Investing: Back The Winners Or Buy The Bargains | Rebalancing The World

A properly diversified stocks portfolio will cover the whole world and be made up of ETFs or funds that allocate across all geographies.

Many investors do this by owning a single product, such as the Vanguard All World ETF (VWRL).

Others prefer to piece together a global position manually with several ETFs.

This way they can choose how much of their portfolio to allocate to each region – perhaps to place greater emphasis on the emerging markets and less on the USA.

This second approach will include the act of rebalancing, an important annual task if you own more than one investment.

Apart from the allocations, these methods are pretty much the same, right? Wrong. They are massively different approaches: one method compels you to back the winners, while the other buys the bargains.

So which approach is best? The all-in-one approach, or owning several regional ETFs?

We’ll look at the arguments for and against both methods and whether it makes a difference in which you go with.

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2 Approaches To Equity Portfolio Building

The most popular approach to world equity portfolio building is to do just that – build a portfolio using multiple funds and ETFs, and even individual stocks, to choose your own allocation.

The other way to do it is to buy 1 fund that simply tracks the entire world by market capitalisation – such as Vanguard’s All-World ETF.

The all-in-one approach tracks the world markets faithfully. When a region outperforms, the fund composition changes to have a higher allocation in that region.

Whole world indexes have only been around for a few decades or so, but we can see how a world tracker would have moved between 1900 and 2012 in this study by Credit Suisse.

World market capitalisation over time

As national stock markets rose and fell over the timeframe, more prominence would have been given to America and less to the UK and France.

And we know that in the years since this study, US stocks have continued to grow to around 55%, and UK stocks have fallen to around 4% in global market cap.

A world tracker automatically backs the winners. This is different to a set-and-forget multi-ETF portfolio, which in fact does the opposite at regional level.

The regional approach sets allocations for several world regions, which usually include the US, UK, Europe, Japan, Rest of Developed Asia, and Emerging Markets.

The allocations you assign will soon become different from the actual allocations, because of drift from over and under-performing regions, and must be rebalanced annually to bring them back in line.

It is this rebalancing that forces you to reject the winners and buy the bargains.

Rebalancing

The job of rebalancing is to bring your asset values back in line with your initial target percentages.

Once a year you’d reduce your position in the best performing ETFs, and increase your position in the worst performing.

This controls risk by not having all your eggs drift into one temporarily-overperforming basket, and theory says that it is likely to deliver a performance boost over the years by forcing you to sell high, and buy low.

Reasons To Just Use A Single World Fund or ETF

#1 – No Need To Choose Allocations

The story of the last century has been America’s outperformance over all other stock markets, and the decline of the old-world countries into market-cap mediocrity.

Looking back at that pie, a multi-ETF portfolio that weighted regional allocations toward the market cap of the world at the time would not have done nearly so well over the long term.

Someone investing in 1900 probably grew up knowing that the UK was the powerhouse of the world, and if they’d built their own portfolio they likely would have been happy to overweight the UK – and would have been wrong to do so.

It might have been better to have the process automated by just tracking the world.

#2 – Backing Winners With A Track Record

Backing world winners is a good strategy in itself. These companies have proven they can do well, by securing such high market caps.

These companies will likely have competitive advantages and good management teams which were capable of making strong profits in the past, and so will likely be able to make strong profits again in the future.

The companies a world tracker focuses on are the ones with proven track records.

In its own way it is guessing which areas of the world will do best in the future, based on proven tracks records of market capitalisation, while removing the need to rebalance.

If you have ever rebalanced a portfolio, it’s hard to escape the nagging feeling that you’re throwing good money after bad.

“Why am I selling S&P 500 stocks to buy Japanese ones?”, might be a legitimate complaint. “Why am I swapping Amazon and Google for Toyota and Nintendo?” Maybe there’s something to be said for backing the winners instead.

#3 – Structural Reasons

Choosing to use a single world tracker is a rejection of guesswork – by which we mean you don’t need to set initial regional allocations – and also a rejection of favouring underperforming regions.

There’s good cause to suspect that there are structural reasons why some of these regions are underperforming and will continue to do so.

The poor relative performance of the UK stock market is largely compositional, meaning the sector allocations of its indexes help explain poor performance.

For example, as at the end of 2019, more than 20% of the FTSE 100 was in financials.

That is significantly higher than for other major stock markets – 13% in the US and 16% in Germany.

Tight regulation of financials since the 2009 crash leaves 20% of FTSE companies with little room for manoeuvre to make profits.

Countries like America and Germany have natural advantages. America is the size of a continent and is heavily weighted towards tech stocks, which by their nature are very innovative.

Germany is known for and has always had a strong car manufacturing industry that has outperformed. There’s a high chance this will continue, so why sell these stocks if they do well?

Reasons To Build A Custom Portfolio Of Regional ETFs/Funds

#1 – It Can Be Cheaper

You might set your initial allocations more towards cheaper stock markets, i.e. those with a lower PE ratio. And the act of rebalancing forces you to sell high priced stocks for cheaper ones elsewhere.

The PE ratio of the UK’s FTSE100 index is 18, while America’s S&P500 is 25.

Having the freedom to allocate a higher percentage allocation to the UK than the Vanguard All-World ETF’s tiny 4% means you could buy more UK at a potential bargain, with the assumption that PE ratios will eventually level out.

Backing winners is expensive. The long-term average PE ratio for the S&P 500 is 15, far below where it sits currently at 25.

If you like to bag a bargain, rebalancing a custom multi-region portfolio can do this.

A one-fund portfolio that moves to track the world will favour more expensive stocks.

For example, if Tesla doubles in price, and other stocks stay the same, its market cap will go up and so the fund will gain a higher exposure to Tesla.

#2 – Emerging Markets

Backing winners doesn’t have to be only based on track record. By building your own custom world portfolio, you can choose to back nations that are poised to do well in the future – the Emerging Markets.

Emerging markets turn into developed ones. Remember that many of the developed countries we know today were once emerging markets.

China is widely expected to become a major competitor to the US over the coming years, possibly even overtaking them economically.

Having the freedom to allocate your portfolio manually more towards the Emerging Markets means you will reap a higher reward if China or other emerging markets have a growth spurt.

The Vanguard FTSE All World ETF only has 5.6% in China.

We don’t know how much this will change over the next 20 years but we’re betting it will take a much larger piece of the world pie.

Maybe it’s a good idea to customise the allocation more in favour of the emerging markets now, rather than waiting for a world tracker to catch up?

So – Which Approach Is Better?

We can’t conclude which method will turn out better as the future is unclear, and historical data we have access to doesn’t go back far enough to properly compare what would have happened over a meaningful timeframe.

The multi-ETF approach has the following going for it:

  • At asset class level, the act of rebalancing stocks against bonds has been proven to reduce risk by keeping to a fixed allocation – logically that should apply within the stocks category too
  • You can custom build your allocation towards cheaper markets
  • You can custom build your allocation towards emerging markets, or any region you like

But the historic returns under such a portfolio are unknown.

As for single world trackers; the index behind the Vanguard FTSE All World ETF has history only going back 15 years – not long enough to draw conclusions.

But we can look at other world indexes to see how well a single world tracker would have done.

Over the last 51 years since 1969, the MSCI Net World Index, which tracks stocks from developed economies, has returned an average of 8.7% per year.

Maybe you think an 8.7% return is good enough to not have to worry about which approach is better.

Maybe you could squeeze out a higher return by using multiple ETFs – maybe not.

The MSCI World Index strangely doesn’t include the Emerging Markets. For that we would need to look at the MSCI Net Emerging Markets index but the data we could find for that only covers the last 20 years.

Over that limited time frame it returned on average 8.8% annually, which again is pretty good.

Don’t Overthink It

The conclusion is, don’t overthink it. Whichever of these 2 strategies you choose you are likely to do very well.

Let us know which approach you’re taking in the comments below!

Also check out the MoneyUnshackled YouTube channel, with new videos released every Monday, Thursday and Saturday:

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Why 100 Minus Age Rule Doesn’t Work (Shares Vs Bonds Asset Allocation)

A frequent dilemma faced by investors is, what asset allocation is best? What percentage of your portfolio should be in stocks and how much in bonds, and how much, if any, should be in other asset classes? – property, gold, cash, crypto, and so on.

The answer to this question could depend on many factors such as attitude to risk and age. The ‘100 minus age rule’ seeks to answer this pertinent question but does the rule work? Did it ever work?

In this post, we’re going to first look at what the  ‘100 minus age rule’ is, then look at the problems with it, and then suggest some other options so that you can maximise your investment returns for a given level of risk. Let’s check it out…

Stocks vs Bonds

It’s generally recognised that stocks will outperform bonds over the long term. There are many studies that go back several decades, and the Barclays gilt study goes as far back as the year 1900.

We think the conclusion of this study is stunning – see below. It shows that stocks have absolutely annihilated UK government bonds over time. For the 115 years analysed, a £100 investment in equities would have grown to over £2.2m. But the same £100 invested in gilts would only have returned just £36,000. Note that the insignificant rounding we applied to the equity figure was the total return from gilts. I mean that’s says it all – the gilt return is a rounding error.

 

Armed with this knowledge you might think that this means you should invest 100% in stocks, but unfortunately it might not be that straightforward. There have been long periods when stocks have not only underperformed relative to bonds but have also had negative returns spanning many years. This could be a problem if that stock market underperformance period happens to fall during the years that you’re investing.

Government issued bonds such as UK gilts and US treasuries tend to be far less volatile than stocks. This means they can be ideal for investors who cannot handle the huge swings that you often get with stocks.

Not only that, but stocks and bonds react differently to the things happening in the economy. For example, a change in interest rates will have a direct effect on bond prices. That’s not to say they don’t impact stocks at all, because they do, but the impact is not as prominent and is more indirect.

To get to the point, stocks and bonds behave differently and holding both in your investment portfolio can reduce volatility and help to increase the chances of steady growth. This will likely lower overall returns over the long term but may help an investor to sleep at night as it hopefully avoids huge portfolio losses at any one time.

What Is The 100 Minus Age Rule?

As we just discussed, most investors will want to diversify across asset classes because it enables them to maximise return for a given level of risk. The difficult part is how can you determine what asset allocation you should choose.

This is where the ‘100 minus age rule’ helps because it’s so simplistic. The rule of thumb says, you take your age and deduct it from 100. The figure you get should be the percentage that you invest in the “risky” stock market, with the rest being held in “low risk” bonds.

For example, if you’re aged 35, you would invest around 65% in the stock market and 35% in bonds. If you’re aged 40 it would be 60% in the stock market and 40% in bonds, and so on. The idea is that as you age you cannot afford to take on excessive risk, so this method will gradually reduce risk as you get older.

As you get older most people will be more concerned with the return of their money rather than the return on their money. This is because when you’re young, if you lose money you have the time, and probably the health and ability to fix this. Also, you will have more years for stock markets to recover. You won’t have this advantage the older you are.

Why The Rule Doesn’t Work

#1- Designed When Bonds Were Good

The biggest gripe we have with the rule is that it was created when interest rates were good but that’s not the world we live in today. Even when we were younger, we can remember receiving juicy interest payments on cash savings, but today you will get next to nothing.

US 10-Year Treasury Yield Rate

The chart above demonstrates what’s happened to interest rates nicely. It shows the US 10-year treasury yield rate from 1962 – almost 70 years. This rate is the benchmark used to decide mortgage rates across the U.S. and is the most liquid and widely traded bond in the world. In other words, it’s a great proxy for the return an investor could expect from bonds.

A you can see the current rate is a joke – we won’t sugar coat it. Moreover, the long-term trend has been downward and if the interest rates from other countries are a sign of things to come, then rates could get even worse.

A 50-year-old investor basing allocation on the ‘100 minus age rule’ would have half of their portfolio in this lacklustre asset – returning nothing and producing a negative real return.

#2 – Access To Different Assets Now

Another problem with the rule is that when it was first conceived an investor would have likely had access to only their local stock market and local bond market. Today we can invest in almost anything imaginable.

It is possible to invest in almost any listed company in the world, and the range of available assets classes has also greatly improved. To put it another way, we can build a portfolio that just wasn’t possible decades ago. For one, Gold, which historically has been a great store of wealth over the centuries, was illegal to own in the US from 1933 to 1975.

This means that other investments that would have been beneficial to an investor’s portfolio had not been considered when the rule was first formed. Today it doesn’t make sense to stick with just 2 asset classes when there’s so much more choice.

#3 – Not All Equity Carries The Same Risk

Not all stocks are created equal. Some are very cyclical and boom and bust with the economy, whilst others are essentially bonds in terms of their risk.

A water utilities company will have very predictable revenues as demand for their product is very stable. We all need to drink no matter what hell is happening in the economy. Therefore, defensive stocks like water companies will have more stable share prices and dividend pay-outs. It seems crazy to lump this type of company with more risky stocks such as a car manufacturer or an oil exploration company.

#4 – No Longer Need An Annuity

In 2015, UK pension rules were changed so that you don’t have to buy an annuity when you retire. An annuity is an insurance product, which guarantees an income.

Instead you can keep your pension pot invested and drawdown on it, but this puts you at the mercy of investment markets. Therefore, it’s really important that your investments continue to work well beyond your retirement age as you may need this money to last for decades. Imagine being aged 70 with 70% of your wealth in bonds producing no return. Your pot will run out leaving you royally screwed.

#5 – Life Expectancy And Retirement Age

We all are living longer. If you’re hanging up your working boots decades before your expected age of death, you need that investment pot to continue growing at a respectable rate above the meagre return provided by bonds.

According to the ONS, a 32-year old man is expected to live until age 85 and has 25% chance of reaching 95. For women they have a life expectancy of 88 and a 25% chance of hitting 96.

#6 – State Pension (Social Security)

We’ve covered this a few times recently but as reminder, governments around the world including the UK are broke. An axe will have to be taken to areas of government spending that are unaffordable, and we’re sad to say the axe will almost certainly fall on the state pension sooner or later.

Consequently, you are fully responsible for your future and you need to grow your own investment pot. To give it the best chance you need to take on more financial risk than what the ‘100 minus your age’ rules implies.

Now that we’ve disproved the rule, What Other Options Are There?

110 Or 120 Minus Your Age

Some financial advisors are now supporting ‘110 or 120 minus your age’. It’s exactly the same concept but ensures you hold more equity than the previous rule proposed. So, for example, a 40-year-old using the ‘120 minus their age’ rule would have 80% in stocks and 20% in bonds. Even at age 70 you would still have 50% in stocks.

We can’t advise you, but this modified rule does give your investments a better chance of surviving for longer.

We also wouldn’t ignore other asset classes. We would be more inclined to split the allocation of the portfolio previously assigned to bonds to also invest in other defensive assets such as gold.

Property could also be used as their values don’t fluctuate as much as stocks and tend to have more reliable income.

Vanguard’s Glide Path

Vanguard use a glide path in their Target Retirement range of funds. We don’t have time to discuss them in any detail now but check out this post if you’re interested in learning more about Vanguard.

 

Vanguard's Target Retirement Glide Path

We don’t know the origin of this particular glide path, but Vanguard must have faith in it as they built an entire fund range around it.

This differs to the ‘100 minus age’ rule as it shifts from equity to bonds more slowly and never drops below around 30% shares no matter your age.

Risk Tolerance (Larry Swedroe)

Instead of basing asset allocation solely on age, Larry Swedroe, an investing guru, encourages us to consider the amount of risk we can tolerate and proposes these allocations:

 

 

Larry Swedroe's Risk Tolerances

An investor who could accept a loss of 35% should split their portfolio 80% stocks to 20% bonds. We really like this method because it takes into account all our unique risk tolerances. As you age you can adjust your portfolio as your risk tolerance decreases.

Build Up A Large Pot So It Doesn’t Matter

Here at Money Unshackled we think that the amount of wealth you build is entirely up to you. If you are in a position where you have to live in retirement constrained by money decisions, then you didn’t build up a large enough pot.

Our plan is to build up so much wealth that we can live comfortably through retirement without worrying about it running out. Constantly worrying about money is no way to live. This would mean we can leave our wealth invested in riskier assets as it wouldn’t matter if the markets were to fall, as the likelihood of the pot running down is practically zero.

This is one way the rich keep getting richer because they’re not constrained by money concerns and their wealth can grow unimpeded. For our younger readers we would urge you to take measured risks while young, so you don’t have to count pennies when you’re old.

What is your asset allocation and why? Let us know in the comments below.

Now go claim your free stock. The Stake platform have a give-away offer of a free stock for every new customer – worth up to $100. It’s a platform for UK investors interested in accessing the US market.

Check out the MU Offers page for the offer link and more info!

Also check out the MoneyUnshackled YouTube channel, with new videos released every Monday, Thursday and Saturday:

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Your Opportunity Fund – Career, Investing & Side Hustles

Everyone gets opportunities to make more money. But most people either aren’t equipped to take them, or don’t see them. Missed opportunities keep you poor.

Money opportunities can be small and incremental, like buying a stock when it’s cheap or changing jobs. On their own they won’t make you rich, but taking your opportunities day after day will soon add up.

The problem is, to take advantage of most money opportunities you need to already have some money to fall back on – enough cash and investments to give you the balls to take a risk.

This is your Freedom Fund, which looked at through a different lens is really an Opportunity Fund.

This article should help you to capitalise on the opportunities that life throws at us, and tell you why you need an Opportunity Fund – and why having one of any size makes the difference between being too afraid to make money, versus having the confidence to get rich.

Your Opportunity Fund

At its heart, the Freedom Fund that you hopefully have stored under your metaphorical mattress is there to pay you an income and also to allow you to take advantage of life’s opportunities.

If you see an investment worth buying, or a career or business opportunity worth taking, the fear of loss will stop most people.

A Freedom Fund – or Opportunities Fund as we’re calling it today – is there to be used to pursue opportunities. Not risked recklessly, but used in a targeted way.

Opportunities to make or save money come along daily and can compound to make you much better off, but you need to be zen enough with your cash situation to risk putting some on the line to make more.

With our own Opportunity Funds, we’ve found we grow more relaxed about making money the bigger it gets.

What An Opportunity Fund Buys You

#1 – Better Jobs

At the smaller end of the scale, your Opportunity Fund gives you the confidence needed to change jobs or change careers, as you have assets and maybe even investment income to fall back on.

It’s all about being able to politely tell your boss that you no longer have need of their employment, and will be going off to pursue better options.

Finding a new job is a chore, and finding a good one that’s worth trading your life in for should be given some serious effort to find. It’s not something that’s easy to do whilst already in a job.

In our view, with jobs it’s best to first quit, then give 100% of your time and brain power over to the search for a replacement, climbing higher up the career ladder as you do so.

We’ve only been able to do this because we had Opportunity Funds to catch us, and genuinely believe our strong career paths were made possible by the comfort of having that cash buffer.

#2 – Better Investments

You want to be in a position where you never again have to turn down an investment opportunity because you’re living on the breadline.

It’s not just poor people who live like this – half the middle class families that we know are living pay check to pay check.

It can take time to learn how to start investing, and it would be disheartening to not be able to put theory into practise.

If the FTSE 100 falls to 10-year lows, like it did in 2020, you know in your bones that you should be putting some of your spare cash into buying a FTSE 100 index fund while it’s cheap.

But if you don’t have an Opportunity Fund, you can’t do what’s necessary to help yourself – in this case reallocating some resources into the FTSE 100. It’s just another chance you missed out on to get ahead.

With a decent sized Opportunity Fund you can also take advantage of riskier investments like small-cap stocks and property. Those with a small or non-existent Opportunity Fund must take safe harbour in less volatile and less rewarding investments instead.

With property, it’s more about the investment being expensive to buy in the first place, and that it may need funds to maintain.

If you go through an untenanted period, or the roof leaks, you need a pile of cash to fall back on. It’s the type of investment you’d only buy if you also had some spare cash set aside for (possibly quite literally) rainy days.

#3 – Better Side Hustles

Side hustles are becoming more popular as a way of making extra money in these troubled times, with the Independent reporting that 20% of people already do things like dog walking and selling old clothes and gadgets to top up their bank balances, and a further 25% wanting to start a side hustle.

These are the types of hustle you might do if you had no capital behind you. After all, anyone can walk a dog or sell some junk.

But side hustles are not limited to the financially challenged. If you’ve first built up a decent sized Opportunity Fund, you could start a far more profitable side hustle.

With a bit of investment into monthly web-hosting fees you could open an online shop to sell your bits and bobs – by buying a van with a nice paint job, some equipment and paying a helper or 2, you could have a dog walking business catering for hundreds of dogs.

Essentially, if you commit yourself and your finances to a side hustle, it can turn into a business that replaces your job.

“But a new business is not guaranteed to make enough money to live on”, most will say. Exactly. This is why the confidence boost of having an Opportunity Fund is essential for taking the leap.

A lot of money management is psychological. You might have the best business idea in the world, and a plan for how to implement it, but if there’s a slight risk that it won’t make money immediately you probably wouldn’t do it.

Fear of potential loss always takes priority over excitement of potential success. It’s just human nature.

#4 – Better Business

At the larger end of the Opportunity Fund spectrum, a successful small business owner might be too scared to hire their first employee.

Do they wait to hire someone later when they can more easily afford it; or do they hire someone now while they can’t, but trust that the value created by the staff member will mean they pay for themselves?

It could be the difference between a business that grows fast versus one that stagnates.

If you have some small amount of cash set aside so you can survive for say 6 months without any payback on this employee, it’s a different decision from if you were living hand to mouth without any savings.

#5 – Better Experiences

It doesn’t have to all be about making more money. A big Opportunity Fund gives you better opportunities to have fun.

Perhaps you’re given a once in a lifetime chance to sail the world, or a mate asks you to tag along on an excursion to Antarctica to see the penguins.

Or maybe you’ve got the chance to go to the World Cup final, or your favourite singer is doing one last tour.

How Big Your Opportunity Fund Needs To Be

The answer is that any size is better than nothing. A small Opportunity Fund of £10,000 might give you the confidence to change career.

A pot of £100,000 might give you the confidence to move 30-40 grand into a rental property to leverage some of your returns by using mortgage debt.

A pot of £500,000 might kick out enough passive income that you never have to work a day again and can spend your time starting or investing in businesses.

While a pot of £10,000,000 will have people coming to you to throw equity at you, Dragon’s Den style.

Getting Started

The hardest part can just be getting started building that initial fund. If you were able to just save aside a few extra hundred quid a month it could soon make all the difference.

You’d be able to start taking advantage of small-scale money opportunities which further compound your wealth.

One thing we’ve both been trialling is matched betting, a step-by-step process of scooping up cash bonuses offered by bookmakers by placing bets on both outcomes of an event. We’ve each made around £500 per month from it, but some people put more time into it than we can and make over £1,000 monthly.

To do this we’ve been using OddsMonkey – they collect all the bookie bonuses in one place, hold your hand while you scoop them up, with specific walk-through guides and tools for all offers.

For instance at time of writing, one bookie has an offer for £100 in free bets – OddsMonkey will walk you through how to grab this free cash, plus hundreds more offers like it.

Check out our matched betting page to read more about it and get discounts for matched betting services that you won’t get by going direct.

Other Ways To Grow Capital

Other than taking advantage of easy income enhancements, you can build up your Opportunity Fund by keeping more of what you make, which can often be done by just making better spending decisions.

Even saving up a few grand will get the ball rolling, which can then grow itself by investing it, as well as using it to grab opportunities as they arise.

Most people we know waste money on frivolous crap – it’s fine if you’re happy to take that enjoyment now, but accept that it removes your ability to take advantage of lifestyle enhancing opportunities in the future.

One of the best arguments for paying down your mortgage early is so you can free up money each month to spend on opportunities without fear.

We’ve countered this argument before by saying it’s better to lower your mortgage payments by extending your term, and use the money saved on opportunities while you’re young.

But both are better financial decisions than blowing that money on a new Range Rover.

Having an Opportunity Fund is a choice. Some people have big cars – others conservatories, holidays in California, or designer handbags.

The people who get ahead can have all of these things too, and more. They just get them later… after they’ve first built up an Opportunity Fund.

Money Leads To More Money

The old saying that you need money to make money isn’t true, but it certainly makes it easier or perhaps more accurately, makes it faster.

Money leads to more money – if you allow yourself to take your opportunities as they come.

What have you been able to do with your cash that made your finances better? Let us know your stories in the comments below!

Also check out the MoneyUnshackled YouTube channel, with new videos released every Monday, Thursday and Saturday:

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Plan, Automate, Ignore, Get Rich

We honestly believe that anyone can be wealthy. Wealth is not just reserved for an elite group of people – anyone can get it.

You’re watching this video – so obviously you want to get rich – and getting rich starts with really wanting to get there. Money is attracted to those who seek it.

Contrary to popular belief, your ability to become rich is not just down to your intelligence, work ethic, luck, who you know, what you know, your upbringing, and it’s certainly nothing to do with staying within the law. By this we mean you don’t need to be a drug dealer or a criminal to get rich.

In fact, becoming wealthy is not even difficult and can be achieved by following these four steps – Plan, Automate, Ignore, Get Rich!

It essentially boils down to what you do with your money and how you invest it. In this post, we’re going to look at these crucial four steps. Put them into action and you will become wealthy. Let’s check it out…

Getting Rich Has Never Been Easier
Undeniably, getting rich in today’s world has never been easier. With the advancement of incredible technology such as the Internet and the mobile phone, we all have access to the world’s information at our fingertips.

When Phil Knight founded Nike, or its predecessor Blue Ribbon Sports, he had to travel to Japan, trick his way into a meeting with a potential supplier – god knows how he did this with the language barrier, and also struggle to raise finance from what was then a very different banking sector to what it is today. Then of course he had the not-so-easy task of selling the shoes.

Most of us will openly admit that this would be an absolute ball ache to have done any of this, but today we don’t have the same excuses. You can literally do all of these things from the comfort of your home.

Another thing we can do from the comfort of our homes is invest in pretty much any kind of investment on the planet. This gives us a massive advantage over generations that came before us. As a matter of fact, these opportunities are arguably far better than what the wealthiest and most financially savvy people in the world have been taking advantage of for centuries.

The sad reality is that despite this fantastic opportunity most people will either fail to capitalise on it or will get it horribly wrong and will be far worse off as a result. So, what do you need to do?

Lay A Strong Foundation

First things first, you need to pay down your expensive bad debt, build up an emergency fund and then begin to invest. To do any of these you need to live on less than you earn. These are all vital steps but help with achieving these goes beyond what we’re talking about today.

Plan
End Goal

As with any target in life you need to have a good plan for how you’re going to achieve it. A goal to become wealthy is not a good goal because the end point has not been defined. You’re unlikely to reach a goal if it’s ambiguous.

A better goal would be to build wealth of X number of £££s by X Age.

From that end point, you work backwards to calculate the amount of money you need to invest and what you likely to need to invest in. You also need to factor in your attitude to risk.

This is really important as it will show you how feasible this goal is. Let’s say an investor, let’s call him Dave, can invest £500 a month for 30 years but his end goal is £8 million. To achieve this, Dave would have to earn on average 20.1% annual returns. This is highly unlikely from the stock market. That’s Warren Buffett level performance.

After a harsh dose of reality, Dave realised that a more realistic final pot from £500 a month for 30 years might be just over £700k. This can be achieved with 8% annual returns, which seems like a good barometer as this is roughly what the S&P 500 has returned on average over many decades.

Aggressive Versus Defensive Assets

Although 8% returns are more realistic, is a broad stock market index like the S&P 500 in line with Dave’s attitude to risk? This index has on occasion plummeted in value by over 50% and has remained below its peak for years and years, meaning you could be sitting on huge losses for far longer than you can stomach.

Because equities are so volatile many investors will build a diversified portfolio across asset classes.

The S&P 500 might be considered a more aggressive strategy but you can temper this volatility by also investing in less risky or more defensive investments such as bonds, but this could also include cash, insurance products and commodities like gold. The problem with investing in a more defensive basket of assets is that it will highly likely lower your overall returns over the long term.

If we assume that a portfolio mixed between aggressive and defensive assets returned 4% annually and the monthly investment and timeframe remained constant, then the final pot would be just £344k. When you factor in inflation of say 3% annually, the final pot in today’s terms would be just £210k – not bad but significantly below what our investor Dave had initially wanted.

Dave has a few options. He can accept that that is the likely outcome, come to terms with the fact that he may need to take on additional risk, extend the investing timeframe from 30 to say 40 years, find a way to increase his monthly contributions or a combination of these.

What To Invest In

We believe that your portfolio should be kept as simple as possible. Although this is not personal advice, we feel that the more risky or aggressive element of the portfolio should be invested in a broad stock market index or a few indices that cover the whole world stock markets.

Investing in individual stocks is not for the faint hearted and if done properly is not passive at all. In fact, we would urge most investors to avoid it entirely, and those that do insist on investing in individual stocks should limit the amount they invest to a small percentage of their portfolio.

We ourselves allocate just 15% to this type of investing. This means that 85% of our portfolios are planned, diversified and passive. But as we say, most people would be better off sticking with index tracking funds.

Automate

Once you’ve decided on your portfolio or have outsourced the work to a robo advisor, the key is to automate your investing every month.

You should look to set up a direct debit or standing order to your investing account, so that the money is invested as soon as you get paid your wage. This has three main benefits:

#1 – Pay Yourself First

It’s far too commonplace to save whatever you have left at the end of month, but this will too often be nothing. It’s far better to pay yourself (aka your investments) first.

This forces you to live within your means and allows you to spend guilt-free knowing that you’ve already taken care of your future according to the plan you’ve already laid out.

#2 – Pound Cost Averaging

Investing in the stock market is a roller coaster. There is a real danger that you invest at the top, only to see share prices crash leaving you with paper losses for years.

As a reminder, if you had invested in the S&P 500 in the year 2000 you would have had to wait until 2007 until the stock market recovered back to previous highs, for it to only crash once again, making you wait a further 6 years before share prices recovered.

This obviously isn’t great but it’s not a major problem because if you automate your investing you will have smoothed out your purchase price. By investing monthly, you end up buying when stocks are high and crucially also when they’re low.

#3 – You Will Fail To Time The Market

Knowing that stock markets go up and down can tempt people to try and time the market. Don’t be tempted to wait because the chances are you will never start. You are more likely to buy high and sell low. Historical charts show incredible buying opportunities but when you’re in the thick of it will you be able to find the courage to invest?

All those lows coincided with apocalyptic news stories projecting doom and gloom. Humans are hard-wired psychologically to get this wrong. This is why auto-investing in good times and bad will see you build wealth over time.

Ignore The News

If you follow the ‘plan, automate, ignore, get rich’ strategy as per this video we think it’s sensible to completely ignore the news when it comes to investing. The media are in the business of selling newspapers, and to persuade you to watch their TV programs or read online articles.

Bad news sells, which is why every news piece is sensationalist. If you follow the news you will always find a reason not to invest. There’s always something bad going on.

Over time most of these reasons are completely forgotten about and the stock market powered ahead regardless of these negativities. Apologies if this chart looks a little blurred but we thought it makes the point far better than we can.

Let’s just take some time to look at some of these. We’re sure the Flash Crash felt like a big deal at the time. When the US government shut down people were like, “oh my god, the world is ending!”. The Brexit vote was in 2016, and Trump was elected at around the same time – again, everyone in the media thought the economy was done for. The markets continued upwards.

If we were to look further back in time there are always many reasons not to buy – events like the Cuban Missile Crisis must have felt like the only thing worth talking about at the time, but can anyone remember the impact this had on the stock market? Of course not.

S&P500 History

And there’s one good reason you should buy. Charts like this make it look like share prices didn’t move for decades but the volatility was no different than what was experienced in the 90s to the current day.

S&P500 History - Logarithmic

A logarithmic chart will show this better. As you can see the trend has always been up and we see no reason why this trend will ever end!

Get Rich

Follow this investment strategy and you are very likely to build wealth and be able to live the life you want. Moreover, this strategy excels further because it is passive. It doesn’t involve you putting in any effort other than the initial setup and the occasional rebalancing. The process is fully automated, and you don’t ever need to fret about events that could upset your goals.

While everyone else is busy worrying you can get busy living! Crucially, this passivity frees up your time to go generate more income, allowing you to boost your monthly investments. The more you can invest the sooner you will hit your financial goals.

This is why we always encourage our viewers to break free from the chains of employment. Some career paths do pay handsomely, but your salary income will forever be tied to the hours input. With a business you can scale your income. Whether you work towards boosting your employment income or whether you choose to build a business empire, the fact that you don’t need to constantly manage your investments means you can focus on what matters to you.

Will you be following this passive investment strategy, or will you be chopping and changing your portfolio? Let us know in the comments below.

Also check out the MoneyUnshackled YouTube channel, with new videos released every Monday, Thursday and Saturday:

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Tax-Free World Portfolio With Synthetic ETFs

We recently did a video showing how the new iShares S&P 500 Swap ETF (I500) could eliminate Dividend Withholding tax and supercharge your returns.

 

This newly launched ETF led us to us to thoroughly research a specific type of investment that we were previously overlooking, and we discovered that we could save hundreds of thousands of pounds over a lifetime by using synthetic ETFs rather than physical ETFs.

 

If you’ve not seen that video, then it’s worth checking out after this one but we’ll try to cover the key areas here too.

 

Dividend Withholding tax is a sickening hidden tax imposed by many countries around the world. Investors will feel the sting mostly from their US investments as Uncle Sam will take a hefty 15% of your dividends.

 

We hate dividend taxes of all kinds because they’re taxes on cash flow – not profit. You may receive a dividend of say 3% and get taxed, but if the value of your investments had fallen by say 20% you would be sitting on large losses and yet still be paying taxes – not right at all.

 

Anyway… US Withholding tax is the most important and the one that you should focus on eliminating first where possible, because it is highly likely that US investments make up the bulk of your portfolio.

 

A world fund based on market capitalisation will hold about 55% of the portfolio in the US, so it’s clear you want to tackle US withholding tax first.

 

However, investors should be aware that other countries are often as bad or in many cases even worse. Japan will also withhold 15% of your dividends and Germany will withhold 26.375%.

 

Synthetic ETFs are a fantastic tool to eliminate withholding tax but as they are more complex to understand than physical ETFs, there is far less choice.

 

Since the financial crisis of 2009, many synthetic ETFs converted to the physical type but recently there has been a growing demand for tax-efficient synthetic ETFs, and availability has been improving.

 

In this video, we’re going to look at building a world portfolio of synthetic ETFs and make some comparisons to our world portfolio built from the physical variety. The idea is that we squeeze as much return out of our investments as possible! Let’s check it out!

 

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Take Control Of Your Financial Life – You Can’t Rely On Anyone Else!

We see a lot of people whinging on social media and in some news publications about how the government is a disgrace and that they’re not doing enough. We agree that the government are making a pig’s ear out of everything recently, but is it their job to mollycoddle us?

The same people complain that their boss isn’t fair or that rich corporations are somehow dodging taxes. They complain about their wages, their commute, the tax they pay, the cost of a beer. They pretty much moan about everything. Everything but themselves of course.

People can generally be split into two camps – the Doers and the Do Nots.

The Do Nots are the complainers who want everything for free and done for them; and the Doers are those who take control of their futures.  The Doers know that nothing worth having in life comes for free and that you can’t rely on others to improve your life. You must take control to improve your own future.

Today we’re going to look at some of the things that too many people are foolishly relying on getting, and will be whinging about and blaming someone else when they don’t get them. These are all key areas where you can snatch back control and improve your life.

If you are one of these people that expects something for nothing and has a tendency to be easily triggered, we advise you not to read any further! With that said let’s check it out…

Reliance On The State Pension

Too many people put their wellbeing, security, and life in the hands of the state. This is especially true when it comes to retirement. Growing old is not a surprise. If we’re lucky it will happen to all of us.

And yet, millions of people in the UK fail to prepare – instead choosing to be saved by a future government. A government that will not be able to carry this burden.

A lot of people pay taxes throughout their lives and assume that the government must put some of that aside to save for their future state pension. This is not the case at all. Any taxes that you pay goes towards paying for the state pension of current pensioners. There is no state savings pot for you.

State pensions are really just a pyramid scheme on an epic scale. Pyramid schemes only survive for as long as new members can join at the bottom. Sooner or later the whole thing comes crashing down. This will happen in some form to state pensions.  There is no doubt about it.

When pensions were first created in 1909 it was only paid out to some people aged over 70. At the time, only one in four people reached the age of 70 and life expectancy at that age was about a further 9 years.

Nowadays, the age you can take a State Pension is set to rise to 68 from the current 65. But 68 is not high enough –from a “how we gonna pay for this” point of view – as too many people are qualifying for it and drawing from it for too long.

Children born today are expected to live until they’re 90 years old. That’s over 20 years of taking from the system, rather than contributing. The state pension relies on a large worker-to-pensioner ratio, but the problem is that the ratio is forever shrinking.

In 2004, there were approximately 4 working age individuals for every 1 person aged 65 and over. By 2056 this ratio is predicted to fall to about 2:1. Therefore our kids will be asked to pay the living costs of twice as many old people as we do today.

Despite all these problems, people continually moan that the amount paid out is not enough, and the age that you can claim at is too high. FYI, the state pension is currently over £9,000 a year. This won’t get you a lavish lifestyle by any means, but the state should never have been expected to do this in the first place.

State benefits should be an absolute minimum. People have 40-50 years to plan for retirement and need to take action now.

Reliance On Government Handouts

Worryingly, there seems to be a growing dependency on and expectation of government handouts. Ask 10 people what they think the role of the government should be and you will likely get 10 different answers.

We consider the role of the government is to run and manage the parts of the country that the private sector cannot or should not. This includes things such as a military defence, fire and police services, basic healthcare, the transport network, basic education, social services, environmental protection and ensuring everyone has access to utilities – water, gas, electric and broadband.

It’s now taken for granted that the government should be the wage payer of last resort. This was always the case with the benefits system, but has been significantly ramped up during the coronavirus response.

The need for a furlough scheme – whether an arbitrary 80% or 73% – is only there because barely anyone has taken the steps over their working lives to put money aside. It surely must be recognised that the country is so deep in debt that it cannot afford such expensive schemes.

There is a lot of noise that the current job support scheme is not enough, but we ask the question why do so few people not have an emergency fund? Instead, since the last recession many of these people have been splashing the cash on frivolous stuff.

While the exact timing of the Corona pandemic is unexpected, recessions are fairly routine, with history littered with them. The one before 2020 was only in 2009.

For the record we don’t think the government should be force closing any business in the manner they have, but why were the masses not financially prepared? This time it was Covid that sunk their finances, but next time it could be something else entirely such as a personal injury, or a war sending the country into a financial depression.

We all need to be prepared, so that we can fight off temporary setbacks, and it starts with having an emergency fund of at least 6 months of living expenses. Help from the state should only ever be sought as a last resort, not in the first instance. Why do so many grown adults depend on the state like a child depends on a parent?

Reliance On Chance

We’ve come across countless people who hate their lives and hate their jobs but do nothing tangible to change this. Instead too many people are relying on chance, such as a lottery win or an unexpected windfall from an unknown relative, to improve their lot.

Other than by a miracle this isn’t going to happen to you. The chance of winning the lottery is 1 in 45 million.

There is also ample evidence showing that many lottery winners blow their fortune because they didn’t learn financial literacy. Believe it or not, statistics show 70% of lottery winners end up broke and a third go on to declare bankruptcy, according to the National Endowment for Financial Education.

The problems they had with money before they had wealth carry over but on a much larger scale.

Reliance On A Boss

Why do so many people put their future in the hands of one person? One person who frankly doesn’t give two hoots about them.

Bosses are people too with their own lives to think about, and most people have enough problems on their plate to worry about yours as well. Sure, some bosses will genuinely care, but not a single one will care about your future and your wellbeing as much as you do. This means you must take control of your future and don’t rely on someone creating it for you.

Time and again people are hoping their boss gives them a pay rise out of the kindness of their hearts.

No! You must take what is yours.

Your boss’s performance and therefore his or her own bonus is probably measured against a department budget. Paying you more or sending you on an expensive training course will result in the department going over budget. Your boss is being incentivised to pay you as little as possible. They don’t have your best interests at heart.

This conflict of interest also affects the work you’re doing. Sooner or later most people get bored to death doing the same task over and over again. Trust us, we’ve been there before.

At this point your boss might dangle a carrot. It might include additional responsibilities or more interesting tasks. Rarely does it involve relinquishing the existing tedious work. Your boss doesn’t want the hassle and expense of having to find someone else to do your work. They will do whatever they can to keep things ticking over. This again is not in your best interest.

You need to stimulate your brain, which means you likely need to progress elsewhere, but only you can make this happen.

Businesses generally break down massive processes into small, tedious, repetitive tasks and assign one person to each. Think of a car production line but it happens in offices as well. If you’re screwing that same screw for the 1 millionth time, you are not developing yourself.

Reliance On The Crowd

By this we mean deferring our major life-decisions to society’s standard playbook.

This is most illustrative in the life path dictated by society. You know the one. You go to school, get good grades, go to University, get a good job, buy a nice car, get married, buy a nice house, fill it with expensive stuff, have children, have an annual holiday, work until old age, and then retire.

Too many people are not engaging their brains and instead just follow the crowd. They believe if other people do it, that means it’s right. Nobody ever stops to question why or whether they even want it.

When you think about it, maybe you don’t want this. Maybe you don’t want to work a crappy job for 50 years; maybe you don’t want to waste £30k on a wedding; maybe you don’t want to be a slave to debt repayments for your entire life.

Following the crowd doesn’t just apply to how society dictates your path, but also impacts every decision you make. For example, from our backgrounds we know that too many people don’t make their own investment decisions. They are looking for that hot stock tip, so they can get rich quick. Analysing the investment themselves is too much like hard work – far easier to follow the crowd.

Reliance On Family

A long time ago, Andy (MU Co-Founder) was talking to a friend of his about retirement planning and was shocked that she wasn’t contributing to her workplace pension, despite the company matching any contributions.

Andy could not understand why she would throw free money away and that she wasn’t preparing for old age.

The reason she didn’t contribute to her pension was nothing to do with her young age. She said that she expected her future family to look after her in her old age.

This is both stupid and selfish because it was passing over responsibility of her life into someone else’s hands. Even if her family did want to help her, they may not have the strong finances to do so. Life will throw a lot of curve balls and it’s very presumptuous of her to think that her family will bail her out. They themselves could die young, develop financial or health problems, move away, may have their own problems, or simply not want to be put in that position.

Our suggestion to you guys watching is to make sure that you take action today to control your own future, by first building that emergency fund and then investing. This is well within your power.

Are you independent or do you rely on the government and other people to get by? What are you doing about this? Let us know in the comments section.

It’s worth checking out the Money Unshackled Offers page as we have tonnes of awesome cash bonuses and ways to make money listed that are continually being updated, including how you could make £500+ tax-free each month from Matched Betting.

Also check out the MoneyUnshackled YouTube channel, with new videos released every Monday, Thursday and Saturday:

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The Complete Guide To Vanguard Investing – For UK-Based Investors

Vanguard tends to be investors’ first port of call when it comes to index investing and ETFs, which in many cases are the investment products that we believe should be at the foundation of any respected investor’s portfolio.

 

Vanguard products are diverse and cheap enough to provide a one-stop-shop for investing, no matter your experience level. It is up to you just how complicated you make it and Vanguard really do try and simplify the entire process.

 

As one of the biggest ETF providers on the planet, with trillions of dollars of assets under management, we’ve regularly mentioned Vanguard on this website. Their investment range is incredibly cheap, they are always lowering costs for price conscious investors, and here in the UK they even have their own investment platform.

 

So, in this post we’re going to give you the complete guide to Vanguard investing for UK based investors. By the end of this guide you will know everything that you need to know to either begin investing or to take your investing up another level. Let’s check it out…

 

A Brief History

The late Jack Bogle, the founder of Vanguard, created the first public index mutual fund in 1975, tracking the S&P 500. At the time, it was heavily derided by competitors as being “un-American” for making no attempt to beat the market, and the fund itself was referred to as “Bogle’s folly”.

 

Fidelity Investments Chairman Edward Johnson was quoted as saying that he “[couldn’t] believe that the great mass of investors are going to be satisfied with receiving just average returns”.

 

Fast forward to today and we know that index tracking, whether that’s in the form of index funds or Exchange-Traded Funds, is forever growing in popularity.

 

That first Vanguard index fund started with just $11 million of assets under management but today’s equivalent now manages $573 billion of assets.

 

Differences Between The US and UK

Here in the UK we frustratingly get fed a lot of US-based information that isn’t always relevant to us. This is especially true when it comes to investing.

 

There are often differences in terminology. For example, in the US they have Mutual Funds, whereas in the UK our equivalent is called an Open-Ended Investment company or OEIC.

 

We also have different account types. In the US they have accounts such as Roth IRAs and 401(k)s but these are totally irrelevant to UK investors. In fact, in the UK we have even better accounts such as the SIPP and ISA.

 

When it comes to Vanguard, the UK Vanguard offers a slightly different service to the US version in that it is a much slimmer and streamlined offering. That’s means it’s even simpler to understand but with reduced investment choice.

 

What Vanguard Offers In The UK

Vanguard’s offering can be split into about 5 distinct areas:

  • ETFs;
  • Index Funds;
  • Fund of Funds;
  • Active Funds; and
  • An Investment Platform.

 

ETFs and Index Funds

ETFs and Index Funds are our preferred way to invest in the stock market, and we use them to build a core portfolio that aims to track the whole world market.

 

Vanguard is ideal for this because they have focussed on creating regional based funds such as funds that hold European stocks, North American stocks, Asia Pacific stocks, and so on.

 

There are differences between ETFs and Index Funds, but a beginner investor probably doesn’t need to get bogged down in the intricacies of these investment vehicles. They essentially both pool investors’ money together allowing investors to get much wider diversification than what they could get on their own. For instance, the Vanguard FTSE Global All Cap Index Fund, one of our favourites, holds 6,900 stocks from across the world.

 

ETFs and Index Funds are able to do this for incredibly cheap fees and Vanguard are at the forefront of this price competition. This particular fund costs just 0.23%, but costs can and do go much lower. For example, Vanguard have a S&P 500 ETF, which tracks 500 of the biggest US companies, for an almost non-existent fee of just 0.07%.

 

Fund of Funds (FOF)

Vanguard have a great set of funds that invest in other Vanguard funds. They are essentially a one-stop shop for the lazy or uninclined investor, which we think are great for those who don’t want to manage their own portfolio.

 

(1) LifeStrategy

The first set are called the LifeStrategy funds. There are actually a few different versions and the idea is that you pick one based on your attitude to financial risk.

 

Each LifeStrategy fund will contain a mixture of Shares and Bonds. For instance, Lifestrategy 100 is 100% allocated in shares, but LifeStrategy 80 has 80% in shares and the remaining 20% in Bonds. LifeStrategy 60 has 60% in shares and 40% in Bonds. You get the picture.

 

Considering each LifeStrategy fund is a ready-made portfolio the fee is unbelievably cheap at just 0.22%.

 

Shares generally provide greater returns than bonds over the long term but are riskier.

 

As two dudes who love investing you might think it were strange if we were to tell you that we both invest in LifeStrategy 100 ourselves. Those that watch this channel regularly will know our efforts go towards financial freedom today, and so we can’t be bothered to manage our own pensions. This makes the LifeStrategy range ideal for our very long-term investments and could suit yours too.

 

To get an idea how these funds work, here are the underlying funds within the LifeStrategy 80 fund. LifeStrategy funds contain other Vanguard funds and ETFs based on Vanguard’s own proprietary global view. By this we mean it’s not a genuine global tracker as it’s been tilted towards UK listed securities.

 

If you want to explore each individual holding you can find it on Vanguard’s own site, or for a good overview some investment sites give a great snapshot of the portfolio, such as what can be seen here on Fidelity’s site.

 

(2) Target Retirement Funds

The next set of Fund of Funds from Vanguard is their Target Retirement range, which cost just 0.24%.

 

These are ready-made portfolios specifically designed to be used for retirement savings. They shouldn’t be confused with a pension though as they can be bought within many investment accounts including Pensions, but also General accounts and ISAs.

 

Target Retirement Funds are similar to the LifeStrategy range, in that they too hold Vanguard funds. The way they differ is that the equity allocation is reduced over time and replaced with a higher bond allocation, called a glide path approach. The theory is that investors will want to de-risk as they approach retirement age. This is achieved by moving to a higher allocation of less risky bonds.

 

All you need to do is pick the fund closest to the year when you want to retire. So, for example, if you were between age 20-23, Vanguard suggest you choose the Target retirement Fund 2065 based on a retirement age of 63 to 68. However, there is a wide choice and you just need to choose the one that suits you.

 

We’re not too sure whether a glide path is as relevant today as it once was for retirement savings. Up until just a few years ago you were legally required to buy an annuity with your pension, so it made sense to de-risk as you age.

 

Nowadays, we all have lots of freedom with what we do, and many investors will remain invested in the markets. Therefore, a larger equity allocation is probably more prudent than what this fund provides and certainly something we would prefer with our own retirement pots.

 

Active Funds

Vanguard are known for their index funds and ETFs, but they do also have a small selection of actively managed funds, which are reasonably priced when compared to other actively managed funds.

 

The Vanguard Investment Platform

Unlike most other fund and ETF providers, Vanguard also offer their own investment platform. You will be able to open a Personal Pension (known as a SIPP), a Stocks and Shares ISA, a Junior ISA, and a General account.

 

The main advantage of all these accounts with Vanguard are the low fees, which are incredibly cheap at just 0.15% and there are no hidden nasties such as switching fees or withdrawal fees. Also, there are no additional trading fees, which are ubiquitous on the premium investment platforms.

 

The main downside is that you would be limited to Vanguard funds, which might not be a problem for most people, but avid investors often want more exotic investments. Most notably you can’t invest directly in stocks or in commodities like Gold through Vanguard. Nor can you make sector specific investments.

 

Recently we did a video and a post on the gaming industry here and mentioned the VanEck Gaming ETF. This would be unavailable on this platform along with thousands of investments from other fund providers.

 

Vanguard state that you can invest from as little as £100 per month or add a lump sum from £500 but in our experience, you don’t need to commit to any regular payment.

 

A lot of younger investors might be disappointed to hear that there is no mobile app but as investing through Vanguard is intended for long term investing, there really is no need to continually monitor it.

 

Alternative Platforms

A lot of people new to investing often think they can only buy Vanguard investments directly through Vanguard’s own platform, which is not the case. You will be able to buy Vanguard funds and ETFs through any good investment platform.

 

In fact, Vanguard strangely limit the range on their own platform, so you can only get the full range by using an alternative. Andy (MU Co-Founder) personally uses Interactive Investor, which you can join here.

 

But the cheapest place to buy Vanguard ETFs are on free trading platforms like Freetrade, as the funds themselves cost the same, but without any platform fee. Vanguard’s platform fee is 0.15% – Freetrade’s is 0%.

 

Open an account with Freetrade through the link on MoneyUnshackled.com’s Offers page, and Freetrade will award you with a free stock worth up to £200!

 

Wrap Up

Some important takeaways:

 

  • The regional funds/ETFs from Vanguard are incredible but probably won’t cover all your needs. There are no sector-specific ETFs, no commodities, nor any REITs. iShares, SPDR, Invesco and a few others are all great ETF providers. As long as you aren’t using Vanguard’s own platform you will be able to pick and choose what you like from these.

 

  • Most or maybe even all of Vanguard’s funds are domiciled in Ireland. As a UK investor this is generally what you want as it takes advantage of Irish tax benefits.

 

  • Depending on how big your portfolio is, it might be preferable to invest across multiple fund providers. The level of the financial protection from the regulators is not clear for foreign domiciled funds. There are protections in place but being spread across multiple ETF providers will give you added comfort in case the worst was to happen.

 

  • When investing in index funds and ETFs, their ability to track the index is clearly very important. The good news is Vanguard are up there with the best as demonstrated here with their FTSE 250 ETF, which closely hugs the returns of the index year after year.

 

Finally, an interesting closing point is that Vanguard the company is owned by the funds and is therefore owned by its customers. This is said to be a key reason why they can continually keep lowering costs. Most other investment firms have to strike a balance between pleasing both the customers and the shareholders – for Vanguard, they are one and the same.

 

What do you think of Vanguard? Would you use their platform or does lack of funds put you off? Let us know in the comments section.

 

 

 

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Were We Wrong About Bonds?

We’ve said time and again that bonds suck as an investment, and instead have chosen to put the bulk of our respective investment pots into the stock market. With the benefit of hindsight was this a bad idea?

 

We all know that Covid has ravaged stock market investments this year – which have then recovered – and the stock market has since been waiting patiently for more news before it decides what it does next. Meanwhile this year, bond markets have received attention for a strong performance in tough times.

 

If you’re anything like us, you too have probably been ignoring bonds and may be wondering whether you should add some to your portfolio.

 

So, today we’re going to look at bonds – what they are, what we’ve said in the past, a look at their recent performance, reasons why you might want to invest in bonds, how you can invest, and finish off with our latest opinions.

 

What Is A Bond?

Bonds are a popular choice among income-seeking investors and those that want to temper the volatility of the stock market.

 

Companies and governments can raise money by issuing bonds, which are essentially “IOUs”. You lend your money, and at the end of the agreed period you should receive your money back along with regular interest.

 

Companies can use the money to fund projects, pay-down other debts and make acquisitions, while governments will use the money for public spending, on such things as new roads, education, the NHS and so on.

 

We think it’s fair to say that bonds are perceived to be more difficult to understand than shares. There are several factors that all impact on a bond’s return such as inflation, interest rates, the economy and ratings agencies.

 

Bonds also don’t make particularly interesting news stories, so are covered far, far less in the media. Microsoft launching a new Xbox console, or Disney launching a new streaming service are vastly more interesting stories than bond yields falling by a fraction of a percent.

 

If something is boring, then nobody will read about it and so naturally will be less well understood.

 

Bonds 101

We’re not going to drone on about the intricacies of bonds but let’s quickly run through the need-to-know aspects:

  • When bond prices rise, their yields fall, and vice versa

  • Unlike dividends on shares, the bond issuer is obliged to pay the interest coupon, so income is predictable

  • When central bank interest rates rise, bond prices tend to fall, and vice versa.

  • Corporate bonds rank higher in the pecking order than shares if a company goes bust. Therefore, bondholders should receive some or maybe all of their money back.

  • Government bonds issued by some countries such as the US and the UK are seen as “risk-free”, in that the chances of these major economies defaulting are extremely minimal.

What We Previously Said About Bonds

Long-time viewers of this channel will know that we rarely ever mention bonds, and the few times we have we have been critical of their abysmal yields and rock-bottom returns.

 

Although bonds would likely give us lower portfolio volatility, we have said we would rather risk our money in the stock market than accept pitiful bond returns.

 

Prior to the Covid pandemic, UK interest rates were 0.75% and widely believed to be as low as they could possibly go. Therefore, it was reasonable to assume that bonds would only fall in price as global central bank interest rates were slowly increased over time.

 

We now know that things have panned out quite differently, but how has this impacted bond returns, and how does this compare to a reasonable alternative stock market investment?

 

How Have Bonds Performed?

The performance of bonds has not been a straight line in 2020. Prior to the pandemic, bonds underperformed. During the beginning of the pandemic when panic ensued, bonds outperformed hugely; and then there was the pandemic recovery, which saw bonds underperform again.

 

With trillions of dollars of quantitative easing, government intervention and fear in the markets, money has been pouring into safe havens such as bonds. According to a Morningstar survey of UK fund flows, bond funds received £872 million of net new money in August alone.

 

Here we can see the annual returns of bonds and how it compares to a global stocks fund:

We can use the Vanguard Global Bond Index Fund as a way of measuring bond performance overall, which is a particularly good representation as it holds almost 13,000 bonds and manages £5.7bn of assets. The Vanguard FTSE All-World ETF is a good representation of world stocks.

 

2020 looked like it was going to be awful year for stocks but is on track to finish in positive territory. Bonds are set to beat it however, with returns of 4.67% ytd.

 

The table clearly shows that bonds are less volatile over the years but if you had been pre-empting a stock market crash in 2013, 2016, 2017 or 2019 and took harbour in bonds you would have missed huge stock market gains.

 

This relatively small time frame echoes what we know about long term equity returns, which is it is better to ride the waves of volatility in the stock market if you have time to recover from any potential crash.

 

If you need less volatility, then bonds do seem to fit the bill but at the expense of total returns.

 

Why You Might Still Want Bonds In Your Portfolio

#1- Volatility Could Return

Covid is far from over and heading into winter it could get far worse. The huge levels of global government stimulus could be running out of steam, which could cause a sell-off in stocks.

 

There is also a looming US election, and in the UK, there is Brexit to deal with, which seems to be forgotten news right now but is likely to come back with a bang.

 

#2 – Don’t Rule Out Negative Rates

Economies are stagnating and central banks may have no choice but to move onto negative interest rates. This will lead to higher bond prices. More on this later.

 

#3 – Too Much Risk Is Priced In

Some analysts believe that fear of corporate defaults has been overdone and there is room for price increases.

 

The global head of fixed income at Fidelity said, “Many companies will have strong enough balance sheets to survive another six months of local lockdowns.”

 

#4 – Portfolios Need To Be Balanced

2020 has reminded investors why a balanced approach to portfolios is necessary. When dividends are cut and income dries up, bonds can provide much needed income.

 

Also, insurance and pension companies cannot only hold riskier investments because their customers cannot have their retirement funds wiped out. To preserve capital, these companies have no choice but to stick with bonds even knowing it will be a terrible investment for returns.

 

How To Invest In Bonds?

Most retail investors in the UK don’t invest directly in bonds and in fact not many investment platforms will even offer this service. It is still possible to buy individual government and corporate bonds, but we see little reason why anybody would want to do this.

 

Most UK investors will opt for bond funds over direct investing and this is how we would do it. Like funds that invest in stocks, you will have the choice of actively managed funds or passive funds.

 

Actively managed funds cost significantly more and according to Morningstar, “The typical active fixed-income fund manager struggles to beat the fund’s benchmark after fees.” Armed with this knowledge and what we already know about the importance of keeping fees to a minimum, we personally wouldn’t invest in actively managed bond funds.

 

Based on a list in The Investors Chronicle of top bond funds we noted that cost does vary quite substantially but the average seems to be in the range of 0.5% to 0.8%, which is far too high in our view considering the historical returns on bonds are generally quite low.

 

We don’t plan to end the debate between passive and active investing in this video and we’ll leave this for another time, but there is an argument that high-yield ETFs typically avoid smaller bonds for liquidity reasons. Therefore, active managers have numerous opportunities to add value by investing in smaller, less-liquid bonds that offer higher compensation for that illiquidity.

 

Vanguard along with many other index fund providers offer very competitively priced passive bond funds starting from as low as 0.07%, with most costing around 0.12%, which is significantly cheaper than the active alternatives. Other cheap bond fund providers include iShares, Invesco and SPDR, among many others.

 

You’ll be able to buy bond funds and ETFs through any decent investment platform. Freetrade have a ton of bond ETFs available and if you sign up via our link, you’ll bag yourself a free share worth up to £200. You have to go through our link to get the free share and this can be found on the Money Unshackled Offers page here.

 

Why We’re Still Not Investing In Bonds

Yields have been nothing less than a joke in recent years, and since the pandemic they have collapsed even further. Bonds are very expensive and are now often guaranteeing a loss if you hold them to redemption.

 

An investment manager speaking to the Investors Chronicle said – and we paraphrase – they now only use bonds to manage volatility in broadly diversified portfolios, instead of as a source of predictable return.

 

With hindsight, the time to hold bonds was 2020 but this ship has now sailed. But if we had the gift to foresee economic catastrophes, we would also know which stocks would benefit, and these would provide far greater returns than any bond. So with this in mind, a good stock picker would do better picking stocks than panicking and taking shelter with bonds.

 

Having said this, there is still a high probability that central banks such as the Bank of England will resort to negative interest rates sooner or later. This would likely push bond prices upwards, so you could benefit in the short term if you know when to take profits.

 

Some of you might be wondering why we’re not buying bonds if we think the bank base rate is going negative. Quite simply, we both believe that no matter what interest rates are, stocks will always find a way to provide stronger positive returns eventually.

 

We wouldn’t want to miss a bull run in the stock market by trying to time the bond market.

 

If we were investing in bonds, we would be doing so as part of a long-term strategy. As we’re only in our early 30’s we feel that it’s better to risk our money in equities than to settle for likely low returns from bonds.

 

Also, according to Andy (MU Co-founder), he has speculated enough on interest rates by choosing a tracker mortgage on his main home. If rates do fall, he will get the benefit there, and likewise if they rise he will feel the sting.

 

Alternative Interest-Bearing Assets

We do invest a small allocation of around 10% of our portfolios in P2P Lending for regular income, which in many ways is similar to corporate bonds but without fluctuating capital values.

 

Most of the major P2P platforms have temporarily stopped making new loans using retail money and instead are making loans solely using government funds such as the Coronavirus Business Interruption Loans Scheme.  If you are an existing lender you should still hopefully be receiving regular repayments, which far surpass the yield on bonds.

 

Loanpad, which is one of the few platforms still lending new money will be paying 4.0% interest – currently at 4.5%. Ben (MU Co-founder) personally uses Loanpad himself and has been very impressed with how they have handled the Covid situation.

 

In addition to the decent interest on Loanpad, new investors who use the link on the Money Unshackled Offers page will get a £50 bonus if they invest at least £5,000.

 

Do you invest in bonds, and if not, why not? Let us know in the comments section.

Should You Jump Aboard the Clean-Energy Stocks Bull Run?

Clean Energy stocks are well into an established bull market run.

 

It’s a sector with serious momentum behind it: when we recently looked into the most popular funds amongst UK investors, a fund containing only clean energy stocks was in at number 3, wildly ahead of all other industry specific funds, and even ahead of general US S&P 500 funds.

 

Even if you don’t really care about all that green stuff, and just want your portfolio to make you some serious flipping moolah – then clean energy is looking more and more each day like it should be a part of your portfolio too.

 

There are sound reasons to believe that the momentum behind this sector is a long way from over yet, with many wind and solar energy companies very much still at the initial stages of the technology’s potential.

 

And with Western governments lining up behind clean energy and throwing everything but the kitchen sink at it from their taxpayer’s money, you’d be swimming with the tide by allowing your money to tag along for the ride.

 

Should you jump aboard the clean energy bull run? And which stocks have the best outlook? Let’s check it out!

 

Offer time: Free-trading investment platform Stake are giving away a free US stock worth up to $100, to everyone who signs up via the link on the Money Unshackled Offers page. Stake has a huge range of over 3,800 Stocks and ETFs – including the clean energy stocks mentioned in this video!

 

The New Energy

Investors used to get their energy fix from a cup of Texas Tea, but now oil is falling out of favour.

 

The smart money is assumed to be in clean energy, but so few companies are self-sufficient – is it all good feelings and ideology?

 

The overtly dominant position of governments in the West is that clean energy is a good thing, and are very pro subsidising it until it reaches an advanced enough stage to survive in the open market.

 

Only Trump’s America remained opposed.

 

Wind and solar power are assumed to provide unlimited cheap energy, but they are in fact very capital intensive.

 

To make much energy, you need to litter the countryside in very expensive tech; compared to gas power stations, which already exist and for which the gas burned is very cheap to source.

 

The question of whether cost effectiveness takes another 10 years, or 100 years, or never, seems to be largely irrelevant – governments are committed to transitioning away from fossil fuels.

 

Investing For Fundamentals

Don’t worry – we’re not about to suggest you should invest your money based only on what is popular with world leaders at Davos – although it often does help to go with the flow.

 

We also demand good fundamentals from our investments. But when researching the industry, we were reminded how just so few clean energy stocks have sound fundamentals!

 

They’re mostly either loss making, or are propping up revenue by taking on an absolute tonne of debt to buy their assets with.

 

Loss Making Debt Guzzlers

Although clean energy companies are likely to continue receiving a tonne of subsidies over the next decade or so, we like our assets to be productive under their own steam.

 

You can keep a coma victim alive for years on a life-support machine, but remove the machine and they’re done for.

 

Our investments need to be able to stand on their own two feet.

 

The many green stocks which are loss making and heavily indebted, and yet are still valued at billions of dollars, are most at risk of being caught out if subsidies were to dry up.

 

With that in mind, we want to pick stocks with a proven track record. And with clean energy, there is a strong argument to invest at stock level, rather than through an ETF.

 

Back in the early 20th century the invention of the car looked set to change the world too, and it did. But there were more loser stocks in the car industry than winners.

 

Using popular iShares Clean Energy ETF (INRG) as an example, the sector average PE ratio is very high at 32 – probably because so many of the component stocks don’t make any earnings!

 

There are a lot of shaky looking companies in the industry which will get caught up in an ETF.

 

Top Clean Energy Stocks

#1 – Renewable Energy Group (REGI)

In our view, this stock looks the best of the bunch in terms of fundamentals, and (MU co-founder) Ben has just added it to his portfolio. This $2.2bn company has a PE ratio of just 5 – it’s dirt cheap, in fact it’s the second cheapest US listed clean energy stock.

 

On popular stock picking analysis site Stockopedia, it qualifies for 6 screens, which is high praise indeed – a decent stock might normally qualify for 1 or 2.

 

This is saying that 6 tried and tested stock picking methodologies would choose this stock above others – for comparison, this is 1 of only 13 US stocks out of 10,000 to appear on at least 6 screens.

 

So what does it do? REG is a producer of biofuels, which are used mainly to power industrial vehicles like lorry fleets.

 

Asking America to replace its entire fleet of lorries with Tesla trucks would likely bankrupt most businesses.

 

However, just switching the fuel of lorries to a compatible diesel made from plants is a significantly cheaper, easier and therefore a more realistic and likely green solution.

 

Going back to the financials, revenue – which ultimately drives profits – was climbing strongly every year to 2019, but projections for the next 2 years are lower.

 

This is understood to be coronavirus related, with a current reduction in travel of all kinds lowering the demand for fuel.

 

It scores well for overall financial health, but Stockopedia was throwing up a warning on the potential accuracy of the accounts, telling us we should look into this further.

 

On closer inspection, it was because they have a big chunk of profits that exist on paper only, not yet received as cash – but this is normal practise in the sector, and that money is guaranteed.

 

It’s from REG’s main subsidy, a tax credit resulting in around a $1.25bn windfall of government cash, which is recorded in earnings but just hasn’t yet been physically paid by the government. So not a problem.

 

Its liquidity is fantastic, and unlike most of the industry, this green stock has no net debt – instead, it’s sat on a couple hundred million dollars of net cash!

 

The downside? There is no dividend.

 

So you’d be buying this stock solely for expected capital growth in an evolving energy landscape.

 

#2 – Wind Energy

In the US, the Democrats would cover the countryside in wind turbines and solar panels if they were in power, with 500 million new solar panels and 60,000 new wind turbines wanted by 2025.

 

If Joe Biden wins in November 2020, expect this to be the immediate plan. If it’s a Trump win, then the plan simply gets delayed by 4 years. But a splurge on wind power is sure to happen sooner or later, and as investors we intend to be ready.

 

The obvious big boy of the scene is NextEra (NEE) Energy, a $150bn goliath in the wind industry.

 

But its forward looking PE ratio is 125, which makes it ridiculous as an investment, just shy of being the most expensive stock in America.

 

Also, its net debt is through the roof at $45bn dollars, around 10x its expected 2020 profits.

 

Broadwind (BWEN) though is a pretty good dark horse in the race, which produces parts for wind turbines. First, it is a small cap stock at just $75m, tiny compared to NextEra, and so has loads of room for growth.

 

It hasn’t turned a profit recently – but on further digging it is expected to start turning a profit from this year. That would give a PE ratio of around 13 – not bad at all.

 

It doesn’t pay a dividend, which is normal for a stock this small still very much in growth-mode.

 

And its debt is high at $23m – but if profits hit $7m by 2021 as expected, this would be just a 3x debt ratio. Acceptable by any standard.

 

#3 – Silver

Until recently, all silver was good for was sitting in a vault and looking impressively valuable.

 

But now silver has a significant industrial application – not only is it used heavily in the production of electric cars, it is also essential in the production of PhotoVoltaic cells, the building blocks of solar panels.

 

As we’ve just said, when the Democrats are next in power the plan is to build 500 million new solar panels, each one built using silver.

 

The 2020 election aside, over the next couple of decades we’re sure to reach a position from one government or another where solar panels get built in bulk in the deserts and open plains of mid-USA.

 

And when that happens, silver’s price will surely skyrocket.

 

You can invest in physical silver through an ETF, or you can invest in a silver mining stock. The benefit of investing in a commodity producer is that you can get paid dividends – and cash is king.

 

Pan American Silver (PAAS) is a Canadian headquartered stock traded on the Nasdaq which operates out of silver mines in North and Central America.

 

The company has strong revenue growth which hasn’t always translated into strong profits, but its profit projections look promising.

 

Essentially though, the share price of this stock tracks more or less to the silver price – but with a dividend thrown in for good measure.

 

What Happened To Oil?

Oil enthusiasts can take solace that while high PE ratios run riot in the clean energy sector, dirty energy stocks can be snapped up for next to nothing.

 

This is reflected in the current rock bottom oil price, and in the ridiculously low share prices of oil stocks.

 

Exxon Mobil (XOM) has a balance sheet of net assets worth $192bn, but its shares are priced at a market cap of only $144bn.

 

Don’t underestimate Big Oil – they have seen the writing on the wall, and Exxon alone invests $1bn a year into R&D science for new energy technologies.

 

The oil companies that we think of as “dirty energy” today might be the leading hydrogen or fusion energy producers in 20 years’ time. If they don’t invent the winning formula, they’ll buy the company that does!

 

Which energy companies are in your portfolio? Let us know in the comments below!

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iShares Introduces Game Changing TAX-FREE Synthetic S&P 500 ETF

iShares have just launched a new ETF – and we think it could be a game changer.

 

Some of you will know that certain greedy governments around the world deduct a percentage from dividends known as a withholding tax.

 

Up until now we believed this nasty tax was mostly unavoidable, but we’re now delighted to say we have a solution!

 

iShares have just launched a synthetic replicated S&P 500 ETF costing just 0.07%. It’s called iShares S&P 500 SWAP ETF, ticker I500. On the face of it that doesn’t sound too impressive but bear with us while we explain why this changes everything.

 

This ETF should significantly outperform any physical S&P 500 ETF that you likely hold in your portfolio!

 

Don’t worry if you have no idea what this means as we’ll cover everything you need to know in this article, but you definitely don’t want to miss this as we think this knowledge could save you over £200,000 over a lifetime! This is no exaggeration, and we’ll show you how we calculated this soon.

 

iShares are not the first to launch this type of fund but their involvement in synthetic ETFs lends much needed credibility to this ETF replication structure.

 

In fact, there are plenty of synthetic ETFs available on the London Stock Exchange, but this new launch has led us to reassess everything we thought we once knew about ETFs and investing.

 

We believe this entire facet of investing is misunderstood or in many cases, people are completely oblivious to it because the major players, iShares and Vanguard, were overlooking it.

 

In this article we’re going to look at dividend withholding tax, what a synthetic ETF is, their advantages including how they can boost investment returns, and any associated risks.

 

We will of course finish with what action we’re taking as a result of this.

 

Where We Look For Synthetic ETFs

Synthetic ETFs are more specialised investment products, which may not always be available on the free trading apps.

 

Andy (MU co-founder) personally uses Interactive Investor^, which has amongst the widest range of available investments and there you will be sure to find every London listed ETF you can think of.

 

Dividend Withholding Tax

This tax is one of our most despised because it is often taken without the recipient of the dividend even knowing. Investing in an ISA, which are often paraded as tax free havens will not help you when it comes to dividend withholding tax. ISAs only spare you from the big UK investment taxes.

 

Withholding tax is a tax levied by an overseas government on dividends or income received by non-residents. For example, the US Government charges non-US residents’ withholding tax of 30% on any income received from US investments.

 

Many countries will charge exorbitant withholding taxes and finding the rates by country is not easy.

 

Investors should be wary of this horrid tax and in some cases may want to actively avoid investing in certain countries.

 

UK investors can reduce US withholding tax to 15% by completing the relevant form, and Irish domiciled ETFs have a tax treaty with the US to also pay 15%.

 

Truthfully, let us know down in the comments whether you knew that foreign countries were deducting tax from your dividends. We’d like to see just how well understood this deceptive practice really is.

 

Synthetic ETFs: Previous Misinformed Beliefs

Firstly, let us tell you what our misinformed beliefs were as we suspect that almost everyone has the same perception. We think that most people will either:

 

  1. a) Not even know what a synthetic ETF is, or;
  2. b) Know they use complex derivatives to achieve the returns of an index and therefore think they are very risky.

 

There is a belief that there is little reason to use a synthetic ETF because of the risk when there are similar physical ETFs that will achieve the same returns.

 

We were part of the latter group and when there were alternative physical ETFs, we pretty much had written off synthetic ETFs as unnecessary.

 

This is understandable when you look at past performance tables and see that physical ETFs are often achieving or even bettering the benchmark returns.

 

Take Vanguard’s S&P 500 ETF, ticker VUSA. This is a market leading ETF with over $26 billion of assets under management and is a personal favourite of ours.

 

When we looked at the annual NAV total returns, it beat the benchmark every year, which is remarkable. We’re always told that ETFs can’t beat the market, but we know loads that do (at least against reported benchmarks).

 

Up until now, we believed that the ETFs we were investing in were performing to our expectations by tracking their indexes closely.

 

The Truth About Past Performance

It turns out that despite ETF providers stating that they’re tracking a certain index, the reality is usually very different and hidden away in the small print that only an eagle-eyed investor would ever spot.

 

Collectively we have over a couple of decades of investing experience and we will admit that we have only just learned the truth about the benchmarks as we’ve all been misled.

 

We’re using Vanguard to demonstrate this but the same applies to all the ETF providers that we’ve looked at. Vanguard clearly state that the objective of the fund is to track the performance of the Standard and Poor’s 500 Index.

 

Based on this deception it is reasonable to assume that all the benchmark figures are those of the S&P 500.

 

But the real benchmark turns out to not be the S&P 500 that we are familiar with. We were always under the impression that it was the Total Return of the S&P 500 including reinvested dividends without thieving taxes. How wrong were we?

 

The reality is that it is the Net Total Return, meaning it has had withholding tax deducted. According to S&P Dow Jones Indices, multiple versions of the S&P 500 index are produced:

 

  • the Price Return, which we all know;
  • the Total Return, which includes dividends, and;
  • the Net Total Return, which includes dividends but deducts withholding tax.

 

When evaluating our investments, we don’t want to see performance benchmarked against a figure that has had a sneaky tax deducted because a smart investor can often minimise tax if they at least know about it – like what we’re about to do by using synthetic ETFs.

 

What we’d prefer to see is the real total return of the S&P benchmark and a column inserted showing the bridge between the actual return and the benchmark performance. The difference being explained by the withholding tax taken.

 

The difference between the Total Return and Net Total Return on the S&P 500 is quite shocking. On a 10-year annualised basis it is 0.70% – which translates into a huge cost over the years.

 

People split hairs over the odd 0.01% when comparing investment platforms and fund ongoing charges, but are being completely hoodwinked when it comes to ETF benchmark performance.

 

What Are Synthetic and Physical ETFs

Synthetic ETFs provide exposure to an index by entering into a swap agreement with a counterparty, usually an investment bank, to receive the performance of the index.

 

In other words, they use complex financial derivatives to financially engineer the same return.

 

Conversely, a physical ETF achieves the return of an index by physically holding the underlying index securities. So, a physical S&P 500 ETF will literally hold shares in the companies that make up the index such as Amazon, Apple, Pepsi, Walmart and so on.

 

Pros of Synthetic ETFs

One advantage of synthetic ETFs is that they typically offer a lower tracking error compared to their physically replicated counterparts – although tracking errors are not usually an issue for investments in very liquid stocks found in the S&P 500.

 

But one of the main benefits of synthetic ETFs is their tax advantages.

 

As synthetic ETFs do not actually own the underlying securities, they are not liable for withholding tax, leading to an immediate performance enhancement.

 

The S&P 500 typically pays a dividend yield in the region of 2%. But as 15% of this is instantly lost to the US tax man, this means UK investors are hit with a drag on performance of 30 basis points every year, making your dividend returns around 1.7% instead of 2.0%.

 

This government theft not only exceeds the ongoing cost of the ETF many times over but has a huge negative impact when compounded over the years.

 

£200,000 Boost To Your Wealth

Earlier we said that this new iShares ETF and ones like it could boost your wealth by over £200k and it’s all because of that seemingly tiny 0.30% performance boost from not having to pay withholding tax. Here’s how.

 

We will assume you have an existing investing pot of £30,000, you will add £500 to it monthly, and invest for 40 years, earning 7.7%. This is what we expect the S&P 500 might return yearly after the deduction of the withholding tax. This will give you a final pot of £2.079m.

 

By using a SWAP ETF instead and therefore not paying the withholding tax you would earn 8% annually on average. In this scenario you would have a final pot of £2.273m. That’s an enormous difference of £194k.

 

We’ve even been conservative with those numbers as many investors will be stashing away much more than £500 per month.

 

How Risky Are Synthetic ETFs?

The main risk that comes from Synthetic ETFs is counterparty risk. Counterparty risk is the chance that the swap provider goes belly up and fails to meet their obligations.

 

An investment bank failing might seem unlikely, but it does happen. Let’s not forget the collapse of the seemingly indestructible giant, Lehman Brothers in 2008.

 

According to ETFStrategy.com, the popularity of the synthetic structure declined sharply following the global financial crisis due to concerns over counterparty and liquidity risks.

 

Counterparty risk can be somewhat reduced by using multiple counterparties and this is what iShares have done, with JP Morgan and Citi both being used, with more to be added as the ETF grows.

 

UCITS ETFs, which this is one, restrict an ETF’s exposure to any counterparty to a maximum of 10% of its Net Asset Value.

 

The other 90% of the ETF’s value should be covered by collateral held on its behalf, that would be sold to reimburse investors in the event of a default. FYI, synthetic ETFs generally physically invest in a basket of unrelated assets that act as collateral.

 

In the case of the iShares ETF, collateral will consist solely of non-dividend paying S&P 500 equities, so further reduces the risk as these should be high quality stocks.

 

What Action Are We Taking?

We’ve still got a lot of researching to do but it seems that our original dismissal of synthetic ETFs was misplaced. Our final thoughts:

 

  • Some physical ETFs such as Vanguard’s S&P 500 do consistently beat their index. If this is commonplace, perhaps there is still no need to use a synthetic ETF. We suspect the reason they can do this is partly because apples are being compared with pears, with different tax treatments applied to the physical ETF performance than to the benchmark.

 

  • The existing SWAP based ETFs tracking the S&P 500, such as one from Invesco and the new iShares version, claim to be tracking the S&P 500 Net Total Return index as well, just as a physical ETF would. This doesn’t make any sense based on the fact they don’t pay withholding tax and all our research supports everything we’ve told you above. We’ve reached out to iShares to confirm this and we will let you know in the comments section when they get back to us.

 

Once all the facts are fully nailed down, we will be looking at supplementing our world ETF portfolio with synthetic ETFs!

 

Do you invest in synthetic ETFs and what are your thoughts on returns and risk? Let us know in the comments section.

 

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