Taking a View – Twenty Questions for Investors

Twenty Questions for Investors

Today’s post is a summary of the most important questions that every investor needs to answer for themselves.

Twenty Questions for Investors

The average person has a surprisingly low (to me) level of interest in what a full-time investor/financial blogger gets up to every day.

  • But on the relatively rare occasions that people do express an interest, I usually say that the key factor is psychology.

You need to know yourself and make sure that your plan matches up with your temperament so that you will stick to it.

  • I also say that everything that you need to know about investing could be written on a single sheet of paper.

But last week I realised that I had never actually bothered to produce that sheet of paper.

  • This article is my sheet of paper.

Since the “right” answers are specific to the individual investor (and their psychology), I decided to structure it as a series of questions.

  • I’ll provide some answers that fit me, but you’ll also need to work out your own replies.

So here are twenty questions for every investor:

  1. Time (1) – How long have we got?
    • Unpleasant as it seems, you need an estimate of your likely remaining lifetime.
    • The ONS has stats on this – apparently, I have 25 years to go.
  2. Time (2) – When do you want to stop working?
    • We need to know how long the “accumulation” (savings) phase will be.
    • Subtract that from your remaining lifespan to work out your “decumulation” (spending/retirement) phase.
  3. Money (1) – How much can you live on now?
    • This is one you should be able to work out from your bank account.1
    • I’ll use £25K pa to keep my math simple.
    • The key point here is that the less you spend, the more you can invest, and the more quickly you can retire.
  4. Money (2) – How much can you live on in retirement?
    • Most people spend less once they are retired.
    • The PLSA has three levels for a single person in the UK:
      • Minimum = £10.2K pa
      • Moderate = £20.2K pa
      • Comfortable = £33K pa
    • I’ll use £25K pa again.
  5. What do you consider a safe withdrawal rate (SWR) and are you planning to leave a bequest?
    • This is strictly two questions, but they are intimately connected.
    • The 4% rule is famous, but the true failsafe withdrawal rate is closer to 3% pa real (after inflation).
    • This lets you work out how much you need to retire – a 3% SWR implies a pot which is 33 times your income.
    • So my £25K pa just became a pot of £833K.
    • Add on the average UK house price of £256K and the finish line becomes £1.09M
    • If you qualify for the State Pension (and are prepared to wait until age 67 for retirement) you can cut £304K from that target, bring it back to £785K.
    • The good news is that this target includes a pot to make requests from – if you’d rather spend it yourself, you can increase your SWR to spend the pot.
  6. What does good look like?
    • Another thing that we can use the SWR for is as a return target.
    • 3% pa real is the reliable return from a diversified portfolio (which is why it’s safe to withdraw it from your retirement pot)
    • Recent returns have been much higher in the recent bull market (since 2009) but they are not typical.
    • Using your SWR lets you calculate how long it will take you to get to your retirement number.
    • So 3% plus inflation (say 5% pa) is your first target to try and beat.
    • You should also design a personal benchmark, based on your high-level target allocation.
    • My own benchmark includes UK stocks, international stocks, property bonds and cash.
  7. What level of risk are you comfortable with?
    • Risk in investment is usually translated into price volatility – this is strictly incorrect but practically useful.
    • People don’t like volatility, but unfortunately, the assets with the best returns (stocks) have the highest volatility.
    • We can compare rates of return to the volatility of those returns using the Sharpe Ratio (SR) – higher is better, but too high is unbelievable.
    • When you have a high SR, you can use leverage (see below) to reach any level of return that you need.
    • Another useful measure of risk is the maximum drawdown – stock markets regularly fall by 35% and more.
    • The level of risk that you can tolerate will determine your allocation between risky (return) assets and less risky (stability) assets.
  8. Would you like to save tax?
    • This one should be easy to answer, so the real question is how.
    • The key shelters in the UK are ISAs and SIPPs, plus your primary residence.
    • After those, you have VCTs and EISs and finally spread bets (see below).
    • And never forget to max out your workplace pension.
  9. Do you believe in passive investing?
    • The first thing to note is that there is no such thing as passive investing – we are all taking a view
    • “Passive investing” is really a brand used by fans of market-cap indexing.
    • This is not an optimal strategy, but it does provide a good fit to the market conditions of the last decade, so it’s very popular at the moment.
    • If you do want to go “passive”, you will still need to decide which products to use – ETFs, OEICs or investment trusts (ITs).
  10. If you believe in active investing – can you beat the market yourself?
    • There are two options here – are you a good stockpicker?
    • Or a good market timer? The key here is finding signals that enable you to predict recessions, and hence to avoid the associated stock market crashes.
  11. In either case, you’ll need aks yourself when you understand when to sell?
    • This is more important than when to buy.
    • One of the big debates here is whether to use stop losses (I do – sometimes).
  12. If you don’t believe in yourself, do you believe in star managers?
    • Terry Smith, Nick Train and Cathie Wood would be the current examples.
    • Neil Woodford and Bernie Madoff are (very different) cautionary tales from the past.
  13. A wider version of this question is how much help do you need?
    • If you aren’t ready to go full DIY, you could opt to use a robo advisor (Spoiler alert: they are over-priced and generally use very boring portfolios).
    • Or you might get a financial coach.
    • At the other extreme lie Independent Financial Advisors – these are very expensive and their strengths are sales, hand-holding and regulation – not investment chops.
  14. If you think you can handle DIY investing, the big question is which assets do you believe are uncorrelated?
    • Diversification is the only free lunch in investing, and it depends on uncorrelated returns.
    • At the top level, we have the asset classes – stocks, stock alts (private equity, venture capital, property, commodities, hedge funds), bonds, bond alts (DB pensions, infrastructure, royalties) and true alts (long vol, global macro, precious metals and crypto).
    • Some of these can be divided by geography (UK, US, Europe, Japan, APAC, EM, China), or counterparty (government vs corporate bonds) or size (large-, mid- and small-cap).
    • How many assets you need depends on your portfolio size and your deal size.
    • UK trading costs and holding periods usually point to a deal size of between £2K and £10K.
    • So a £100K portfolio would support between 10 and 50 assets, depending on how many you think you can keep track of.
    • Another big question here is whether you think that bonds are likely to be more or less correlated with stocks in the future, given current economic conditions (you might even question whether you should have an allocation to bonds at all, given their low and potentially negative future returns).
  15. The other big question in asset allocation is how much home bias would you like?
    • The UK only makes up 5% of the global equity market, but research shows that moderate overallocation to your home market (in the 20% to 40% range, say) rarely has a negative impact.
    • I used to target a 25% allocation, but the increased volatility of the pound/dollar change rate since the Brexit vote means that my current allocation to UK stocks is around 12.5%.
    • I have a much larger exposure to Sterling (around 60%) since my non-listed portfolio is all in the UK.
    • You should also watch out for “away bias” – the US makes up 55% of the global equity market, but I equal weight between regions, so I only have around 14% of my stock allocation in the US.
  16. Do you believe in outperformance factors?
    • Academic research shows that there are several ways to outperform in the long run – momentum, small-cap, value/dividend, low vol and quality.
    • Which ones do you believe in today, and how will you incorporate them into your portfolio?
    • Note that growth – the winning strategy in recent years – does not have academic support.
  17. How will you rebalance your portfolio?
    • Most people use annual rebalancing (if anything), but cashflow rebalancing is better – most people are either adding new money to their pot or taking money out of it.
    • An alternative is to use percentage triggers for assets which have grown out of step.
    • Remember not to sell down stocks when they are in a downtrend.
  18. How do you feel about leverage?
    • Since stocks (and therefore diversified portfolios) trend upwards, moderate leverage can boost your returns without adding too much risk.
    • I rarely use more than 2% leverage, but I have come across several investors who successfully use 10% or 15% leverage.
    • Spread bets are the easiest way to access leverage, with the added bonus that you can short (bet on prices going down).
    • Options are an alternative, but they are harder to access for UK retail investors than they are in the US (via RobinHood and TastyTrade)
    • If the thought of leverage worries you, remember that a mortgage is a leveraged way to purchase a property.
  19. Will you hold any satellite portfolios?
    • These can lower your overall volatility and in some cases add to your returns.
    • Candidates include Trend following, Theme sectors (ESG, biotech and tech) & Crypto.
  20. How will you deal with tail risk?
    • We touched on this above when we looked at market timing signals, but you could also look at using trend following and options strategies.
See also:  Cheap ETFs 2016

That’s the lot – how did you get on?

  • Until next time.
  1. Hint: don’t use your pandemic year spend []

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 35 years, with some success.

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Taking a View – Twenty Questions for Investors

by Mike Rawson time to read: 6 min