Puddy muddles
by Doug Brodie
In this blog:
/1. Don’t ignore the objective and debate the detail
/2. Starting with the basics
/3. Two rules of thumb that investors should accept and not debate
/4. Why doesn’t everyone do this?
The analogy of the wet weather transposes very smoothly to the investment sphere: there’s a lot we know for sure about investments, and a couple of elements that turn all the predictability on its head.
This is the stellar year that Scottish Mortgage had in 2020. In that period the return was 112%.
This chart is also Scottish Mortgage:
So if an investor thought the 112% was a cracking reason to invest and jumped in during October 2021, he/she’d have lost 50% in the next nine months. Boo hoo.
The predictability here, like the UK weather, is that investment returns are NOT predictable, so as an investor, sometimes you will most definitely get wet. If you expect that not to happen, then your expectations are wrong, you will be aggrieved and supremely disappointed when the markets turn down, and you are then highly likely to make an emotional, irrational decision.
/1. Don’t ignore the objective and debate the detail.
Many folk come to us at the end of their working career, having had competent, technical careers, mostly with responsibilities attached. It’s only natural that such people want to understand what’s happening with their money, which is why we run lengthy Zoom meetings to demonstrate the nitty-gritty about how income is generated and why we recommend natural income portfolios. However, the overall objective is the income, it’s most definitely not for you to learn the intricacies of inflation-based income investing in a regulated environment.
What you’re reading now is the exponent of a technical function called behavioural economics – the power of this earned Richard Thaler his Nobel Prize, and is further well documented in all the books from Messrs. Kahneman and Tversky (‘Thinking fast & Slow’, ‘Noise’, ‘Heuristics and Biases', etc). The FCA has previously published its own research summary outlining that it saw the worst financial decisions frequently made by over-confident, unqualified men over 50, making decisions DIY and not taking advice.
/2. Starting with the basics.
This is the share price chart of the FTSE 100 going back almost 40 years: it’s wobbly, it’s volatile, it’s unpredictable:
If you invest in the markets the capital will be volatile, it will move up and in lurches and hiccups – if that’s not what you are expecting, then your expectations are wrong.
That chart shows the capital value of the index, the “The FTSE closed 35 points higher today at 7549” value. However, this is the chart for exactly the same index but not looking at the capital, just looking at the income paid each year by that index:
Which one would you prefer to use for generating income for you to live on when you are 64? 77? 93?
What I have shown you here is not a fund chosen by us, not an ‘investment strategy’ we have worked out or a methodology drafted for us by some serious pointy heads – these charts are simple visualisations of the data from the index. We use income because it has always displayed all the characteristics of being reliable and predictable, even if not guaranteed.
/3. Two rules of thumb that investors should accept and not debate:
No major stock market index has ever failed to pay an annual income.
The only ways to lose money investing in the FTSE All Share are a) for all the companies listed in London to go bust, or b) to sell at a price lower than you paid.
If all the companies go bust, you won’t need a pension, you’ll need two large dogs and a shotgun:
(best I could find, sorry: Ed.)
The issue is selling at a price lower than you paid – that’s just irrational. If you have a fund, ETF or trust you’re probably holding not less than 60 companies in that wrapper. If you’re diversified across (say) 8 funds, then you are probably spread across the best part of 400 companies, across different sectors, different industries, different geographical areas.
The people selling out of those funds are generally doing one of two things:
a) selling to re-invest elsewhere, adjusting their asset allocation, or
b) selling because they need or want to hold cash instead.
The un-practiced DIY investor, even the non-specialised IFA or financial adviser, will attempt to jump from peak to peak of the index or the fund valuation, and prey they don’t let their/your money fall in the puddle.
Look back at the very first chart here, the FTSE 100 index, and ask yourself if you or an adviser is likely to successfully hop from peak to peak for the entirety of your retired life. We think not.
Investment trusts use reserves to place a step between the peaks, so your income doesn’t fall. It’s worked for 155 years so far – that’s not a guarantee, but it’s a damn close alternative.
/4. Why doesn’t everyone do this?
In the pension industry they do – I’m talking final salary pensions here. Those pensions estimate the future payments they need to make, source income from their investments plus from the employer, save some cash under the proverbial mattress, and pay out the monthly pensions. You/we don’t have the luxury of sever £000 million in our pensions, so we ask the boards of investment trusts if we can use the reserves that earlier investors have paid, to protect our future incomes. Thank you to the boards, they have always said yes.