I’m going to stick my neck out against a common shibboleth here. Compared to many UK FI pursuing people the Ermine has only a short accumulative investing life; this is because I am FI, I haven’t done a stroke of work for more than three years. Because I am earning zilch I still have a very large cash holding of several times my erstwhile gross salary. Some of this was won hard by working for The Firm, but a decent part of it was won hard by investing in 2009 and to a lesser extent in 2011, with a generous risk-free punt assisted in taking up The Firm’s kind offer of Sharesave in 2009 with both hands, yes, please, lots, and a little bit of help from ESIP. In retrospect I could have played the latter far better, but the stupid mind-games played by The Firm hammered my perspective somewhat, and I focused on pension and ISA savings.
Once I get a steady pension income I can invest a large chunk of this. However, I have a shorter investment perspective and can’t take 30 or 40 years to do it because a) I’m likely to be dead by the end of the term and b) the ravages of inflation will destroy roughly half the value every ten years at the long-run UK inflation rates. In comparison, a worker starting out now will steadily earn the money they will invest in the market.
Disclaimer
Most of you have 30,40 years of working and investing life ahead of you. Bear that difference in mind, and remember that this is my opinion. The history of the world is littered with people honestly believing things that are totally wrong. This article is worth exactly what you paid me for it. Remember you are not me. The UK PF/FI-RE blogosphere has changed greatly in the last few years for the better with younger writers looking to escape the rat race extremely early. Most of you are young and in the prime of your working life. You are not me, a grizzled veteran with a dwindling stock of financial ammunition but a decent sized accumulated bunker where I will make my stand. Etc.
This also assumes you are looking at making money through stock market investment. By far and away the best way to make money through your own efforts is to add value through starting a business, which gives returns greatly above the return on a diversified portfolio of stocks, which are basically a secondary market for businesses other people started and sold to us all. The trouble is that the odds against success are absolutely terrible and the lifestyle isn’t that great in the early years either. Which is why most of us are (dis)contented wage slaves working for The Man. Working out whether to pay your suppliers or your fellow humans working for you when the kitty is nearly empty is a peculiar type of stress that employees just never get to experience.
Enough of this disclaimer shit, I’ve done my duty. You have been warned that this may be a total load of arrant bollocks, like anything else on here 🙂
Slow and steady investing in low cost assets is the received wisdom
Received wisdom is that to build capital in the stock market as a wage slave, save a steady amount every month come rain or shine. Do this in a widely diversified low-cost index fund for decades and you’ll be sorted. Minimise platform fees and fund fees and take advantage of tax privileged accounts where possible. Here is a decent instruction manual and here is someone living the dream.
Let’s first take a butcher’s hook at why this works for most people. Basically if you work for 20 or thirty years, then look at the FTSE100 (in practice you’d go for a wider index)
your job is now to find any start period where you are worse off at the end of 20 years that you were at the start bearing in mind that this chart doesn’t show the effect of dividend income so you need to tilt it up by about 3.5% p.a. which is the long-term average yield of the FTSE100.
But it gets better – since you are buying whatever you can get for regular lumps of cash, you buy more in bear markets, Google dollar/pound cost averaging to see how it works. Your accumulated capital is roughly doubled over a normal 40-year working life because you reinvest earnings. Although I am eternally cynical about the magic of compound interest, a doubling is worth having – it is more valuable if your earning power peaks early, which seems to be one aspect of the modern career arc compared to mine. You can simulate your odds on firecalc. I’m not going to spend any more time on talking about how great slow and steady investing is because this is about the counterfactual, for people who don’t have decades of investing ahead of them. Loads and loads of other people are going to give you that spiel, and if you have 20 to 30 years of accumulation then knock yourself out and JFDI. It’s lowish risk, as long as you anticipate there still being a global financial system in 30-50 years time. If you don’t then you have much bigger problems on your hands that fretting about early retirement, and you are misallocating intellectual and nervous capital by reading further. The fundamental win of slow and steady investing was identified many years ago by Jesse Livermore the Boy Plunger
And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!
That’s not to say the Livermore was a Boglehead, far from it [ref]Livermore was an extremely active investor, and not only that, one who favoured shorting stocks. Because stock markets creep up over the long term, you are fighting a headwind as a shorter. Livermore scored by shorting through the Great Depression :)[/ref] , but he was a shrewd operator. In general, the market goes up over the long term. Put the time in the market, and you get more of the up.
Valuation matters more for people with shorter time scales
One fellow raised this a few years ago and got continuously slaughtered for it by the cognoscenti to the extent he shows serious signs of becoming paranoid (Rob, don’t even bother commenting should you come across this tiny backwater – I thank you for your ideas which I came across in 2008 but I won’t tolerate conspiracy theories because life is too short). GIYF for readers interested in the story, the keywords passion saving will take you most of the way there. Nevertheless, if you don’t have thirty years then you should at least look at the Shiller CAPE and ask yourself if this carries no meaning at all to inform your investment decisions – Jarrod Wilcox’s overview is a good summary.
Long story short, run towards fire. Buy when valuations are low. There is a corollary that you should sell when they are high, which I don’t use, because I have come to the conclusion that I am not a good caller of the time to sell. As a result I buy and hold[ref]This philosophy inherently limits me to HYP style dividend paying shares and income versions of funds/ETFs[/ref], I just don’t sell. But I do modulate when I buy, and for the last couple of years when valuations have been high I have not committed new money into the market, I have focused on discharging capital gains tax liabilities[ref]you can discharge more CGT in bear markets because your unwrapped holdings are worth less. But that would come at the cost of shovelling new money into a bear market, so it’s better to defuse CGT more slowly in bull markets.[/ref] by selling unwrapped holdings within the CGT limit and either buying the same or diversifying into my ISA. Yes, I’m buying overvalued stocks, but on the flipside I am selling overvalued stocks so it’s a wash from the high-level view.
I can’t afford long term drip feeding, because it ain’t going to help me fast enough. I don’t have a huge talent for spotting the up and coming. But valuation has served me well three times now, and hopefully will serve me well again if the sound of distant thunder turns out to be an incoming storm.
How to use valuation
Buy in bear markets and/or stop buying in bull markets. Simples, eh? Easy to say and an absolute sod to do, because every other bastard is running like hell the other way. Humans are social animals and seeing everyone else flee makes all of us want to flee. That’s great when dealing with wildfire or bison, but it absolutely sucks when dealing with the stock market. You can know that as much as you like but still find it hard.
Though I am a buy and holder[ref] something else that kills private investors is transaction costs of churning their portfolios in the hunt for the next best thing. It’s very hard to wrap your head around just how thin the pickings are in the stock market, and thus how much of your return you give up incurring any costs[/ref]. I am not an indiscriminate buy and holder. It’s a statistical thing. As the market CAPE falls, you chances or getting a better return in future improve. In market routs this applies to the sort of individual shares I buy too, and investment trusts amplify sentiment by widening discounts in bear markets and getting premiums in bull markets. This gives rise to opportunities like this. I don’t generally buy ITs at a premium, and the one exception was an error of judgement on my part.
There is a second order subtlety for the very well off (as opposed to the stinking rich) which is in bear markets also buy tax-unwrapped as well as in an ISA – in bull markets bed-and-ISA from unwrapped to wrapped. For the stinking rich the amount you can put in an ISA is so paltry it’s not worth the faff or you can pay a flunkey to think about that sort of thing.
How to buy in a bear market
JFDI 🙂 It’s hard when you are surrounded by fear, and it never gets easy. I found it hard in 2009. I found it hard in 2011. I will find it hard the next time even if that is this coming week. Don’t chase the low-water mark – you’ll miss it. Once you have decided a level to buy, do it, and do it steadily over time, and knock it off if there is a recovery of sentiment above your entry level until you have worked out how to explain to someone else why it’s different this time. I set scads of stock price alerts on iii (I used to use iii until I fell out with them, but I still use them for research and alerts). A fusillade of incoming alerts means interesting times ahead. I may reach this point next week, it all depends.
The markets have been tedious as hell these last couple of years. When I start buying, I will see the value of what I bought fall. That doesn’t feel good. It never has done, never will, because we are hyperbolic discounters at heart and the gut feels the immediate loss and can’t zoom the telescope out to the five-year and plus mark. Even worse, we feel loss more than putative gains. I feel that.
One of the most helpful things that anybody can learn is to give up trying to catch the last eighth or the first. These two are the most expensive eighths in the world. They have cost stock traders, in the aggregate, enough millions of dollars to build a concrete highway across the continent.
Jesse Livermore
People say you can’t time the market. Can you call the exact low-water mark? Well, I know of one fellow who managed to do pretty well with the 2009 GFC, though he asserts it’s luck rather than judgement 🙂
The thing is, you don’t have to call it to the day or even the week. A decently diversified portfolio is a statistical thing. If you only have a few years of investing to go, improve the odds – the CAPE helps with that. If you are investing over years – and remember that although my buying horizon is short, my owning and beneficiary horizon could be 30 or 40 years, you can up the odds a tad, but you do so at a downside risk, because your cognitive biases will tend to sit you out of the market a little bit too long, which is why buy and hold gets such a hard push.
To use valuation. you don’t have to spot the low-water mark, just the general low tide. Observing the high tides is also worth doing. These last few years I have avoided the US market with a vengeance, not because I believe American entrepreneurialism has run out of steam, but because the cost of the ticket is too damn high for me. I’d love to own more of the US – it is still more than 50% of investible assets in the world by market cap and I should have got into some of that in 2009. But I didn’t, I focused on what I knew and spend too much time fretting about doom and death spiral deliberations to get my shit together. Those times would have been a great time to buy some of Lars Krojer’s world index fund, because half of it would be American. But I wasn’t thinking in those terms then. I did okay, because in routs it doesn’t really matter what you buy. Just that you buy. Nobody knew in 2009 that the US market would power it’s way out of the credit crunch.
One possible response is to try and become a materialist rationalist [ref]materialist rationalism is how most of the people I know who believe this describe it, but ontological materialism is apparently the more correct description[/ref] but I can’t live like that although I entirely respect other people’s choices (and don’t claim I’m right either, buggered if I know). So I have to work with the frailty of human emotion, but I try not to be it’s slave, though I am sure that I don’t get that all right. I don’t have to hit every ball, just enough. And I do look in the rear-view mirror by unitising my results to ask the question ‘what would have happened if I invested every ISA allowance in VGLS100 or a UKX tracker.
Why the slow and steady approach is better for people with a long-term view – be no forced seller
Although I am poorer[ref]put your damn violins away, this is a relative term – the UK PF scene has welcomed a lot of younger folk often working in finance who are looking for extreme early retirement in their 40s. These guys need to be a lot richer than me because they will be retired a lot longer than me and they will probably live a lot longer too[/ref] than most of the modern clutch of PF writers and therefore I presume readers, my risk and costs profile is hugely different to most of you. I have some intangible advantages and accumulated luck – I own my house outright and I have a defined benefit pension that I will easily be able to live on now Osborne has enabled me to duck the actuarial reduction of drawing early. I didn’t expect that when I retired – a combination of much lower costs in retirement, better investment performance than anticipated and Osborne’s changes helped me. I can take risks that many people working can’t. I don’t have to fear redundancy. If you have a 20-30 year investment horizon then almost by definition you are working, and you need to keep the flow of income going or start drawing down reserves.
Above all else, whatever you do in the stock market, you must make sure you have enough working liquid capital that you are never a forced seller. The reason is because the risks to your income such as loss of job etc are highly correlated with stock market swoons, so if you need to sell in the stock market to underwrite one of those risks you are very likely to find your investments command a poor price. I would go as far as to say unless you have the means to pay your bare-bones running costs for three years, you need to ask yourself whether you should be in the stock market at all, other than in your pension. However, there are ways round this – the disciplined can use borrowing to make up some of the difference. The three-year criterion is because most market swoons come a long way good in three years, which usually helps with job prospects too.
This is called market timing
and there are lots and lots of people who are ready to tell you that the market is efficient and prices everything at the right price all the time and you can’t do that. You should seriously ask yourself what do you know that they don’t before you adopt such a scandalously iconoclastic position 😉 Particularly if you have decades of accumulating ahead of you.
Simple Living In Somerset 
You should be using a logarithmic scale on your (google finance) FTSE 100 chart.
In case anyone doesn’t understand why, here’s an example. Using a linear scale, a fall from 10000 to 5000 looks much worse than a fall from 100 to 50. But a 50% fall is a 50% fall.
Using a logarithmic scale, a fall (or rise) of a given percentage always takes up the same vertical distance (so that exactly exponential growth or decay is represented by a straight line).
LikeLike
Hi Ermine
Interesting article, particularly as I also don’t have lots of time before I need to start taking money out of the pot (until I start to receive my DB and State Pension).
When you do commit funds, do you invest in funds or in individual companies?
At present I favour companies, but if I do need to withdraw capital, it will be much easier and cheaper to do it from funds, so may need to change my strategy soon.
I am currently thinking of taking some of my spare cash and adding to my ISA, but haven’t finally decided as yet.
Best Wishes
FI UK
LikeLike
@Owl agreed – that was a sketchy run of the pros of the default position of a slow and steady approach of which are many. The Barclays equity/gilt study and the FT summary here does a far better job but this was too long already!
@FIUK I’m primarily a HYP shares sort of guy, although the issues associated with valuation run pretty widely across equity investments. I don’t plan to draw down the capital from my ISA for the next 20 years or so, but if I did I’d guesstimate how much capital I expect to draw down a year and compare platform costs and transaction costs. Even if platform costs point away from funds I’d favour ETF indexes then, as selling out individual shares tends to be expensive if you are properly diversified since you need to sell a representative slice
LikeLike
I think a 3 year cash buffer is too big. If dividend re-invested shares outperform cash by 4%, then with a 1 year buffer forced sales in years 2 and 3 can afford 4 and 8% hits, which just won’t occur that often in a 30 year investing life. The forced sales are also allowing you to diffuse CGT which is always building and will bite you if you leave buy and hold too long. It seems a good idea to bed&breakfast frequently to keep those 11k allowances coming, and bear market sales just allows you to reset the clock on more stock.
One tip for CGT, its a huge pain to calculate on drip feed funds with dividend re-investment, lots of piddly little transactions to track and worries as to the nominal dates of purchase when doing a partial disposal. Much better to invest in blocks in different funds, staggered in time, so you can easily assess that selling all of a £40k block that”s not been touched for 4 years and has grown to £50k won’t trigger CGT. It also reduces dealing fees.
LikeLike
@John B – you’re probably right analytically. But remember that the retiree has to live this. He has a gun which has a magazine loaded with all the ammunition he has to fire in his remaining financial lifetime. He’s going to play it safe. Get to the end with half a magazine loaded is very different from falling half a magazine short in defending the bunker.
I’ve carried cash savings worth far more than the risk I was eating. because I don’t ever want to have to go back to work. I’ve tasted freedom from that, and no consumer spending is worth having to suck it up to a boss. So I hoard my powder across the years. I will buy less stuff and go on fewer cruises in my time. But on the other hand, I get to say what I do with every day’s allotment of twenty-four hours. That’s worth a lot to a fellow who once looked into an punk of a manager’s eyes and knew I was all out of options and had to suck it up…
LikeLike
An interesting take. You’ve got to have cojones to keeping buying whilst everything is falling around you. Reminds me of the kipling poem if, if you can keep your head while everyone around you is losing theirs and blaming it on you…. if you can make one heap of all your winnings and risk it all on one turn of pitch and toss and lose and start again and your beginnings and never breathe a word about your loss
let’s just hope it never gets to risking it all on one turn!
LikeLike
A lot depends on where you are in a drawdown profile. If 50 you need to be working your money hard so the 1.04^30 converts 1 year into 3 in the 80s, such is the power of compounding. This risk balance is often expressed as equity:bond ratios, but both fluctuate, its rarely quoted as a equity:bond:cash triplet where each profile adjusts.
One solution is to live within your means, delaying purchases and extravagances in lean years. But for health reasons that Antarctic cruise might not be practical once the recession lifts. The U-shaped spending profile of bucket list ticking, quiet contemplation and nursing home is very hard to model too
Contemplating this at 47 with a father who lived to 89 and an aunt who’s 100, the end game does seem an awful long way away.
LikeLike
@Dom – I’ve got a lot of time fo the values of grit and determination espoused by If…
Although I played against rational materialism in this piece, because my experience of life is that when the chips are down an ounce of inspiration beats a ton of theory, I do think that CAPE offers a way out along the rational axis. It’s enough to stack the odds, you don’t need to find the maximum d(return)/d(t). Just better than you otherwise would have done with pound cost averaging will be fine. You’re not an Ivy league endowment with an infinite time horizon.
But yeah, Kipling showed where the way lies. It should never be underestimated how much intestinal fortitude is required to look at a 50% loss and go “meh. Tomorrow we fight another day”. It’s easy to say, and tough to do
LikeLike
@John B >the end game does seem an awful long way away
That sounds like good news to me 🙂
I’m intrigued by the 3D model of equity/bonds/cash. And also grateful that in my case a DB pension softens some of the calculation.
> But for health reasons that Antarctic cruise might not be practical once the recession lifts.
True, though early retirement helps you get the 30 mins exercise that seems to make a lot of the difference. I find that I also write off shoes and bicycle components at a dramatically higher rate than as a wage slave, just in the process of day-to-day living.
Typical recessions last less than three years. Your physical decline is (hopefully) slower…
LikeLike
One of the reasons I want to get out of a desk job is boost my health. 10000 steps a day and some volunteering with lots of bending and stretching is key. Anyone want their garden pruned?
BTW, I don’t have too much of a problem with contrarian investing, though I do find the daily fund valuations a frustration compared with the instancy of ETFs. But each purchase is a strain, so I’d rather go for bigger lumps than smaller, and it helps with CGT too. In I went on Thursday with a Europe tracker only for it to fall on Friday. But its was better than last week or last month, and you can’t ask to be more accurate than that as a private investor.
I don’t like committing more than 5% in any one transaction, so you win some, lose some. At least its not the house market, where you spend so much more, have huge transaction costs, and can’t liquidate or split easily.
LikeLike
And indeed it seems I guessed wrong, and it gnaws at me a little, but I have to think of it as a 5% of 5% of my savings, which is pretty small.
LikeLike
That be some excellent reading 🙂
Index investing works for me for the moment, not because I think that valuations are intrinsically wrong or sketchy, but because when it came to it I would probably sketch out myself and go into a buy/sell frenzy. When the plan is buy and hold each month with my wage, that’s easier to stick to during a down turn.
LikeLike