of course Mr Market could take that £5,000 away this week, but it reminded me of the two phases of wealth building that I'm seeing as I'm working to build wealth over a quite short period of time.

The first phase is Building Capital.  As you start on your wealth building journey this is the first phase you pass through.  Here you just want to be adding as much capital to your wealth as quickly as you can get your hands on it.  Saving Hard by Earning More and/or Spending Less will have a much bigger effect in this phase than Investing Wisely.

The second phase is Return on Capital.  Here while Building Capital is still providing a big boost to your wealth it’s now more important to have a stable investment strategy which is very tax and investment expense efficient.  In this phase you could even start to ease of the Saving Hard by for example going part time or taking up that lower paid higher enjoyment opportunity you’ve always desired without moving your financial independence day greatly.

Let me demonstrate the two phases with a simple example (where I’ll ignore inflation) that tries to cover many of the points that I personally live (and have lived) as well as regularly capture on this site.  Average Joe works hard and for his hard work receives £45,000 per year making him a 40% higher rate taxpayer.  Joe wants early financial independence to give the option of early retirement and so starts to think about he might achieve that.  He realises he firstly needs to focus on Building Capital by Saving Hard.  His employer offers a pension scheme where if Joe salary sacrifices 5% of his own salary then they will match it.  There’s some free money there so he goes for it.  Salary sacrificing also brings the benefit of lowering Joe’s taxable salary to £42,750 saving both employee and employer National Insurance.  Joe’s employee NI saved is added immediately to his pension but his employer also generously adds the 13.8% employer NI that they also save.