Disclaimer: I'm not a financial adviser and this is NOT a financial advice (might not even be right). So don't consider it as a financial advise for any of your financial decisions.
This is Part 2. For part 1, go here: http://zombieprojects.weebly.com/blog/non-speculative-portfolio-part-1-introduction-and-objective
1. What to buy: shares and bonds vs mutual funds (vs ETF)
My conclusion is that when you're starting with investment, mutual funds are a no-brainer. The main reasons are:
2. What sub-type should you buy?
Having concluded that mutual funds are the way to go, which ones should I buy? Well, according to Lars, the cheapest ones. This is an important point because as Graham's book mentions, there has been studies demonstrating that expensive funds tends to have worst performance than cheaper ones. Lars has a pretty good explanation of the best instruments to buy in relation to what you get out of them, risk and other aspects. It boils down to 4 sub-classes of funds:
Each one of these instruments has a different risk associated with it and the yield should move together with this risk. I think, the mix makes sense because your diversification will be absolute. This is probably the best way to protect you from market fluctuations. The key is the percentage in each one of them which is what I'll discuss in the next chapter.
When choosing bonds, Graham's also raises the question of whether you should be going for taxable or tax-free bonds but it doesn't really applies to the alternatives of funds I've seen so far -this might change in the future-. Also, when the inflation is at a low price like now (2015 UK-US), you want to go for inflation linked bonds that will not loose value when the inflation goes up (in the case of government bonds). In order to fight a rise in the interest rate, short term bonds are ideal [interest rate and inflation going up will mean that bonds price go down. Here in the UK the interest rate is mainly used to control inflation so they are quite correlated].
There is more to be said about inflation-linked bonds from a stable governments but Lars conclude that they are the most secure investment you can find. Because of this very low risk, you expect to earn very little out of them. For example at the moment they have a yield of zero. Non-inflation linked bonds give a bit more, so perhaps you want to go for a mixture of both.
Finding a short-term only inflation linked government bond mutual fund would be ideal, but as I'll describe in the implementation section, it isn't always possible.
Finally, using a tax-efficient wrapper such as a (N)ISA -or whatever similar depending where you’re- is probably the best idea -but you need to bare in mind the platform costs-.
Stay tuned for the next article
This is Part 2. For part 1, go here: http://zombieprojects.weebly.com/blog/non-speculative-portfolio-part-1-introduction-and-objective
1. What to buy: shares and bonds vs mutual funds (vs ETF)
My conclusion is that when you're starting with investment, mutual funds are a no-brainer. The main reasons are:
- They are cheap [this is something that Lars discusses in depth. For an investment to beat a cheap mutual fund is has to do really good. Graham also mentions it saying that it is easy to get the same results as the market but doing better is a lot more difficult.]
- They provide -very importantly- good diversification out of the box and they require a lot less research work. Ase mentioned before, Graham and Lars agree hammer this point several times.
- They keep your instruments up-to-date. Let's say for example you want to keep a certain bond maturity a good mutual fund will do this in your behalf [rather than having to be constantly buying and selling new bonds as they mature].
2. What sub-type should you buy?
Having concluded that mutual funds are the way to go, which ones should I buy? Well, according to Lars, the cheapest ones. This is an important point because as Graham's book mentions, there has been studies demonstrating that expensive funds tends to have worst performance than cheaper ones. Lars has a pretty good explanation of the best instruments to buy in relation to what you get out of them, risk and other aspects. It boils down to 4 sub-classes of funds:
- high quality government bonds,
- worldwide corporate bonds,
- worldwide shares in the form of trackers and
- risky (sub-AA) government bonds.
Each one of these instruments has a different risk associated with it and the yield should move together with this risk. I think, the mix makes sense because your diversification will be absolute. This is probably the best way to protect you from market fluctuations. The key is the percentage in each one of them which is what I'll discuss in the next chapter.
When choosing bonds, Graham's also raises the question of whether you should be going for taxable or tax-free bonds but it doesn't really applies to the alternatives of funds I've seen so far -this might change in the future-. Also, when the inflation is at a low price like now (2015 UK-US), you want to go for inflation linked bonds that will not loose value when the inflation goes up (in the case of government bonds). In order to fight a rise in the interest rate, short term bonds are ideal [interest rate and inflation going up will mean that bonds price go down. Here in the UK the interest rate is mainly used to control inflation so they are quite correlated].
There is more to be said about inflation-linked bonds from a stable governments but Lars conclude that they are the most secure investment you can find. Because of this very low risk, you expect to earn very little out of them. For example at the moment they have a yield of zero. Non-inflation linked bonds give a bit more, so perhaps you want to go for a mixture of both.
Finding a short-term only inflation linked government bond mutual fund would be ideal, but as I'll describe in the implementation section, it isn't always possible.
Finally, using a tax-efficient wrapper such as a (N)ISA -or whatever similar depending where you’re- is probably the best idea -but you need to bare in mind the platform costs-.
Stay tuned for the next article