New Sunday Times Feature - Diary of a Private Investor

Monksfield said:

The analysis does not differentiate between capital and income

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Of course it does; that’s what causes the poor results in the BlackRock simulations where the fund is depleted fast: investments must be cashed when prices are down. An artificially simple example illustrates my point: if dividends exactly cover the investor’s income needs every year, then none of the investments will have to be cashed, and the value of the fund at the end (after income has been taken) will be exactly the same, irrespective of the route by which it arrives at the end point, assuming returns each year as per the BlackRock example. The amount of the investor’s income will vary from year to year, of course, but dividends are far more stable than stock prices, so the income will not be nearly as volatile as prices.

I think we may be talking at cross purposes.

Colm is obviously describing a variable withdrawal strategy where an investor only withdraws from the income generated by a portfolio. As I noted in an earlier post, if an investor has sufficient assets/flexibility to only ever need to withdraw from the income generated by a portfolio in a given year then the sequence of returns of that portfolio is largely irrelevant.

The BlackRock example refers to three hypothetical investors that withdraw a constant euro amount from their respective portfolios each year. In this example, the amount withdrawn from each portfolio equated to 6% of the opening portfolio balance and the same amount, adjusted for inflation at an assumed rate of 3%, was withdrawn every year thereafter. The three hypothetical portfolios in the BlackRock example each generated an annualised return of 7% per annum but one portfolio was still exhausted during the 30-year withdrawal period because of the order in which the portfolio returns were generated.

I suspect that the vast majority of retirees will not have sufficient assets/flexibility to pursue Colm’s variable withdrawal strategy to any material extent and will need to withdraw (and spend) something very close to a constant euro amount from their pension pots every year, simply to fund their lifestyles. Volatility matters hugely to such retirees for the reasons already outlined and therefore I would be strongly of the opinion that the vast majority of ARFs should never be anything like 100% in equities.

I would agree with Sarenco, and feel that not only do most retirees not have the flexibility to have a variable withdrawal strategy, most will not be aware of the risk of sequence of returns and the subsequent need to reconsider a 100% equity buy and hold strategy when in their de-accumulation i.e ARF phase. We show clients who have successfully held a buy and hold approach whilst accumulating their funds, what happens in a 5% withdrawal phase if we have a bear market followed by a bull market versus a constant 5% return after costs example. Our working example isn't as dramatic as Blackrock's where one fund is exhausted, as we have both fund values returning to equivalent values after 10 years of a notional cycle. Even in this reasonably benign projection the retiree's income is approx 37% lower over the period and a higher level of nominal growth is required in the 'bear followed by bull' portfolio to equal the 5% constant return portfolio. Clearly the income would be higher if we were to model a 'bull followed by bear' cycle. After a long bull run in equities, for ARF holders perhaps its a reasonably good time to reassess if a 100% buy and hold equity strategy is the best/optimal approach.

I agree that we are talking at cross purposes, and there is nothing to be gained from prolonging the discussion. We both picked extreme artificial examples: the BlackRock extreme example assumed investment in a single asset that did not pay any dividend, and which is cashed once a year to provide the required income; my equally extreme example assumed that the income requirement was less than the dividend each year. The reality is somewhere in the middle, but my earlier point was that the “somewhere in the middle” situation is confused further by the fact that, in the real world, investments are constantly being turned over. My contention (based on my own experience) is that this makes the BlackRock example completely meaningless but I can understand that others may take a different view.

Fair enough Colm.

I certainly take the point that the hypothetical portfolios in the BlackRock simulation do not purport to reflect the actual experience of any real life portfolio over the period.

Having said that, the annualised total return (income and capital gains) of the S&P500 wasn't actually far off 7% over the last 30 years, with an average inflation rate of around 3%, so I don't think these inputs look particularly extreme.

NO!! The point I'm trying (in vain) to make is that it has absolutely nothing to do with the total return on the index; it's how the return is made up between dividends and capital gains/losses. If it's entirely capital gains, then your analysis is correct, but it's not! The BlackRock simulation is completely misleading in that respect, as it assumes zero income.

I'm sorry Colm - I'm obviously missing your point completely.

I really don't understand why you think the BlackRock simulation assumes that the return is made up entirely of capital gains/losses with zero income.

Total return is computed with dividends reinvested, which means that making withdrawals from dividends during a market drawdown means missing out on lower-priced reinvestment opportunities. In other words, surely an investor should be neutral about whether withdrawals are made from the income or principal component of their portfolio?

Absolutely accept that dividends are less volatile then stock prices and if you can afford to largely withdraw from income alone then that very significantly reduces sequence of returns risk. However, you seem to be saying something beyond that.

Brendan Burgess said:

I have locked in a fixed euro/ sterling exchange rate until mid-2016 and the present intention is to renew the lock when the current one expires.

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A little bit of trivia. The £IR broke with £Stg on 30th March 1979. Today the £IR touched parity (€=£.787564) with £stg almost 37 years after the break. Surely this is unique in exchange rate history.

One big advantage of being anonymous is that no one knows when you make a fool of yourself. Sadly, that’s not the case for me in this instance! I completely overstated my argument in my last contribution. You are right, of course, Sarenco, and I was wrong. I still stand by my earlier statement that dividends, even at a relatively low level, combined with “normal” turnover of investments, are normally more than sufficient to meet compulsory withdrawal requirement. It may be just the comfort factor of not having to cash investments at the “wrong” time, but it’s very real for me.

Many thanks for the response Colm. I'm sure I'm not alone in greatly valuing your contributions to this forum.

I certainly wouldn't discount anything that touches on the psychology of investing - it's hugely important in my opinion. Finding a degree of comfort in an uncertain world is really key to the whole issue.

Clearly Colm's articles have stirred some interest for I am given to understand that next Sunday the Sunday Times will be pitting Sean Casey of New Ireland fame and supporting the Unit Linked Party against our hero Colm Fagan of the DIY Party. Surely PaddyPower will open a book

Duke of Marmalade said:

A little bit of trivia. The £IR broke with £Stg on 30th March 1979. Today the £IR touched parity (€=£.787564) with £stg almost 37 years after the break. Surely this is unique in exchange rate history.

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Yes I noticed this fascinating fact too the famous 1.27 rate €/£ is back

Sarenco said:

Many thanks for the response Colm. I'm sure I'm not alone in greatly valuing your contributions to this forum.

I certainly wouldn't discount anything that touches on the psychology of investing - it's hugely important in my opinion. Finding a degree of comfort in an uncertain world is really key to the whole issue.

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+ 1

I will defer judgement on the Great Debate till later but for now merely reflect some puzzlement at the graphic used to illustrate the contest. As I understand it Colm's approach is presented as being akin to buying smarties whilst Sean's is a most precarious dangling from a cliff outcrop with only a rope attached to a young lady standing on top of the cliff saving you from certain death.

Just wanted to say I really enjoyed this discussion, it has confirmed a lot of what I have learned in the 10 years since I first started investing.

1. I have found one of my biggest mistakes in investing is selling winners too soon. When I examined the winners I have had in my portfolio, I have found that by selling too soon, I have denied myself some massive returns. In one case (Apple), I bought shares at the adjusted split price of $13, sold at a 100% profit at $26, only for the shares to go up to $104 today (a 700% return, instead of the 100% return I got). My justification at the time was that Apple was expensive, and that if I sold, I could buy in at a cheaper price later. Of course, I never got the chance to buy cheaper. The error was obvious - market timing on my behalf. The lesson learned? When you have a quality company, don't be afraid to keep holding. Colm mentioned that the first company he ever bought decades ago is now well in multi-bagger territory. Colm is not alone here, Lord John Lee followed a similar strategy with spectacular returns - http://www.ft.com/intl/cms/s/0/ec659efe-c40f-11e5-b3b1-7b2481276e45.html#axzz453CyZCiq

2. You should diversify a little in terms of the number of stocks, but a lot in terms of industries/sectors. There's no golden number, but I think 10 stocks reasonably balanced is a decent enough number to protect you from a shock to one or two. It's also important to diversify sectors. Having 1 oil company is fine, but filling the portfolio with oil companies is not a good idea. Again, I agree with Colm's thesis on this - put your eggs into a few baskets, but watch the baskets closely.

3. Don't try to time the market, invest often. The one exception I make to this is that I do like to keep a small amount of uninvested money set aside to invest if the market goes down 20%. I have a handy rule set up where if an index drops 20% below a moving average, I get an alert to buy stocks. At that point, I don't listen to the news, don't listen to experts, I just buy. It's only in the last 3-4 years of investing that I have actually had the discipline to do this, and the strategy has paid off nicely.

4. Don't be afraid to sell a company that is under-performing. Companies generally can under-perform for two reasons, either due to a downturn that occurs across the sector that company operates in (beware!) or because the company itself slipped (maybe a bad acquisition, or a bad management strategy). The trick is to identify if the downturn is a blip, or something more serious. Tesco was one of these companies that caught me. I think it was about 4 years ago they had their first profit warning. I didn't want to sell on one bad piece of information, and ended up hanging on for another 2 years as bad new just continued to flow. At that point, I looked across the sector, saw that retail was just a mess, and cashed out. Ended up with a slight loss on that one, but at least I gave it a chance and cut my losses before things got worse.

Those would be the major things I have learned and have worked well for me. Colm, I'd be interested to here your thoughts on the bottom two points, if you're still around.

Hi Raskolnikov

Thanks for your very interesting comments. I will try to deal with them below, but first I’m afraid that I have to impart some sad news (well, sad for me anyway): the Sunday Times “Money” section has been dropped with effect from Sunday last, April 3, which means that “Diary of a Private Investor” will no longer appear in the paper. It was fun while it lasted!

On your first point (holding on to winners instead of selling them too soon), I agree wholeheartedly. My investment strategy now is completely different to what it was say ten or even five years ago. I used to be like a magpie, picking of lots of stocks here, there and everywhere, based on something I might have read that impressed me, and then selling them when they had generated a nice profit. Of course, quite a lot of them were duds, and I didn’t have a disciplined approach to getting rid of them. As recounted in the column, I now try to make a detailed evaluation of a share before buying it. I build up a picture of how I think the business will progress over the next number of years. If progress is broadly as I had expected, and the share still represents good value at whatever is the prevailing price from time to time, then I’m happy to hold on, having no regard to how the price has progressed in the past. "History is bunk." In practice, this has resulted in me holding onto shares longer and has also led to greater concentration in the portfolio. I can’t say for certain that the new strategy is delivering better results than before, but I am much more relaxed than previously about short-term fluctuations in share price, provided the fundamentals remain sound (in my opinion of course).

On your second point, I’ve already made my position on diversification clear in the column and on this forum. I agree with you that 10 stocks are sufficient, provided there is sufficient diversification. It’s not sufficient to diversify in terms of sectors however. For example, I now realise that I have a lot of exposure to China through my two biggest holdings, Renishaw and Apple, even though they operate in quite different sectors and one is dependent on retail customers (Apple for iPhone sales to Chinese customers) and the other on wholesale customers (i.e. Renishaw for sales of precision measuring equipment to Chinese manufacturers). On the other hand, companies can be in the same sector with very little correlation between them. Two of my larger holdings are in the insurance/ reinsurance sector: Phoenix Group Holdings and Munich Re, but they are as different as chalk and cheese.

On your third point (keep something in reserve to be able to buy cheap when prices have fallen), what you’re doing seems reasonable but I cannot reconcile myself to keeping more than 5%, or 10% at most, in cash. It’s absolutely dead money and will cost you in the long term. In situations like that, what I have done in practice (as I did a few weeks ago) is to cash whatever investments have fallen the least in value. My bond holding is disappearing fast as a consequence!

I’m running short of time, so I’ll come back to you on your final point tomorrow. I’m going out for what should be a really exciting evening – a dinner for retired actuaries!!!!

Hi Raskolnikov

Coming back on your final point, re selling a company that’s underperforming, you’re absolutely right again: we shouldn’t be afraid to sell, but all sorts of psychological as well as technical factors come into play. That is true even for the professionals. We all find it hard to admit that we made a mistake.

To your list of reasons why a company is underperforming, you can add supply and demand, de-rating, and even fashion. Supply and demand can be a factor for small-cap companies with limited liquidity. The analysts don’t cover them and the share price can be determined in the short-term simply by whether someone is trying to offload or to buy a line of stock. I tend to treat such fluctuations as opportunities to buy more (if the price has dropped) or to offload a few shares (if the price has increased). Obviously, I could be wrong in my judgement, in which case, if the price has fallen, I could end up with too much of a poorly-performing, illiquid stock. It has happened.

If a company is de-rated, obviously the market now thinks that growth prospects are not as good as was thought previously. I always start from the premise that even the highest-flying companies –the Facebooks, Amazons, etc. of this world - will eventually be de-rated. They just can’t grow like topsy forever. When I factor in the possibility (certainty?) of future de-rating, I generally find myself shying away from such stocks. That has cost me dearly by causing me to miss out on the FANG’s of last year, but it also spared me some of the sharp falls in the same stocks in the early part of this year.

My strategy for trying to avoid duds is to buy a small amount of a stock initially. I then study carefully news of its progress, financially and strategically, for a period. At the end of the “trial” period, I decide whether to buy more or get rid of the stock, based on the price prevailing at that time, not what I bought at originally. Daimler, the German carmaker (Mercedes, etc.) is in the “trial” period at the moment. I’m down quite a bit on what I paid for the share. The company’s financial performance is excellent, but the share price isn’t responding. I think the major fear in the market (besides the risk of lower sales in China if there’s a severe slowdown there) is whether Google, Apple, etc. will eat its dinner in a few years’ time. There is also the threat from Tesla, the electric carmaker. The market is obviously treating those threats very seriously, but is it overly worried by them? I’m still not sure which way to jump. If I decide to sell rather than add to my holding, I’ll take some consolation from the fact that the loss won’t be nearly as great as it would have been if I had decided to make a big investment in the first place.

Psychological factors dwarf technical considerations when it comes to selling. I mentioned earlier in this column the endowment effect, whereby we ascribe more value to things we own simply because we own them. One of the contributors remarked (quite correctly) that this phenomenon is related to having an emotional investment in a stock. Both conditions could be at play for my largest holding, Renishaw, which is showing a considerable loss over the last 12 months, but which has stood me very well over the course of almost two decades. I know the top management team (and they know me at this stage from asking questions at AGM’s!); I like the fact that the boss owns almost half the company; I empathise with their strategy of constantly investing for the long-term and of maintaining a strong balance sheet; and with their antipathy towards analysts and their refusal to meet them on a one-to-one basis, as it would mean treating them better than private investors. That may cloud my judgement to their many flaws.

I’ve prattled on for far too long. I’ll finish now.

A couple of days ago, I published an update on LinkedIn of the now-defunct "Diary of a Private Investor" column, which appeared in the Sunday Times for a few months in 2015/ 2016. During the time the column appeared in the Sunday Times, I enjoyed the feedback and challenge from AAM readers.

The people on LinkedIn are timid by comparison: I have had only one response so far to Thursday’s posting, and no challenge whatsoever. I decided that the best way to get the desired challenge was to put it on AAM; hence this posting.

This is it. I'm sure AAM readers will rise to the challenge!

Firstly, I am pleased that the companies that got favourable mention in my Sunday Times column have fared well in the meantime. There were just three of them, so it's easy to give an update.

Renishaw featured twice, on 4 October 2015 and on 7 February 2016. Its share price increased from £18.80 at end 2015 to £25.28 by end 2016 and then more than doubled, to £52.45 by end 2017. In my column of 7 February 2016, I said that Renishaw accounted for over 25% of my equity holdings. The proportion represented by Renishaw is much the same today.

Apple was the subject of my column on 6 December 2015, when its share price was $117. At end 2017 the price had increased to $169.27 and it has increased still further since then, to $178 at time of writing. It accounted for 18% of my equity holdings at end 2015; that proportion has now fallen to 9%.

Phoenix Group Holdings, the third company to get favourable mention in my Sunday Times column, might seem at first glance to be the black sheep of the family. Its price was £9.17 at end 2015; it fell to £7.35 by end 2016 and increased to £7.56 by end 2017. But movements in share price only tell part of the story. I do not invest in bonds: I think they're too expensive. Phoenix is my bond proxy. The dividend yield over the last couple of years has averaged over 7%; I believe it's a safe 7%. The 7% from Phoenix compares with barely over 1% that I could get from a government bond. A second reason why share price movements don't tell the full story as far as Phoenix is concerned is that the sharp price fall in 2016 was mainly due to a rights issue in October 2016. This entitled me to buy 7 extra shares for every 12 I already held, at a discounted price of £5.08 per share. Any shares I didn't take up in the rights issue, I could sell the rights in the open market. The third factor to be considered is movements in the Euro/ Sterling exchange rate over the period. As we know, sterling fell sharply following the Brexit vote in June 2016, but I had shielded my Phoenix exposure from movements in the exchange rate movements in two ways: (1) by borrowing in sterling to invest in a portion of my shareholding - borrowing at (say) 3% to invest in something yielding 7% seemed smart – and (2) by taking out a sterling hedge for the balance of my exposure to Phoenix. Taking all these factors into account, I reckon that I lost about 3% (in euro terms) on Phoenix in 2016, but gained close to 12% in 2017.

I still like those three shares and plan to hold onto them for the foreseeable future. I recognise however that it will be difficult if not impossible to do as well on them in future - Apple and Renishaw in particular - as I have done over the last couple of years.

Given my low-turnover, "buy and hold" strategy, I'm happy to add one good share to my portfolio each year. Last year, I added Samsonite, the luggage company, as a core holding. I bought my first shares in Samsonite in May 2017, at HK$29.30 each, and increased my holding in July, at HK$30.83, in November at HK$33.98 and in January 2018 at HK$34.70 a share. It is now my fourth largest holding, marginally behind Apple. The current share price (1 March 2018) is HK$34.70. It's worth adding that the share purchases were made by borrowing in Hong Kong dollars. This reduces the exposure to currency risk but, as the best magicians say, it's not a trick to be tried at home without careful consideration of the risks involved. I’m hoping that Samsonite’s results for 2017, to be announced within the next few weeks, will justify my confidence in the company.”

Hi Colm

Very interesting reading.

Colm Fagan said:

In my column of 7 February 2016, I said that Renishaw accounted for over 25% of my equity holdings. The proportion represented by Renishaw is much the same today.

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I had shares in DCC which had done so well, that I was too overweight in them. So I sold half and bought Renishaw based on your story.

So thanks for that. Mind you it was the most roller coaster of a ride I had had up to then. ( It has since been outdone by my spread bet on Bitcoin.)

However, no matter how good any share is, you simply should not have 25% of your fund in it.

Let's assume that you are among the .000001% of the analysts who can pick winners.

Even so you can still make mistakes. Or something unforeseeable might happen and wipe out the shares.

I found it very hard to part with my DCC shares and I had a big CGT bill, but it was the right thing to do.

Fond as I am of my Renishaw shares, they are now too big a part of my portfolio. I won't sell half of them, but as I need cash, I will sell them down.

I get attacked for suggestion that a portfolio of 10 blue chip shares is enough. Some of the others here must be getting heart attacks when they see you with 25% of your portfolio in one share.

Brendan

As a general point on the article and picking winners.

Is there a survivorship bias here? If one of your big three had crashed, would you have come back and told us about it?

I could pick three shares which had done very well for me. But for you to assess my stock picking performance, I would have to tell you about all the shares I have bought ever. The Power Securities I chose when I was a stock picker that fell to zero. I think I had another share which fell to zero as well.

Colm - I am sure you have picked duds in the past? Maybe even recently? Could you tell us about your errors?

Brendan

Colm Fagan said:

A couple of days ago, I published an update on LinkedIn of the now-defunct "Diary of a Private Investor" column, which appeared in the Sunday Times for a few months in 2015/ 2016. During the time the column appeared in the Sunday Times, I enjoyed the feedback and challenge from AAM readers.

The people on LinkedIn are timid by comparison: I have had only one response so far to Thursday’s posting, and no challenge whatsoever. I decided that the best way to get the desired challenge was to put it on AAM; hence this posting.

This is it. I'm sure AAM readers will rise to the challenge!

Firstly, I am pleased that the companies that got favourable mention in my Sunday Times column have fared well in the meantime. There were just three of them, so it's easy to give an update.

Renishaw featured twice, on 4 October 2015 and on 7 February 2016. Its share price increased from £18.80 at end 2015 to £25.28 by end 2016 and then more than doubled, to £52.45 by end 2017. In my column of 7 February 2016, I said that Renishaw accounted for over 25% of my equity holdings. The proportion represented by Renishaw is much the same today.

Apple was the subject of my column on 6 December 2015, when its share price was $117. At end 2017 the price had increased to $169.27 and it has increased still further since then, to $178 at time of writing. It accounted for 18% of my equity holdings at end 2015; that proportion has now fallen to 9%.

Phoenix Group Holdings, the third company to get favourable mention in my Sunday Times column, might seem at first glance to be the black sheep of the family. Its price was £9.17 at end 2015; it fell to £7.35 by end 2016 and increased to £7.56 by end 2017. But movements in share price only tell part of the story. I do not invest in bonds: I think they're too expensive. Phoenix is my bond proxy. The dividend yield over the last couple of years has averaged over 7%; I believe it's a safe 7%. The 7% from Phoenix compares with barely over 1% that I could get from a government bond. A second reason why share price movements don't tell the full story as far as Phoenix is concerned is that the sharp price fall in 2016 was mainly due to a rights issue in October 2016. This entitled me to buy 7 extra shares for every 12 I already held, at a discounted price of £5.08 per share. Any shares I didn't take up in the rights issue, I could sell the rights in the open market. The third factor to be considered is movements in the Euro/ Sterling exchange rate over the period. As we know, sterling fell sharply following the Brexit vote in June 2016, but I had shielded my Phoenix exposure from movements in the exchange rate movements in two ways: (1) by borrowing in sterling to invest in a portion of my shareholding - borrowing at (say) 3% to invest in something yielding 7% seemed smart – and (2) by taking out a sterling hedge for the balance of my exposure to Phoenix. Taking all these factors into account, I reckon that I lost about 3% (in euro terms) on Phoenix in 2016, but gained close to 12% in 2017.

I still like those three shares and plan to hold onto them for the foreseeable future. I recognise however that it will be difficult if not impossible to do as well on them in future - Apple and Renishaw in particular - as I have done over the last couple of years.

Given my low-turnover, "buy and hold" strategy, I'm happy to add one good share to my portfolio each year. Last year, I added Samsonite, the luggage company, as a core holding. I bought my first shares in Samsonite in May 2017, at HK$29.30 each, and increased my holding in July, at HK$30.83, in November at HK$33.98 and in January 2018 at HK$34.70 a share. It is now my fourth largest holding, marginally behind Apple. The current share price (1 March 2018) is HK$34.70. It's worth adding that the share purchases were made by borrowing in Hong Kong dollars. This reduces the exposure to currency risk but, as the best magicians say, it's not a trick to be tried at home without careful consideration of the risks involved. I’m hoping that Samsonite’s results for 2017, to be announced within the next few weeks, will justify my confidence in the company.”

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Hi colm
Very interesting update
How do you borrow in HK$ and Sterling ? what are the basic mechanics?
thanks