A New Financial Year looming, plus the Sound of Thunder in the Distance

April 6 is the new financial year in the UK for some curious reason, as it seems the fiscal year ends on the more rational March 31. I’ve maxed my ISA for now, so the change of year means I get to have another bash at building tax-free assets that won’t be counted as income in future. It’s also a chance to have a general reshuffle. Every so often I have to get to lift the drains up and hose out the accumulated fat and grease of the finances to see if it accords with my values and beliefs. That’s not the same as getting the right answer, because my crystal ball is as cloudy as anyone else’s. but at least it will be my own mistakes 😉

I don’t bugger about with formal rebalancing of my ISA, because I’m just not that kind of guy, and also because I am still in full ISA purchase mode what I do this year could shift my asset allocation by about 40%. So I rebalance by going to buy what I don’t already have a lot of. Which probably means mining, pharma, some REITs and some financials, but I have to research this.

What I need is a jolly good stock market crash this year, so I can buy cheaper. There are distant sounds of thunder – some of the eurozone rumblings and of course all that oil war adventure is probably good for some of this. Some part of me suspects that this distant sound of thunder is the beginning of the end, as Peak Oil starts to overcome industrial civilisation as we have currently set it up. Although I wasn’t economically active in 1973 I was sentient, and we’ve been here before, so I may get my jolly good stock market crash this year, possibly on the popular revolution in Saudi Arabia. The challenge, of course, will be whether it (the stock market, rather than Saudi…) gets up off its knees afterwards as it did then. An awful lot of companies’ business cases would look a lot different with oil at $250 a barrel, and not many of them would look better.

I wasn’t used to how National Savings Index linked certificates worked last year. In particular I didn’t realise that these were desert blooms, only available for a short time after the Spring rains. My plan was to buy £500 of these each month to give me a steady index-linked income boost in three year’s time (now two years). That doesn’t fit with the seasonal availability, so I only got £2000 into that before they were summarily canned. Which sort of put the kibosh on that bright idea 😦

However, NS&I may still serve me well. I have an emergency fund of about £7500 in a two year’s back to back Nat West Cash ISA, which, all credit to them,  has actually continued to provide a3%-ish interest rate. Now on reflection, there is a lot to be said for shifting this to NS&I certificates, because you can

  • get the money out at short notice, although at an interest penalty
  • but it’s a little bit of bother, so you have to think about it
  • and thr RPI indexing means an emergency fund of £10k today will be able to fix the same amount of emergency in five years hence
  • oh yes, and did I say it’s tax-free, so what the heck is the point of sterilising some of my ISA allowance looking after cash?

Which beats the cash ISA option, which dies a little bit by about 2% a year. There’s also an opportunity here – I believe I can transfer the Cash ISA into my shares ISA ands still load up with this year’s ISA allowance, ie I could get £17700 into my shares ISA earning an income for me rather than £10200 into it this year. Of course the downside of that is I have to save the £7500 to go into NS&I in the next month, plus save up £10200 over this next year plus increase my pre-tax savings in AVCs to keep that greedy tyke Osborne out of my pay packet.

That’s a very serious big ask and I may not make it, though my outgoings and non-financial investment costs have dropped. But it’s a potential opportunity.

As to the asset allocation, for myISA I have shifted it to this

March 11 ISA asset allocation

which, compared with December has changed to more accurately reflect my views on what an ISA should do for me. Which is buy me an income that isn’t considered an income for tax purposes. I’ve dropped all holdings of precious metals in my ISA because I have come to the conclusion that an ISA is not the place for precious metals. This isn’t because I have decided holding precious metals isn’t for me, I simply need to get my policy on that right, so at the moment I am exposed to currency debasement big time, apart from my non-financial investments.

Overall financial asset allocation

Overall my total share allocation including pension AVCs and stuff outside my ISA is more balanced. The obvious holes as mining stocks, AsiaPac and the US, all of which confuse me.

The US is home to an enterepreneurial bunch of go-getting people who aren’t known for taking no as an answer, and I am sure this will work to their advantage in future. However, they have some deep systemic problems arising from being a reserve currency, which has permitted some extreme excesses which are denied everyone else. I’d prefer not to be caught in the crossfire of unwinding those debts. The US is also hellishly exposed to Peak Oil, in a way which is so much more extreme than anywhere else.I can imagine a Europe without liquid transport fuels. I struggle to imagine a US without gasoline, with perhaps the exception of New York and some of the East Coast. And the low taxation of oil makes the US economy far more sensitive to increasing crude oil costs.

I am sure Americans may be resourceful enough to sort it, but they really do have to get off their butts and engage, simply repeating that “the American Way of Life is Not Negotiable” is not what I would consider a rational response. I am not sure that the military option is such a great answer either. There seems to be some doubt about whether it increased oil production in Iraq  some say yes, but it is not a universally held view. So at the moment I don’t do America, other than as part of my FTSE100 holdings.

Mining, yes, shame that is riding high at the moment 😦 A missed opportunity from last year.

AsiaPac – with the current state of the pound that all looks jolly expensive. I don’t do China, because I don’t understand it, and the demographics suck. I could combine mining with an Aussie tracker ETF, since mining seems to be a lot of what Australia is about.

I am tempted by India, which has strong demographics and a go-getting entrepreneurial class, though some very serious strategic problems. It is hard to gauge performance where the currency has such a shocking inflation rate of around 10%. db-xtrackers do a GPB denominated ETF but this is a synthetic tracker using derivatives and swaps, which introduces a lot of hidden extra counterparty risks.

Fortunately there’s no great hurry, apart from targeting that NS&I investment in April, and I have a war chest saved which can sort that for me, I will hit NS&I up to aim to hold a total RPI-indexed emergency fund of about 10k, so I can think about how to tackle the ISA over time.

Seeking Shares for income in 2011 – this was easier in 2010

Unlike investors saving for long-term growth, I want income, and over a specific period between 2012 and 2015, between when I plan to leave work and before I draw my pension. I’ll draw it somewhat early, to reduce the annual amount.

The reasoning is that a pension is taxed as income, so if I can build dividend income to top it up in my ISA, drawing the pension early and lowering the annual amount keeps more of my income below the tax threshold, hopefully £10000 by then. It also lets me stop working earlier, which is all to the good,  and I can make up the difference with the income from my ISA, which isn’t considered as income (though note that dividend income is already taxed at source in the UK)

I expect the government to be rapacious in clawing tax from as many places as it can as it fights the economic headwinds, and I want to do as little as I can to help them. Hence minimising income and maximising tax sheltered stuff.

Because of this short time scale I am seeking income, not growth from my ISA, though obviously at the moment I reinvest the income to maximise my tax-sheltered stake.

The trouble is that there is much complication. I target a yield of 5%, and it is hard to get enough diversification in an ISA using individual shares in a high yield portfolio. I try and keep any purchases in my ISA above £1000 and prefer lumps of £2000-3000. By using the grouping function of my ISA provider I can get trading costs down to £1.50 Since you can put at most £10,000 a year into an ISA, if I focused all my ISA as a HYP I would be woefully undiversified for a long time, accumulating 5 different shares a year.

Investment Trusts – diversification for a smaller stake

That is short of the required 15 according to TMFPyad or 20 according to Monevator. This year I cheated and used an investment trust, Merchants Trust, which I bought in July when it was at about a 5% discount. I bought a reasonable stake in it, MRCH is about 30% of my ISA, and planned to carry on purchasing similar sized lumps of another IT, next one around this time of year.

I fund my ISA from saving from earnings so I can’t load up at the beginning of the year as you’re supposed to. Plus I get some temporal diversification in buying through the year, which in a world of bear markets and double dips is no bad thing.

However, on looking at the investment trust market I observe that clearly I haven’t been the only person with this bright idea and I’d now have to pay a premium for most income investment trust including all the ones on my shortlist, so that idea has now been stuffed. I’m obviously chuffed with my existing investment in MRCH and that can stay right where it is, it’s just a pity that I didn’t get some more at that price.

The DIY High Yield Portfolio (HYP)

So I have to look again at doing this HYP job for myself. Upside is no annual management charges, but the downsides suck, big time. They include that inherent lack of diversification to start with, the fact that I don’t have an illustrious career behind me as a stock-picker (I was hammered in the dot-com bust), and that the whole thing is a somewhat mapless territory. I really liked the investment trust route, and hopefully NAV premiums will go away.

However, I have to deal with the world as it is rather than how I’d like it to be, so some study of the theory behind a High Yield Portfolio is in order. I fully expect the double dip recession to return at some time in the coming year, which is good for share buyers though toxic for the value of a HYP. It may not be as toxic for the income from the HYP, however, it would be nice to see an analysis of that…

Real Estate Investment Trusts

If diversification were my aim, one class of investment I have no exposure to is commercial property. I hate anything with the mention of property in it as an investment – I sold the first house I bought at a 40% nominal, probably >50% real loss. Property is a dirty word all round for me. Let’s look at what commercial property is (the REIT I am considering is BLND)

It’s retail parks, warehouses and a lot of office space in London. Well retailers are going to do really well in the coming year aren’t they, what with VAT up, taxes up, Internet shopping up, punters squeezed on all counts. They’ll take an occupancy pasting in 2011. Office space in London, conversely, I feel okay about. The bankers will moan about relocating the top brass to Zug but they’ll still employ grunts in London.

Then we have the financials – unlike anything else I have ever seen. PE way down at 4-ish (I normally like to see that below 10 but have never seen anything below 5 that isn’t obviously dodgy) dividend cover way up at 5, yield of almost 5% (nice, I like that) and a decent dividend track record though the distribution frequency has changed from 2x a year to 4x.

There’s much to be said for buying something that the market hates, and that PE screams that the market hates BLND (and its stable-mate Land Securities which have very similar metrics) with a vengeance. I haven’t yet discovered why. Obviously the prognosis for commercial property isn’t that great, but it looks like these guys can eat a serious drop in rent income and still keep the lights on. And I do like that yield, so I am tempted.

I need another high-yield share around now and AZN comes to mind, yield about 4.5, PE about 10 and dividend cover of more than 2. And a very respectable dividend growth history. I already hold some of them as 3% of MRCH, the obvious competitor GSK is 7% or MRCH

All in all this whole HYP is a drag to try and do myself, but I can’t hang around in cash waiting for IT premiums to fall as I can’t call when the second dip will come along. So what I will do is build a HYP over the long term, accepting that I could get hammered by the lack of diversity in the early years, and divert my savings to ITs when they look good value.

That way the IT approach will give me the security of diversity, but I will still be able to build up my income when Mr Market is offering a poor deal on investment trusts. I don’t see a bull market turning up at any point while I am building my stake, which is when Mr Market offers a poor deal on everything.

Let’s just take time out to remember what the point of all this is, then

Sometimes at turning points in the year it is good to lift my eyes from the fog of war, and remind myself why I am doing this. I have already missed the boat according to the criteria here (I have been working for more than 25 years). It is also good to take inspiration from people who have managed to escape the rat race, even if it means living very unconventionally.

asset allocation review part 2 and passive investment

Lookinag at RIT’s carefully honed asset allocation, and pondering some of the comments on my post on why passive investing isn’t for me, I figured I might as well consider my own asset allocation. One of the parts I struggle with in the concept of passive investment is indeed the very act of choosing an asset allocation. In this post, TA/Monevator offer up nine different approaches.

They’re all good, I assume, but as soon as you’ve chosen one of the nine you are no longer a passive investor. You are projecting your own hopes and fears for the future upon the empty screen of your ISA; you are choosing and making an opinion. Okay, it’s better than following share tips in the Torygraph – you at least choose a consistent direction for your course, rather than selecting a new direction every day. But you have chosen a direction.

I’m opinionated enough to be prepared to declare my asset allocation is a function of my hopes, fears and expectations, my imperfect comprehension of the economy as a whole, of how I view my imperfect state of knowledge, and what I consider the downside risks to be.

ISA asset allocation

This only shows my ISA asset allocation – I hold more than my ISA in pension AVCs but I don’t have the sophistication to be able to factor them in. So how does my asset allocation reflect my views?

Well, I am distrustful of the UK government, which I believe will debase the currency, shafting savers and hastening in serious amounts of inflation. So the gold and silver holdings (these are ETFs) should be no great surprise. They let me think about things without having to worry about the likes of Mervyn King silently stealing the shirt from my back devaluing the £. Devaluation was bad when I first came across it as a child when Harold Wilson did it in 1967 and no things aren’t different now, it’s still bad. I hadn’t intended to be so overweight in gold and silver, but they both appreciated seriously over the period I’ve been holding them. Or should I say the £ has gone down the toilet while they stayed the same?

The fixed interest and the dividend targeted holdings (investment trusts focusing largely on UK FTSE 100/250 constituents) are a logical consequence of my need for income in the space between two years from now and five years from now, after which the income will compensate me for drawing my pension early.

The emerging markets (=IBZL in my case) is part of the zeitgeist and my expectation that countries with a young workforce and oil reserves will have a better future than the bombed-out and indebted West. Next year I will add to that. I don’t do China – I don’t understand it and don’t trust it, but I will do India, a bit of Australia for their natural resources, possibly Canada for resources, and more of the same UK based IT wise.

I’ll probably give gold and silver a rest unless the Euro or the $ go belly-up, the former for daft attempts to synchronise Greek wastrels with doughty Germans without a Central Bank of Europe and a Central Tax Office of Europe, the latter for the mind-blowing whirlwind that will follow the loss of reserve currency status if the Chinese and the oil producers get their way. I don’t actually want such a high weighting on that, so I will dilute it by focusing on other classes with next year’s ISA allowance.

What’s wrong with my asset allocation, well, no exposure to other emerging markets. In an ISA you can only do so much in a year otherwise you end up with a zillion fragmented holdings, so I will take some of that on next year. No bonds – I don’t understand bonds, I don’t like them, and my pension to be  provides much of the function bonds would in a retirement portfolio so I can afford to indulge my prejudices and ignore this asset class. I may consider commercial property via REITs though it’s another asset class that I don’t understand so I may go with Warren Buffett on that one too – don’t invest in what you don’t understand…

Considering my overall net worth (updated 23 Dec because I got the original chart wrong re gold)

net worth asset allocation

the picture is more balanced, though it is overweighted in cash for someone who spends time moaning about profligate government inflation stoking. Howeer, most of it is in a cash ISA and some of the rest is in NS&I index-linked certificates. Some of this is simply the standard personal finance emergency fund at work, but I target much more than the three months running costs standard recommendation. I will run, not walk, to the dooors of NS&I if they offer more RPI linked savings certificates in future.

This doesn’t reflect the value of my house or the nominal value of any of my non-financial investments, because then ‘other’ would eat up most of the clock and compress the categories into a wedge and make it hard to read.

So there it is – an unashamedly opinionated and un-passive investment asset allocation. In the end money is only crystallised power, and I can’t relate to an investment approach that tries to be unemotional, it doesn’t work for me. If I want to project force, then I must couple my values and beliefs to it. That doesn’t mean I have to chop and change on a daily basis – though my views to the future change over time, they don’t swing that dramatically day to day.

Obviously I must accept the imperfect nature of knowledge, and my own awareness and limited skill. It is why I invest in the stock market even though I believe there will be crash mk2 in the years to come, which could wipe me out totally in financial terms. That is why I invest as if the glass is half full, and at the same time as if it is half empty. It’s not just asset classes where you need diversity – it is also in world-views.

Although passive investing doesn’t sing to me, there is one behaviour that goes along with that which I have adopted. It is the Warren Buffett doctrine – buy and then hold. You have to screen for a reasonable price if you do that – the old drip-feeding idea also doesn’t really cut it for me. I want to buy cheap, and then hold, which means I have to sit and simply accumulate cash if I can’t find a suitable opportunity. However, the stock market of the last few years happens to suit my buying phase, particularly where I am chasing income.

There’s nothing wrong with Schizophrenic Investment

…so long as you’re doing it for a reason 🙂

Monevator berates the Chicken Littles among us for

Yet people far prefer to read doom and gloom disaster stories from people who sound wise by not sounding happy.

and he’s right  – he’s been quietly making money from having the brass nuts to go in to the market in March 2009 when Mr Market was feeling really pissed off and buy by the bucketload. And he’s been consistenly upbeat. What tickled me, however, is that he knows the dirty little secret of bears

By all means keeping reading the bearish blogs, and hear both sides of the argument. But remember many such writers will never change their tune. They’ll either quietly start talking about stocks they bought six months ago, despite their publicly gloomy convictions.

Ah, it’s a fair cop. I’m going to be particularly ornery here. I’m not going to change my tune, and yet I’m happy to ‘fess up that I have been buying since April 2009 (I didn’t have Monevator’s chutzpah) – Legal & General UK/World 50:50 trackers. I’m also happy to tip my hat that it was his March article that crystallised my gut feel to try throwing some money down what looked like being a pretty large drain, in drips so I didn’t get killed all in one go.

These trackers are dreadfully boring (though their perfomance isn’t) so for some excitement I’ve been adding to that, diversifying into Brazilians (ETFs that is) while the £ was still worth something and some UK investment trusts after reading this article, digesting the information and considering my specific requirement for UK income in future. My bearish side comes out in some gold, though after some reflection that is in an inappropriate format. ETFs are real but exchange traded commodities are not the same thing at all. They are achieved with smoke and mirrors.

Oh an I made a right pillock of myself in losing £400 on BP by lacking consistency in what I did. That’s not so bad and I relearned an old lesson, the education was cheap at the price 😉

And yet I’m still a bear.

Why I’m A Bear

Basically I think the Western world is shot. We carry too many passengers, we’ve got lazy and fat during the good years (some of us literally!). We don’t make anything any more. Look at the telly and popular magazines and it’s all bread and circuses, the sickly stench of decadence reeks, plastic celebrities and paper-thin characters, though some of them are mighty easy on the eye.

Our schools don’t differentiate between the clever and the stupid, and too many of us live on the never-never, without the personal accountability to pay for what we want to use or do without it.

Trouble is, as the bread and circuses quote shows, people have felt like this in every generation. They probably didn’t grouch about what was on the telly in AD100 but I’m sure the crabby old gits grouched about the celebrities. So that in itself is no reason to be a bear as far as the stock market is concerned.

The reason I’m a bear is because our economy is predicated upon the myth of continual growth. Our money system needs growth, else it quietly dies on its feet. We even define a recession as two quarters of negative growth. We just don’t do non-growth.

The reason we get away with that is because we are using up a free gift from millennia past. That is reaching its peak production, and unluckily for the West in particular, we are getting old and stale and this happens at a time when there are a lot of new middle-class consumers in Asia who haven’t had the lifestyle we have become accustomed to all wanting a slice. You can’t blame them, but the last time I tried dividing a cake up among twice as many people as orginally intended everyobody ended up short.

The increasing scale of capitalism and the ease with which goods and services can be moved around the world means that wages will be levelled down. If it weren’t for resource shortages it could be quite possible that the total amount of capital in the world would increase even as Western living standards decrease. That would, paradoxically, make me into a bull – it would be a case for intelligent asset reallocation. Factor resource shortages of oil and later some raw materials into the equation and I become a bear.

In particular I don’t trust Western currencies and the £ (and the $ for that matter) to hold their value to the long term at all. I’ve addressed some of this by buying stuff – owning my house outright, and after that buying capital assets which give me some independence from some common costs, and business opportunities. The house is in some ways a daft move, I fully expect house prices to fall to the standard 3.5x average salary, but you always need somewhere to live, and owning it outright gives a certain peace of mind.

so why was I buying shares at nearly the same time Monevator?

Because I’m one of those duplicitous bears, you can’t trust them further than you could throw them? Not exactly – I view this as simply another example of diversification. Though I believe the macro-hazards will get us, I don’t know when they will. Unlike the finacial pundits and guys on the TV and newspapers who make money from having a strong opinion, I can afford to know that I don’t know.

It therefore looks entirely reasonable to me to play both sides of the field, and put half my assets to a tin-hat portfolio of real stuff, to hedge currency death, and the other half towards the sort of world Monevator describes. Most things revert to the mean, and in that case my shares will continue to rise. Then eventually I’ll go on those foreign holidays I passed up while unconventionally actually paying off my mortgage. Presumably that will be in electric airliners powered by thorium reactors.

Hopefully by then everybody in the world will have a living standard such that they produce fewer than two children on average, we will have worked out an economic system that doesn’t demand continual growth, and there will still be some wild places, with birds in the air and fish in the sea. It could happen. I don’t think it will, but if there’s any chance then I’m up for it, yes please, bring it on.

So I think Monevator was hard on the bears. There’s nothing wrong with a bear knowing the limits of its wisdom and the power of his crystal ball. It’s far more interesting to write about what’s wrong in the economy, and the bearish argument always sounds smarter. On the other hand he’s quite right to grouch about the lack of overall balance in the PF blogosphere.

I am bearish of view, and this generally reflects my opinions. I’m not so sure this is a typical PF blog however. Heaven help anybody who is under the impression this is investment or economics advice! My situation is quite unusual, in owning my house and in not having children, so the world will look a very different place to me than to most Brits 🙂

So I’m happy to ride the wave with Monevator. I do it to have exposure to an alternative reality from what I expect, because the data that forms my expectations is noisy and sparse, and distorted through the lens of my own hopes and hangups. A kind of diversification in expected economic futures, maybe. Diversification is a good thing in investing – it means you only get half  killed rather than wiped out if you’re wrong 😉

Dogs of the FTSE 100 – chasing yield

miscellaneous mutt image
Not this sort of dog!

As someone looking for an income from my capital assets, I am going for dividend yield in my shareholdings. There’s no rule that I have to get an income from dividends rather than growth, but realising an income from growth means selling itsy-bitsy numbers of shares.

The majority of my holdings are in the L&G Global 50:50 fund because that’s one of the three funds I can save AVCs in and I was able to save half last year’s salary tax free in it.

The principle behind Dogs is to look for stocks that are currently unloved (the share price is low) and have high dividend yields. Select the 10 highest yielding stocks of the FTSE 100 every March, buy an even cash amount of each, then leave for a year and re-evaluate the next year. Sell the ones that aren’t dogs any more, (hopefully at a profit 🙂 ) and purchase the new Dogs, keeping the per-Dog amount around 10%. An analysis of the results of this approach is available here.

The risks are clear – though companies in the FTSE 100 don’t usually go bust a high yield usually indicates there’s trouble in Paradise. Either the company has fallen out of favour and the price has tanked, or a share split has happened, which means you are looking at the dividend which came from a share that is now represented by 10 shares. In that case you’re not comparing like with like (Cable and Wireless seem to be like this now). You need to screen the candidate Dogs against this sort of thing, and eliminate any which state future dividends will be slashed.

My ISA is small – I could only fund it with £3600 last year as my cash ISA emergency fund blocked half my ISA allocation. So my opportunity to get into the Dogs was limited. However, in my search for yield, I ended up with two Dogs already – BP and National Grid. I work for another Dog (have just checked and its recent share price appreciation means it is Dog no more), and through the  employee share purchase plans I have more than enough exposure to that Dog.

There’s something disturbing about inadvertently setting up a Dog fund in my quest for yield. Having read this Money Observer article on the Dogs strategy, this year I may look for Dogs with intent. After all, it seems to align with my values, so I will use my ISA allocation to load up with the remaining 7 Dogs next Feb/March.